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  • Apr 18, 2014
  • Updated: 3:21pm

From bad to ugly, it's not looking good for Chinese firms

PUBLISHED : Wednesday, 03 August, 2005, 12:00am
UPDATED : Wednesday, 03 August, 2005, 12:00am

The earnings season just starting will reveal a lot about business conditions in China. It could get ugly.


Profit margins at many Chinese companies have been getting squeezed for a year or more. Reckless over-investment in new plants, fuelled by cheap bank credit, has boosted manufacturing capacity in sectors from cars through fridges to mobile phones.


That has generated massive demand for raw materials, pushing input prices sharply higher. At the same time, the sheer profusion of companies in each sector has bred fierce competition, preventing manufacturers from passing their higher costs on to consumers.


As a result, profit margins have been shrinking. According to credit rating agency Standard & Poor's (S&P), median operating margins at Chinese manufacturers of home appliances shrank to just 2.3 per cent last year, down from an already thin 5.9 per cent in 2002. Margins at technology companies and carmakers were not much better, at 5.4 per cent and 7.9 per cent, respectively.


Even those figures understate the true magnitude of the problem. In compiling its data, S&P examined only the cream of corporate China: the top 100 listed companies by revenues. 'There are a lot more companies underneath which are finding conditions a lot more difficult,' said S&P managing director John Bailey.


The environment has deteriorated further this year. The past couple of months have seen a spate of profit warnings from leading Chinese companies. Last week, the National Development and Reform Commission said red ink at money-losing companies had risen to 107.5 billion yuan during the first half, nearly 60 per cent more than for the same period last year. The worst offenders were state-owned enterprises, where losses rose 84 per cent.


Higher fuel costs are partly to blame. Airlines have been hit especially hard, with several expected to record first-half losses. Power generators and chemical companies have also suffered, caught between rising coal and oil costs on one side and state-mandated price controls on the other.


But fuel costs are not the whole story. Much of the deterioration in profitability is the consequence of simple overcapacity. China's saloon car manufacturing capacity is projected to grow by about 28 per cent this year to nearly 4.9 million vehicles, easily outstripping demand, which even the more optimistic forecasters expect to climb to only 2.8 million.


With that much oversupply, prices have fallen. In June, Changan Automobile launched a new model priced at just 22,800 yuan. Within weeks, the company warned investors it was expecting a 50 per cent fall in first-half profits.


There are similar stories to be told across a range of sectors, with former market darlings like mobile phone maker Ningbo Bird, white goods company Kelon Electrical and cooking oil manufacturer China Force Oil & Grains all expected to post losses for the first half.


Mr Bailey believes margin pressure could have a positive spin-off, prompting much-needed consolidation among Chinese firms. But any closures will be fiercely resisted by local government officials anxious to preserve jobs.


For the time being, at least, it is likely that zombie companies will be kept on life support, with China's banks - and investors - shouldering the cost.


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