Saturday, September 1, 2012

China's companies are unprepared for the nation's economic slowdown

A rising tide lifts all boats, and double digit growth did that for China's corporate sector. Built for rapid expansion (and unprepared for "steady state" or a contraction in sales), China's firms are having difficulties dealing with the current environment. In another sign of difficult conditions for companies, and to forecasters' surprise, China's manufacturing contracted in August.

Source: Markit/HSBC

As China's residential construction growth stumbles and with the manufacturing sector beginning to shrink, Chinese firms are struggling to maintain cash reserves. Cash for many of China's companies was never a problem as new sales always generated more than enough to cover inventory and payroll expenses.  In some cases it's been a bit of a Ponzy scheme that works only when new sales exceed those in the previous cycle. But that's no longer the case.

FT: - Both at the macro-economic and company level, reports suggest that Chinese companies are increasingly short of cash – and are having to resort to ever more desperate means to get hold of it. The overall picture is hard to grasp, given a scarcity of data, but the evidence is multiplying.
Stories abound that China's corporate books can not be trusted to determine profitability.
FT/Jefferies: - “Investors should judge companies on the basis of cashflows and not earnings as the quality of profits comes under scrutiny. The recent dividend cutting may be a sign of fragile cashflow.
Declining profitability and mistrust of reported financials has pushed the domestic stock market to new post-2009 lows - the longest monthly losing streak since 2004.

The Shanghai Stock Exchange Composite Index (Bloomberg)

In spite of the flagging stock market at home, things are even worse for China's companies listed abroad. Many of these firms are desperately trying to leave foreign stock exchanges and either go private or list domestically.
Caixin: - Under the increased pressure of competition and regulatory oversight in the U.S. market, many Chinese companies that are primarily listed on overseas markets are returning home. One by one these companies have fled overseas markets seeking the high prices and loose regulatory environment in China's A-share market. The trend has started and is likely to continue in the near future. At least 36 Nasdaq-listed Chinese companies have announced plans to privatize since October 2009, based on Caixin's research.
Of course none of this has anything to do with China's economic slowdown, weak cash reserves, and cooked books.
Caixin: - "The United States still doesn't understand Chinese companies fully," said Zhang Yichen, CEO of asset management firm CITIC Capital Holdings Ltd. "When things are going well, there is no problem. But as soon as stock prices slip or a company's reputation slides, the company is beaten dead with a stick."
Certainly there will be fantastic investment opportunities in China, both in the public as well as the private market. It's just not clear this is the time to look for such investments - because as Mr. Yichen correctly pointed out, foreign investors still don't "understand Chinese companies fully."
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