Beijing-backed mining-to-property conglomerate Citic Pacific has been dealt a major blow by one of the world's leading credit risk assessment agencies.
Standard & Poor's slashed the company's credit rating to junk status yesterday and said it might downgrade the rating further.
The decision to demote Citic Pacific to a B-plus rating, which is one notch below what the agency calls 'investment grade' and incredibly low for a firm backed by the central government, was sparked by Citic's revelation last week that the cost of its Sino Iron iron ore development in Western Australia had ballooned by US$900 million.
The project, which was already slated to cost US$5.3 billion had already suffered cost blowouts and delays. Analysts now say Citic Pacific probably did not understand the risks of its high-stakes foray into mining outside China.
'This is a major greenfield project outside the company's own market. They probably underestimated some of the challenges,' Standard & Poor's Lawrence Lu said. 'We are really not sure whether they can bring the project on stream.'
This is the latest in a pile-up of problems for Citic Pacific. The company is also mired in a Hong Kong fraud investigation into the ill-fated decision it made in autumn 2008 to conceal a HK$15.5 billion derivatives loss for six weeks.
'This is a company that has made a lot of mistakes, and they keep making them,' CLSA analyst Paul Kalogirou, who has a sell rating on Citic Pacific's stock, said.
A Citic Pacific spokesman declined to comment.
The conglomerate's shares tumbled 8 per cent so far this week. The downgrade could make it more expensive for the highly indebted company to borrow the next time it taps the international bond markets. It also makes Citic Pacific one of only two state-backed mainland companies rated below investment grade by S&P. The other is Citic Resources, which has the same parent, Citic Group.
Citic Pacific stunned shareholders back in October 2008 when it admitted racking up the huge loss on an unauthorised, wrong-way bet on the future value of the Australian dollar.
Citic Group provided an HK$11.6 billion bailout the following month.
Former chairman Larry Yung Chi-kin, the son of Deng Xiaopeng's close economic adviser, the late Rong Yiren, resigned in April 2009, just after the Hong Kong police raided Citic Pacific's Hong Kong offices. He was replaced by Citic Group vice-chairman Chang Zhenming.
This March, lawyers for the Department of Justice accused Citic Pacific of defrauding mainland banks by not telling the lenders of the derivatives loss before taking out loans with them.
Citic Pacific also found itself on the end of sharp criticism from Hong Kong legislators last year over controversial land purchases made by Yung just after he resigned.
Yung snapped up five sites in Hainan province close to a major Citic Pacific project in an auction where his old employer appeared to be the only other bidder. This raised questions over whether the firm enabled its former helmsman to claim the land as a parting gift, by neglecting to bid aggressively against him.
The Department of Justice asked Hong Kong police to look into the Hainan land transactions, while Democratic Party lawmaker James To Kun-sun demanded a Securities and Futures Commission inquiry. Neither the police or the securities regulator have announced they are pursuing the matter, on which Yung has never commented publicly.
Last Friday, Citic Pacific said Sino Iron's contractor, state-backed China Metallurgical Group Corporation, needed an extra US$900 million to finish building the mine and surrounding infrastructure.
Back in May last year, Citic Pacific raised Sino Iron's budget by US$835 million. The conglomerate also pushed back the date it expects production to start at Sino Iron from the end of this year to the first half of next year.
S&P's Lu said the reason for the downgrade was that while Citic Pacific had a lot of debt to repay - HK$83 billion at the end of 2010 - its earnings had come under pressure from the cost blowouts at Sino Iron.
Companies are considered below investment grade by ratings agencies if analysts believe they might have problems servicing or repaying their debts.
Moody's, which did not downgrade Citic Pacific's rating yesterday, already rates the conglomerate Ba1, which is a junk rating equivalent to B+ at S&P.
While Citic Pacific is set to spend almost US$6.2 billion building Sino Iron, CLSA, which believes iron ore prices will fall, values the project at just US$3.5 billion.
Sino Iron contains magnetite iron ore, a resource global majors tend to leave in the ground because it can be more than twice as expensive to extract and process than the more popular variety known as haematite. BHP Billiton and Rio Tinto had 'predominantly stayed away from mining magnetite because of the questionable economics', Kalogirou said. 'Citic's plan was always looked upon by the market as fairly ambitious.'
Additional reporting by Denise Tsang
The amount, in US dollars, of the cost blowout at Citic Pacific's Sino Iron project in Western Australia