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Industrial profit to recover on demand, credit growth
By Shen Lan, Benjamin Wong, Stephen Green and Erwin Sanft |
May 9, 2013, Thursday
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Print Edition
Print Edition
CHINA'S industrial profit growth moderated in March, but not as much as the headline number suggested given last year's high base.
According to the National Bureau of Statistics, profits of large industrial firms rose 5.3 percent year on year in March, compared with 17.2 percent in the first two months of the year. This dragged down first-quarter profit growth to 12.1 percent year on year.
Value investors should not be deterred by the weaker-than-expected profit numbers, as the weakness in March was mostly attributable to the high base effect. Profits grew 4.4 percent year on year in March 2012, after falling in January-February. Adjusted for the base effect, we get a much more modest 1-percentage-point slowdown in growth to 16 percent year on year in March 2013 from 17 percent in February, far less than the 12-percentage-point swing suggested by the headline numbers.
Even accounting for the base effect, though, China's industrial-sector recovery is taking longer to materialise than we expected. The economic recovery is still weak at this stage. We expect growth momentum to gradually pick up later this year when demand and sentiment improve across sectors.
The higher base in March 2012 contributed to weaker profit growth in autos and energy. A genuine deceleration, after adjusting for the base effect, was observed in IT and utilities, while capital-goods makers showed strength.
Industrial companies' sales revenue growth moderated to 10 percent year on year in March from 13.1 percent in January-February amid sluggish demand and overcapacity in some sectors.
Local governments appear to have delayed a wave of new investment projects as they take a more cautious approach to urbanization and try to contain credit risks; this weighed on upstream and mid-stream sectors. Slower income growth and government spending seem to have undermined domestic consumption in the first quarter, containing sales in consumption-driven sectors such as tobacco and food and beverages. Meanwhile, delayed recoveries in key developed economies curbed export demand.
Overcapacity remains severe in some sectors. Our commodity analysts found that China's steel mills have been steadily increasing production since January 2013, despite recurring losses, in order to maintain market share and meet the standards required by their banks. As a result, they have continued to suffer from poor margins and tight cash flow.
Slower pace
China's inventory restocking cycle appears to be stalling as the manufacturing sector expands at a slower pace. The differential between rapid growth in raw-material inventories and slower growth in inventories of finished goods narrowed in March-April, indicating that manufacturing companies are slowing the restocking process.
However, industrial companies' inventory-to-sales ratio has fallen markedly on a year-on-year basis since the fourth quarter of 2012, and an increasing number of companies report that inventory levels are returning to "normal" levels. This signals that the restocking cycle has resumed and will gain further momentum once production and sales pick up.
Macro policy should be stable but micro policy should be enlivened. Pressure appears to be building for micro measures targeted at specific sectors or regions to encourage growth and boost sentiment. More investment projects may be approved in the next few months as the new government's urbanization policies become clearer, and liquidity should be kept loose for a while. The state-owned asset regulator recently set a 10 percent profit growth target for centrally administered state-owned enterprises for 2013. We therefore expect to see more supportive measures aimed at securing a steady rise in profit growth.
We expect profit growth to pick up gradually in the coming months on a recovery in demand, strong credit growth, inventory restocking, margin improvement and a more favorable base.
According to the National Bureau of Statistics, profits of large industrial firms rose 5.3 percent year on year in March, compared with 17.2 percent in the first two months of the year. This dragged down first-quarter profit growth to 12.1 percent year on year.
Value investors should not be deterred by the weaker-than-expected profit numbers, as the weakness in March was mostly attributable to the high base effect. Profits grew 4.4 percent year on year in March 2012, after falling in January-February. Adjusted for the base effect, we get a much more modest 1-percentage-point slowdown in growth to 16 percent year on year in March 2013 from 17 percent in February, far less than the 12-percentage-point swing suggested by the headline numbers.
Even accounting for the base effect, though, China's industrial-sector recovery is taking longer to materialise than we expected. The economic recovery is still weak at this stage. We expect growth momentum to gradually pick up later this year when demand and sentiment improve across sectors.
The higher base in March 2012 contributed to weaker profit growth in autos and energy. A genuine deceleration, after adjusting for the base effect, was observed in IT and utilities, while capital-goods makers showed strength.
Industrial companies' sales revenue growth moderated to 10 percent year on year in March from 13.1 percent in January-February amid sluggish demand and overcapacity in some sectors.
Local governments appear to have delayed a wave of new investment projects as they take a more cautious approach to urbanization and try to contain credit risks; this weighed on upstream and mid-stream sectors. Slower income growth and government spending seem to have undermined domestic consumption in the first quarter, containing sales in consumption-driven sectors such as tobacco and food and beverages. Meanwhile, delayed recoveries in key developed economies curbed export demand.
Overcapacity remains severe in some sectors. Our commodity analysts found that China's steel mills have been steadily increasing production since January 2013, despite recurring losses, in order to maintain market share and meet the standards required by their banks. As a result, they have continued to suffer from poor margins and tight cash flow.
Slower pace
China's inventory restocking cycle appears to be stalling as the manufacturing sector expands at a slower pace. The differential between rapid growth in raw-material inventories and slower growth in inventories of finished goods narrowed in March-April, indicating that manufacturing companies are slowing the restocking process.
However, industrial companies' inventory-to-sales ratio has fallen markedly on a year-on-year basis since the fourth quarter of 2012, and an increasing number of companies report that inventory levels are returning to "normal" levels. This signals that the restocking cycle has resumed and will gain further momentum once production and sales pick up.
Macro policy should be stable but micro policy should be enlivened. Pressure appears to be building for micro measures targeted at specific sectors or regions to encourage growth and boost sentiment. More investment projects may be approved in the next few months as the new government's urbanization policies become clearer, and liquidity should be kept loose for a while. The state-owned asset regulator recently set a 10 percent profit growth target for centrally administered state-owned enterprises for 2013. We therefore expect to see more supportive measures aimed at securing a steady rise in profit growth.
We expect profit growth to pick up gradually in the coming months on a recovery in demand, strong credit growth, inventory restocking, margin improvement and a more favorable base.
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