Trafigura ignores market prices to fabricate profit and hides sizeable losses on its balance sheet

Please refer to the disclaimer below.

Commodity trader Trafigura has accumulated a massive debt of $33b and has recorded a negative operating cash flow of $7.3b since 2016. When they finance Trafigura, banks and bondholders probably derive comfort from the valuation of Trafigura’s assets, more than its cash flows. We found that Trafigura ignores economic reality to aggressively overvalue hundreds of millions in debt securities issued by an associate. In our opinion, the group has fabricated profit via an accounting loophole.

Trafigura owns a stake of 49.5% in Porto Sudeste, an iron ore port in southeast Brazil with the capacity of 50 million tonnes. As an associate, the carrying value is a modest $42m on the balance sheet as of September 2018. Trafigura also holds debt securities of Porto Sudeste with a much more substantial carrying value of $490m. The securities are junior debt repaid through royalties derived from volumes shipped by the port. From Trafigura’s annual report: “The holders of the instrument are entitled to a fixed royalty payment per metric tonne processed by the port and therefore have direct exposure to the business risks of Porto Sudeste.”

Trafigura is substantially at risk on Porto Sudeste but there is one big issue: the auditor of Porto Sudeste (E&Y) has underlined the significant uncertainty of Porto Sudeste’s ability to continue as a going concern. Below the warning issued by the auditor:

auditor porto sudeste

The port has clearly not met expectations. Clients have been missing. The port shipped only 9.5 million tonnes in 2018, i.e. 20% of its capacity. No royalties have been paid as not enough cash was available.

The debt securities are traded and their tickers are FPOR11 and PSVM11, depending on whether the investors are qualified to hold such funds under Brazil’s regulations. Amid the port’s trouble, the price of both debt securities has collapsed since they started trading in 2015. FPOR11 fell by 90% since inception while PSVM11 dropped by 85%.

FPOR11

FPOR11

PSVM11

PSVM11

However, you would not see this drop on Trafigura’s balance sheet. In fact, the carrying value of the debt securities has increased from $428m to $490m in four years and a half.

chart

One might assume that Trafigura acquired more securities, which would explain the increase. On the contrary, Trafigura offloaded $91.7mm FPOR11 securities in 2016.

Trafigura does not disclose how many debt securities the company holds and the ratio of PSVM11/FPOR11. If we assume that Trafigura holds FPOR11 debt securities (the most likely assumption as it is a qualified investor and most of the issued securities are FPOR11), we estimate the market value of Trafigura’s securities at $49m. That means a gap between carrying value and market value of $441m. In our calculation, we conservatively ignored the sale of $91.7m FPOR11 securities in the 2016 fiscal year because Trafigura did not disclose the exact timing of this sale and the price dropped quickly in that period. The valuation gap is very large and we strongly believe that Trafigura should disclose the market value of these securities.

How can Trafigura maintain such a high carrying value for these securities, given the price of these securities has collapsed? Listed debt securities should be marked-to-market, and gains/losses should flow through the income statement. This is what Trafigura used to do until 2015. That year, Trafigura disclosed in the annual report that it had switched from marking-to-market to a level 3 cash flow model to value them. This change in policy happened when prices were falling. The justification for the change in policy at that time is puzzling to the say the least.

level 3

The company claims the market is not liquid enough and has “limited insight”, making it vulnerable to “behavioural biases”. It seems Trafigura thinks they are smarter than the market when valuing securities. The lack of liquidity was the infamous excuse used by Noble Group, another commodity trader, to justify its 48-times overvaluation of its associate Yancoal.

If Trafigura sold all these debt securities, it would have to write them down in full. As a result, Trafigura is likely stuck with securities that are continuing to fall with no improvement in sight.

After Trafigura adopted the level 3 methodology, the group booked a revaluation gain of $78.5m in 2015 when securities were plunging. In 2016, Trafigura was more conservative: the company recognized an impairment loss of $125.9m after it sold $91.7m debt securities. However, the company quickly reversed course. It recorded a $135.7m gain in 2017 because of “improved projections of the throughput of the port and a decrease in the discount factor relating to lack of marketability”. An additional gain of US$18.7m was recorded in 2018 as well, and once again $24m in the first half of 2019. The various gains boosted the company’s net profit. We view this profit as fabricated as it ignores the economic reality of the port and the declining market value of the securities. The auditor’s warning for Porto Sudeste also reflects the financial deterioration.

The discount factor for lack of market liquidity was initially 38% in 2015. It was lowered to 26% in 2016, and then to 10% in 2017. If the discount for liquidity is reduced annually, we can assume that the market is increasingly liquid. So why aren’t these securities marked-to-market, as they should be?

In Trafigura’s cash flow model, the port’s revenues are calculated over a period up to 2064. Trafigura’s output assumptions have been incorrect in the past. In 2016, it expected to “ramp-up exports through Porto Sudeste to 15 million tonnes in 2017 and 20 million the following year.” As mentioned, in 2018, the volume of Porto Sudeste was only 9.5 million tonnes.

The fortunes of Porto Sudeste are not improving. Brazil’s Vale has entered an agreement to buy another Brazilian iron ore miner, Ferrous Resources, which is an existing client of Porto Sudeste. In the future, Ferrous is expected to use Vale’s infrastructure rather than that of Port Sudeste. Trafigura lodged a complaint to the competition watchdog in Brazil as it feared that “any move by Vale to shift these shipments to its own infrastructure could hurt the port.” However, Brazil’s antitrust watchdog has just approved Vale’s acquisition of Ferrous Resources. Porto Sudeste is likely to lose an important client.

Trafigura values at $490m the junior debt securities of a company with significant uncertainty as a going concern. In our experience, companies that ignore market prices to value listed securities and prefer their own cash flow model inevitably have to face reality.

Trafigura is not listed so it has no incentive to boost its share price, but it has a massive $33b debt, very large operating cash outflow, and covenants that would probably be affected by the impairment of these assets.

We will cover other issues on Trafigura’s financial statements. We are short Trafigura’s debt.


Disclaimer

Our research and reports express our opinions, which we have based upon generally available public information, field research, inferences and deductions
through our due diligence and analytical process. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been
obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may
otherwise owe any fiduciary duty or duty of confidentiality to the issuer. We strive for accuracy and completeness to support our opinions, and we have a goodfaith belief in everything we write, however, all such information is presented “as is,” without warranty of any kind – whether express or implied. Iceberg
Research (“Iceberg”) makes no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the
results to be obtained from its use. You agree that the use of Iceberg’s research is at your own risk. In no event will Iceberg be liable for any direct or indirect
trading losses caused by any information available on this report. Think critically about our opinions and do your own research and analysis before making any
investment decisions. You should seek the advice of a security professional regarding your stock transactions.
You should assume that as of the publication date of our reports and research, Iceberg may have a short position in the securities (and/or options, swaps, and other
derivatives related to the stock) covered herein, and therefore may stand to realize gains in the event that the price of the covered securities declines. We may
continue transacting in the securities of the company covered in this report, and we may buy, sell, cover or otherwise change the form or substance of our
position in the issuer regardless of our initial views set out herein.
This is not an offer to sell or a solicitation of an offer to buy any security, nor shall Iceberg offer, sell or buy any security to or from any person through this site
or reports on this site. Iceberg is not registered as an investment advisor in any jurisdiction. You agree to do your own research and due diligence before making
any investment decision with respect to securities discussed herein. You represent to Iceberg that you have sufficient investment sophistication to critically
assess the information, analysis and opinions in this report.
We are entitled to our opinions and to the right to express such opinions in a public forum. We believe that the publication of our opinions about public
companies that we research is in the public interest. This report and all statements contained herein are the opinion of Iceberg and are not statements of fact. You
can publicly access any piece of evidence cited in this report or that we relied on to write this report. All expressions of opinion are subject to change without
notice, and Iceberg does not undertake to update or supplement any reports or any of the information, analysis and opinion contained in them.
You agree that use of Iceberg’s research is at your own risk. In no event will you hold Iceberg or any affiliated party liable for any direct or indirect trading
losses caused by any information on this site. You further agree to do your own research and due diligence before making any investment decision with respect
to securities covered herein. You represent to Iceberg that you have sufficient investment sophistication to critically assess the information, analysis and opinion
on Iceberg’s site and in this report. You further agree that you will not communicate the contents of this report to any other person unless that person has agreed
to be bound by these same terms of service.
By downloading, opening and/or reading this report you knowingly and independently agree: (i) to abide by the terms of service of our website, which are
hereby fully incorporated herein, (ii) that any dispute arising from your use of this report or viewing the material herein shall be governed by the laws of the
State of New York, United States, without regard to any conflict of law provisions; (iii) to submit to the personal and exclusive jurisdiction of the superior courts
located within the State of New York and waive your right to any other jurisdiction or applicable law; and (iv) that regardless of any statute or law to the
contrary, any claim or cause of action arising out of or related to use of this website or the material herein must be filed within one (1) year after such claim or
cause of action arose or be forever barred. The failure of Iceberg to exercise or enforce any right or provision of this disclaimer shall not constitute a waiver of
this right or provision. If any provision of this disclaimer is found by a court of competent jurisdiction to be invalid, the parties nevertheless agree that the court
should endeavor to give effect to the parties’ intentions as reflected in the provision and rule that the other provisions of this disclaimer remain in full force and
effect, in particular as to this governing law and jurisdiction provision.

3 comments

  1. anshuman72923 · · Reply

    Interesting story mate.

    Good read.

    Like

  2. A very interesting read!

    Like

  3. Quick and dirty · · Reply

    That’s the tip of the… Iceberg. Please, look at how beautiful it is this other piece of activity, that happened on the marvellous old numbers, just before the books were closed: Trafigura sold 50% of Impala to IFM. Recording gains.

    When did it happen? Exactly on the 27th of September, 3 days before closing the 2018 books. Wow, what a coincidence and how nice to recognise almost 300 million of profits the last days of the fiscal year….

    To be precise, they didn’t sell to IFM, but to a 50/50 JV with them. Now the assets are deconsolidated, yet still “somehow” managed.

    Well, you can then tackle the ridiculous reporting of “adjusted net debt”. If you have to liquidate the stocks in a trading company you do it a distressed value not at book value. So the assumption that anything within 12 months can be easily deducted from current debt is simply too funny… or scary. Not to mention the fact that they include in the amount to be deducted some of the prepaid yet unlifted cargoes, as if you could easily liquidate those (never heard of Ashanti Gold Mines?).

    Liked by 2 people

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: