China's economy appears to have recovered from its summer sickness. But its companies will struggle to turn that into what matters to investors: higher profits.
The latest signs from China's economy are positive. Industrial output, real-estate investment and retail sales all showed signs of improvement in October. That's good news for China's Communist Party, currently gathered in Beijing to manage a transition in the top leadership, and for a world hunting for renewed sources of economic growth.
The problem for investors is that even as China's economy shows signs of speeding up, corporate profits remain flat. Net profit for the 2,500 firms listed on the mainland markets was up just 0.4% year over year in the third quarter, after falling 1.8% in the second period, according to CapitalVue.
Balance sheets are still bent out of shape, with inventory, accounts payable and accounts receivable all creeping up. The ratio of inventory to the last four quarters of revenue was little changed at 20.4% in the third quarter, from 20.5% in the second. In historical terms, the ratio looks high. In 2009, when Chinese firms were surprised by the financial crisis, the ratio peaked at 18.3%.
A higher ratio suggests inventory is turning over more slowly, indicating weak sales. It also means the pass-through from stronger demand to higher output will be muted, as firms work off stockpiles before switching production lines back on.
China's firms are paying the price for pursuit of growth at the expense of profitability. Reckless expansion of production capacity assumed continued rapid growth in demand. As that has slowed, firms are left with higher fixed costs to spread over output. Rapidly increasing wages, up 73% in the manufacturing sector from 2007 to 2011, add to pressure. Average net profit margins have come down from 12% in 2007 to 8% in the third quarter of 2012.
Weak profitability helps explain why, despite stable growth, China's stock markets have been among the worst this year. The Shanghai Composite Index is down 5.5%, compared with a 9.6% gain for the Standard & Poor's 500-stock index. In part, that also reflects the immaturity of China's mainland markets, in which fundamentals are often overshadowed by changes in liquidity and investors chasing momentum.
Renewed infrastructure spending by the government, and a rebound in property investment, will pass through into stronger demand for China's industrial sector, a positive development for profits in the months ahead. But structural problems of excess capacity and rising costs will be more difficult to solve.
留言列表
