New China struggling to emerge as old industries drown in debt

Hong Kong, May 6, 2016

Large “old industry” companies are at the heart of China’s debt problem while “new industry” peers are less vulnerable but still comparatively small, according to the Natixis China Corporate Debt Monitor, the first in a series of annual reports on Asia’s corporate health, published today by Natixis.

This Natixis China Corporate Debt Monitor offers a deep-dive look at the ability of the 3,000 largest Chinese listed companies to repay, comparing them with their peers globally, and drawing conclusions based on the companies’ sectors, as well as ownership and size.

 

New China emerging, but still at an early stage

Chinese policy targets the development of new industries - such as consumer, health care, travel and technology – to supplant the country’s traditional old industry growth drivers – including real estate, energy, infrastructure and industrials.

An analysis by asset size reveals that China’s corporates are still heavily weighted towards old industry sectors (73% of assets in the sample, versus 53% for the global peer group).

The imbalance is most apparent among larger companies. Real estate companies account for over 25% of the assets of the largest 100 listed companies in China versus only 0.5% of the largest 100 global companies. Conversely, companies in the consumer sector account for just over 6% of assets in the largest 100 group in China versus almost 23% globally.

 

Chinese corporates more vulnerable than global peers

The broad snapshot of China’s 3,000 largest listed companies presents a corporate China that is less indebted yet at the same time more vulnerable than its global peer group.

Leverage (measured by total liabilities to common equity) is 86% in the Chinese sample versus 152% globally. However, the repayment ability of the Chinese group is weaker – earnings (EBITDA) cover interest expense by five times versus eight times for global peers  – and funding risk is higher, with short term liabilities accounting for 86% of total liabilities versus 40% globally.

 

Debt concentrated in large corporates

The benign debt figure for the 3,000 Chinese corporates in the sample masks far higher leverage among the largest 100 Chinese companies, at 261% versus 178% for the largest 100 listed global peers. Vulnerability, as defined above, is uniformly higher in China than abroad, with repayment ability clearly lower for Chinese corporates, particularly for the 100 largest.

The over indebtedness of China’s largest companies is a function of the huge volume of assets they have accumulated, primarily in the old industry sectors, putting them at the core of China’s overcapacity problem.

 

Large private companies are the weakest

State-owned enterprises (SOEs) dominate China’s old industries, both in terms of assets and the number of companies, and they are unsurprisingly more indebted (139% leverage ratio) than privately owned enterprises (POEs, 76% leverage ratio). The most vulnerable among the SOEs are the smaller companies, of which about one quarter are unable to cover interest expense through earnings.

Among the largest companies, however, debt levels are much higher in the private sector than for SOEs. This is primarily due to the large share of real estate developers in the sample – real estate accounts for one third of assets owned by private companies. A decline in revenues has also weakened the repayment ability of these largest Chinese private companies - as much as quarter cannot cover interest payments with their earnings.

 

New China best (but too small)

New industry sector companies, by contrast, are in a stronger position, no matter whether SOEs or private. Healthcare and travel-related companies, which are largely from the private sector, are less indebted and more profitable than global peers. Airlines also boast better profit margins than global peers.

However, these three sectors are still minnows compared to China’s old industries, cumulatively accounting for only around 3% of total assets in the sample, versus 43% for real estate, construction and engineering, metals and materials, and chemicals. These old industry behemoths have varying debt rates, but are largely more vulnerable than global peers and Chinese new industry companies, with a higher percentage of short-term funding and lower ability to pay interest from earnings.

 

Overall, higher growth in new industry sectors relatively to old ones cannot but further deepen the divergence in China’s corporate health. Current monetary and fiscal stimulus may ease the problems that Chinese corporates in those old sectors are facing. However, as China rebalances, their revenues will never come back to original levels, and a widespread restructuring of these old sectors seems inevitable.

 

 

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The Natixis China Corporate Debt Monitor is the first in a series of annual reports on Asia’s corporate health. It offers a deep-dive look at the repayment ability of the largest 3,000 listed Chinese companies, and compares them with their global peers. The report breaks down its conclusions based on the companies’ sectors, but also by ownership and size. The depth and breadth of the analysis tells a story unseen in the headline debt figures; that vulnerability across Chinese corporates is far from homogenous.

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