Band leader Gome won't be caught out when retail music stops
'The profit margin is not our main target at this moment. Most important is that we remain No1 in the market.'
Gome Electrical Appliances
YOU HAVE TO say something to soothe shareholders when your sales grow by an adjusted 37 per cent while your earnings do not move up at all. This is the conundrum Gome faced in reporting last year's earnings.
But I would hardly describe this as soothing and I would also not describe the corporate strategy of this mainland retailer of white goods and electronic appliances as staying No1 in the market. I think it better described as Gome crossing its fingers and hoping its seat is not pulled when the music stops in this game of musical chairs.
It is a reasonable hope. It almost certainly will not be Gome's seat that is pulled. It will be the seats of the bankers who finance Gome's suppliers. This, however, will also do little good for Gome. The company may be debt-free but it is hardly free from bills it must pay.
Let us start the story with a chart. It shows you the aggregate net profit margin for manufacturers of electronic appliances in China over the past eight years. There have been up and downs but most recently the trend is down again. Costs of materials and components are rising sharply but buyers are price conscious and a 2.5 per cent overall profit margin is all the industry could manage.
This is danger territory for a volatile and highly competitive industry. Here you have a country with near double-digit economic growth and retail sales growth well into double digits but profit margins in electronics manufacturing are narrow and slipping. They are even worse in white goods. Yes, shudder at the prospects for those margins should the economy slow down.
But there are reasons why they are so low. It is companies such as Gome that retail the goods and Gome plays hard. It owes its suppliers 6.8 billion yuan in bills payable, more than double the figure at the end of 2004. The figures suggest that on average it now delays its payments to them by more than four months.
It also stings them in other ways. If they want their goods given prominent display in Gome's shops, they must pay. Gome's income last year from these fees paid by suppliers was 492 million yuan and that was almost two-thirds of its reported net profit.
Gome's financial position has its own precarious elements, however. Look at what supports shareholders funds of 1.87 billion yuan and you get 840 million yuan due from related parties (who are they?) and 2.72 billion yuan in inventories, 2.5 times what the figure was a year before.
Then there is 3.1 billion yuan listed under current assets as 'pledged deposits'. Pledged to whom? These are all very big and uncertain numbers on which to base owners' equity.
And now let us assume the slowdown that must inevitably come the way of the big consumer boom in China. The first thing to happen will be Gome's suppliers going from profit into loss and then their banks will come looking for the money they have advanced. Ask Gome for that money, the suppliers will say. Gome owes us 6.8 billion yuan for goods we have shipped to it.
So the banks will go to Gome and where will Gome find the money? It has cash but only a fraction of the 6.8 billion yuan it owes. It has deposits but these are pledged. It has some money owed by related parties but they will probably be in financial difficulties too.
It may try to sell down its inventories but that will be a slow process in a downturn and it has to keep inventories if it is to stay in business. Meanwhile, suppliers will no longer be in a position to pay display fees and, without these, there will not be much in the way of earnings to pay the banks, even assuming that Gome will not have to cut its prices.
Yes, big problem indeed but not for Gome. It will be a big problem for those banks that have supposedly been cleaned up and are now busy getting themselves listed overseas. It is they who will find their seats pulled in this game of musical chairs.
And Mr Wong, the founder and chairman of Gome, will quietly have stepped out of the game. He is in the process of selling his remaining parent company stake to Gome and within five years hopes to have no private retail assets. He will have made his pile even if it all goes wrong for Gome.