Chinese wealth management firm Zhongzhi is going under. Zhongzhi was a prominent broker of Wealth Management Products (WMPs). These are uninsured financial products sold to the public, including retail customers and companies. The proceeds of these sales are often invested into property projects, but other asset classes, such as shares and bonds, are also standard. The yields of these asset classes are then passed on to the WMP holder after commission. The WMPs are contracts in themselves and can be bought and sold among the holders.
Alarmed by the news about Zhongzhi, I decided to check whether the Chinese companies in my portfolio invested in WMPs. Indeed, I found references to WMPs in the reporting of Yihai International Holdings Ltd (HKEX:01579), the soup and sauce maker for Haidilao. Yihai's investments in WMPs are significant. It provides very little information on the nature of the WMP contracts and actively trades in and out of WMPs. To show what I mean, here is a snapshot from Yihai's most recent Cash Flows from Investments statement (30 June 2023)
As the notes to the HY 2023 report explain, the financial assets at fair value through profit or loss are WMPs. There is no information on the issuer(s) of the WMPs, the nature of the contracts, the risks or any other details. Yihai bought 442,557,000 RMB worth of WMPs and sold 443,288,000 RMB within the first half-year of 2023. The amount is double the operating cash flows. In HY 2022, a similar trade was almost sevenfold the OCF. This is possible because Yihai has accumulated large amounts of Cash and Cash Equivalents through the years.
Yihai owns the brand names and production rights of the condiments that its sister company, Haidilao, uses in the hot pot restaurant chain it runs. Yihai does not only sell its soup bases and sauces to Haidilao but also directly to the public in branded packages through supermarkets. The sales of these exploded when the Covid lockdowns started. Consumers suddenly had lots of time for home cooking. Many Haidilao regulars wanted to make their beloved hot pot meals at home. When the lockdowns ended, Yihai's sales figures started to dip, and its stock price crashed. I bought the share after this crash because the condiment business will stabilize again. Condiment makers are high-margin businesses and attractive to invest in. Even more so, the share looked cheap.
Let's return to the almost 2 billion RMB cash balance Yihai accumulated. Every financial half year, Yihai spends much of this money to buy into WMPs. Within six months, those are then liquidated back into cash. This cycle starts after 1 January / 1 July. It finishes every time before 30 June and 31 December, which means that Yihai's public reporting will show bank balances instead of WMPs on the balance sheet. It's like continuously driving your car over the speed limit, only to slow down in front of police checkpoints to demonstrate that you are a responsible driver.
Let me be clear that the strange WMP trading does not indicate fraud. On the contrary, the value of a bank balance is easier and more certain to obtain than the value of a WMP product. Yihai accommodates its auditors rather than evading them unless the auditors are in on some kind of scheme and the financial reports do not tell the whole story. Does Yihai try to hide the true nature of the WMPs from its auditors? I don't think so, either. The auditors are aware of the WMPs. We must assume they did at least a basic check on those, even though the WMPs are not held at the reporting dates.
When comparing the disposal value of the WMPs with the purchase value, you calculate a profit of 0.17% resp. 0.86%. First, Let's acknowledge that WMP is a general term in Mainland China. There are different categories of WMPs based on fixed-income, equity, commodity, derivatives, and other asset classes, all with their own risk/reward profiles. WMPs are not, by definition, linked to real estate investments. There is also a wide range of WMP issuers with different degrees of reliability and reputation. The meagre yields that Yihai earned suggest that the WMPs were invested in low-risk assets, for example, government bonds. Why not simply put the money into term deposits with a reputable bank? The whole picture is just weird.
I already sold off my Yihai holding to be on the safe side. The recent news concerning failing WMPs alarmed me. The trading patterns with Yihai's WMPs amplify my concerns. Thirdly, Yihai should disclose the nature of the WMPs in its financial reports, even when WMPs are not held during the reporting date. Uni-President China Holdings Ltd, for example, keeps a small percentage of its cash in WMPs. In the audited portion of its 2022 Annual Report, Uni-President makes clear that it buys its structured notes only from major financial institutions and with focus only on low risk wealth management products (Note 3.3.1). Should Yihai improve its disclosures or stop investing in WMPs, I will consider buying back into the stock.
Disclosure: no position in Yihai International Holdings Ltd or any other company mentioned in the blog at the time of publishing