Muddy Waters Shorts Top China Dairy Farm as Shares Halted

Shares of China’s largest dairy farm operator, Hong-Kong listed China Huishan Dairy Holdings Co., were suspended Friday after short seller Carson Block’s Muddy Waters Capital LLC said the company is “worth close to zero” and questioned its profitability in a report.

Huishan shares slid as much as 4.3 percent to HK$2.69 on Friday, the lowest in 15 months, before being suspended in Hong Kong, which the Shenyang-based company said was pending a clarification announcement on the report. Huishan’s market value post-suspension is HK$37.1 billion ($4.8 billion).

Muddy Waters alleged that Huishan had been overstating its spending on its cow farms by as much as 1.6 billion yuan to “support the company’s income statement." The report also alleged that the company made an unannounced transfer of a subsidiary that owned at least four cow farms to an undisclosed related party and Muddy Waters concluded that Chairman Yang Kai controls the subsidiary and farms.

Those findings came from several months of research including visits to 35 farms and five production facilities, drone flyovers of Huishan sites and interviews with alfalfa suppliers, according to the report. Muddy Waters said it has shorted Huishan’s stock.

“It will be even harder for Huishan to get funded in the capital market after the report, amid a couple of earlier allegations that have raised some red flags to investors,” said Robin Yuen, an analyst at RHB OSK Securities Hong Kong Ltd. Still, Huishan’s shares and operations are unlikely to “collapse” due to its high share concentration and sufficient cash flow generated by its dairy business, he said by telephone.

A two-year slump in whole milk prices, which bottomed out in August last year, has put pressure on the dairy industry from New Zealand to China. On Thursday, China’s second-largest dairy company China Mengniu Dairy Co. issued a profit warning, saying that it expected to record a substantial loss for 2016 due in part to selling excessive raw milk powder supply at market price, thus suffering a loss.

About 73 percent of Huishan’s shares are held by Champ Harvest Ltd., a company that’s in turn 90-percent owned by Yang.

Bearish bets on China Huishan have been creeping up since May, with short interest in the company amounting to about 20 percent of the company’s free float, or trade-able shares. While that’s down from a record 31 percent in August last year, it’s still the biggest proportion among Hong Kong-listed stocks after United Laboratories International Holdings Ltd., according to data compiled by IHS Markit Ltd. and Bloomberg.

Huishan shares had been falling in the second half, sliding 13 percent, while its competitor China Modern Dairy Holdings Ltd. surged over the period amid rising confidence in the industry and amid speculation milk prices will recover.

Buying Spree

A buying spree by Yang had supported the shares last year, making it a painful trade for short sellers. A one-year rally of about 80 percent through a peak in June had made the shares expensive.

Huishan’s Chief Financial Officer So Wing Hoi said in November last year annual profits will increase over the next few years as Huishan expands outside its core market in north-eastern China and builds a nascent renewable energy business turning cow dung into fuel. There were four sell recommendations and three buy ratings on the stock then -- that has now changed to five sells and no one telling investors to buy, according to ratings tracked by Bloomberg.

To raise capital, the company has entered into agreements allowing it to sell assets including property, equipment and 40,000 cows to leasing companies, and then rent them back.