March 18, 2018, 10:15 am
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Cracks in China Inc’s rosy earnings reveal a patchier picture

By Umesh Desai and Patturaja Murugaboopathy

HONG KONG/BENGALURU- At first glance, China Inc’s earnings are off to a roaring start to 2017: first-half net profits surged by nearly a quarter, helped by healthy expansion in the world’s second-largest economy. Last year, the rise was a mere 6 percent.

Robust profits have been a key factor in pushing the benchmark Hong Kong index to three-year highs and its Shanghai counterpart to its strongest levels in 20-months.

But the corporate investment and M&A that is driving those earnings is being fuelled by growth in debt that is too rapid for comfort, analysts say. Frequent use of one-off gains to lift results and unhealthy fundamentals in some sectors may also give investors pause for thought.

Total debt at some 1,200 firms listed in Shanghai, Shenzhen and Hong Kong as of end-June grew 13 percent from a year earlier, Reuters calculations show, much faster than the first half of 2016 when the rate was 7.5 percent.

Profits were not used to retire debt in significant quantities over the period and cash levels at those firms, selected for the survey as they have reported earnings for at least two years in a row, shot up 12 percent.

All in all, debt-to-equity ratios were little changed from last year, an indication that hopes of a broad deleveraging for Chinese firms, widely seen as having worrisome debt levels, seem premature.

“These earnings improvements are credit driven and I have doubts about the sustainability,” said Andrew Kemp Collier, managing director at independent research firm Orient Capital.

China’s property developers have led the way in debt creation, and even if some of the most heavily burdened like China Evergrande did cut back, others kept borrowing.

Acquisition-hungry Sunac saw contract sales almost double and gross profit climb 86 percent, but its total borrowing also jumped, up 60 percent to nearly $28 billion.

“The picture is not as rosy as shown by rising earnings – credit is accumulating faster than nominal growth,” said Natixis Chief Economist Alicia Garcia Herrero, also noting that very short term debt is not captured in conventional leverage ratios.

A study by Natixis shows Chinese companies on average have 68 percent of their liabilities in loans of less than 12 months seen as riskier due to the need to refinance - compared with a global average of 38 percent. 

China’s economy has surprised experts with its resilience, growing by a faster-than-expected 6.9 percent in the first half, on resurgent exports and healthy retail sales - even if it is expected to start to lose some steam. - Reuters
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