Pacific Money

China: “Addicted to Credit”

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Pacific Money

China: “Addicted to Credit”

Another sign that China’s economy, while seeing signs of a turnaround, could face more credit problems.

Whilst the economic data shows at least some signs of an anemic turnaround, China’s corporate results are demonstrating just how difficult things have been.   China’s companies are busy reporting their 3rd quarter 2012 results and there have already been some disappointing results – pretty much explained by the general slowdown. Connected to this however, a worrying trend is developing on many companies’ balance sheets.

Some big names have already seen disappointing profit growth. State owned-Sinopec,  China’s (and Asia’s) largest oil refiner, saw its 3rd quarter profit fall 9.4% and January-September profits slump by 30%. Sinopec is trapped between high crude costs and government mandated price ceilings on sales to consumers.  Oil giant PetroChina also suffered, with its 3rd quarter net profit down 33% compared to last year, driven in part by a $6 billion refining loss over the year-to-date (YTD), and part by a similar squeeze on its natural gas import business (in which its YTD profits have fallen 93% compared to 2011).

China Southern Airlines saw third quarter (3Q) net profit fall 29%, whilst China Life, the largest Chinese insurer measured by premiums, swung to an outright loss in the July-Sept. period.  Meanwhile Sany Heavy Industry Co. Ltd, China’s largest maker of heavy machinery and construction equipment, was hit by 59% fall in 3Q net profit.  Baosteel, one of the largest producers of the metal, saw net profit down 4.88% from a year earlier.

The auto industry in China is undergoing stresses too. Compounded by the fallout affecting Japanese automakers over the island dispute, data shows that overall national auto sales at the end of September fell 1.8% compared to the end of September 2011. BYD, the Chinese company famously backed by Warren Buffet, reported its 3Q 2012 profit sliding 94% compared to 3Q 2011. 

Indeed the auto making sector was put on notice by the Ministry of Industry and Information Technology last week when the latter warned in a statement that the industry required some serious downsizing or consolidation. The statement contained the shocking news that nearly a quarter of China’s nearly 1,300 automobile makers are on the verge of bankruptcy, and hinted that involuntary bankruptcy may be forced onto some of the smaller players.

Most worrying is a drastic rise in the amount of “accounts receivable” (A/R) on the balance sheets of Chinese companies.  Accounts receivable is an item of money owed to the company (from customers) which has not yet been paid. Many transactions are done on credit, and it is normal for companies to have these items on their accounts.  However, Chinese firms’ accounts receivable are estimated to have risen by 45% year-on-year (YOY) according to reports filed so far, whilst sales have climbed by less than half that rate. 

During a slowdown, it is common for payments to be delayed as everyone hangs on to cash. Some companies, though, can be tempted to avoid curtailing production by offering reluctant customers much easier credit to encourage sales, the hope being that the slump will soon end and “natural” demand will pick up again. The trouble of course is that if the slowdown is prolonged, or the recovery weaker than expected, these accounts receivable might turn “un-receivable”, and thus have to be written down as losses.  An increase in A/R is expected, but such a large increase suggests that some companies have been staying in operations through this vendor financing.

In the struggling coal sector, at the end of June, accounts receivable had jumped 52.8 % for the 90 biggest coal firms. YOY Sany’s tally increased 83% over the first nine months of this year, outpacing a still worrying general trend in the heavy machinery sector.  The steel sector is also under stress, as are some parts of the country’s export industry.

China’s economy, as explored previously, is addicted to credit. These large rises in accounts receivable show that it is not only financial institutions and the shadow banking sector which are involved in credit creation.  A payment delay or failure by one company can resonate through an entire supply chain, as each entity feeling the cash pressure then delays payments of its own. The need for a stronger turnaround is becoming more and more urgent.

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