Shandong Ruyi:As the dust settles down;Upgrade to buy

Shareholding misrepresentation concerns.

    Post the press articles (per Bloomberg) on concerns about Yinchuan Tonglian(Yinchuan city government owned SOE) being 26% stake holder, ShandongRuyi conducted conference calls as well as issued clarification indicating thatYinchuan Tonglian remains the legal owner of 26% stake (per local regulatoryrecords). It also said that recent inquiry has revealed that Yinchuan SASAC hasdesignated Yinchuan Yinxin, another Yinchuan city government owned SOE, asthe successor of Yinchuan Tonglian’s 26% stake in Ruyi. Yinchuan Yinxin isrequired to be a registered holder of such stake in local regulatory records bySep 30, 2017 (not yet completed).

    We do not think that this is misrepresentation especially as another YinchuanSASAC owned entity continues to be a shareholder. We are also not majorlyconcerned on eventual exit by Yinchuan SASAC as it would likely end upselling the stake back to company as part of existing share swap agreement,implying no major cash flow impact. We think Government’s support in formof help in setting up plant and other subsidies & preferential tax policies aremore relevant than RMB2 billion equity investment (which infact seems to beon the back of similar amount of investment by Ruyi in other Yinchuan SOEs).

    That said, we do think that company needs to improve on disclosure standard.

    Third party guarantee.

    Third party cross-guarantee exposure has been another key investor concernespecially in light of recent noise on Yuhuang/Hongye as well as negativearticles in local press on Liangshan Linghua, a subsidiary of Linghua Group forwhich Ruyi has provided cross-guarantee. We understand that such crossguaranteesare common practice as per local banking rules in Shandongprovince. Thus, we will read too much into Liangshan Linghua especially asamount of cross-guarantee involved is small (RMB22million) and has been dulypaid off limiting any obligation for Ruyi. We do highlight that Ruyi’s third-partycross-guarantee is largely concentrated to two Groups - Linghua Group(RMB1.2 billion as of YE16) and Abundant Dragon Group (RMB1.1 billion as ofYE16). Separately, company did mention that it has been trying to reduce theexposure (RMB2.8 billion currently vs. RMB3.4 billion at YE16).

    Bond valuation.

    Ruyi bonds have recovered from the lows though are still 2-2.5 points lowerthan pre shareholder disclosure news levels. Looking within China IndustrialHY space, another Shandong based company, Hongqiao, has 2018s which arecurrently trading at ask ytm of 7% despite its situation being even moreconcerning, in our view. Yingde is another example where disclosure standardhas not been great in past and current privatization may not help the causeeither. Its 2018s & 2020s are currently trading at ask ytm of 6.2% & 7.1%respectively. Comparatively, Ruyi bonds look cheap to us. Thus, we upgrade2019s ($98.5/100.5 ask ytm of 7.2%, ask z-spd of 562bps) and 2022s($91.5/93.5, ask ytm of 8.6%, ask zspd of 671bps) to Buy from Hold.