China: Industrial profits continue to sparkle – ING

A combination of the positive result from overcapacity reform in old sectors and growing new sectors is supporting a double-digit industrial profits growth in China, explains Iris Pang, Economist at ING.

Key Quotes

“Industrial profits growth is expected to remain at double-digit pace in September (INGF: 21.7%; prior: 21.6% YTD YoY) even with a fading base effect on the old sectors undergoing capacity reduction. While coal mining should still be the best performer in terms of profit growth, automobile manufacturing should outshine as driver of profits growth in yuan terms.”

“With Xi’s strong team focusing on supply side reform to cut overcapacity, we would see more examples similar to coal mining that would experience cut in supply. Cement and glass are the obvious candidates. The success of supply reduction reform may be attributed to still strong demand supported by global economic recovery. Prices of the materials that experience deep supply cut would rise, and so would profits in the sector.”

“Looking at new sectors, profit growth is high, though not as strong as the deleveraging sectors. But in yuan terms they have been good profit earners. Automobiles earned CNY448bn YTD in August, up 11.7% YoY YTD. Specialized equipment, though not earning a lot (CNY160bn YTD) had even stronger growth at 22.7% YoY YTD. With continuous high growth, new sectors, especially those facilitate use of technology in consumption and businesses, would rise in the profit earners’ hall of fame.”

“However, high account receivables (CNY13trn, +9% YoY in August) remains a risk. We believe that delay of payments and even defaults in overcapacity sectors would continue for a few years. The government has piloted a few solutions to manage the risk, including the first SOE bond haircut bundling with debt-equity swap. The key is that the central government controls the speed of haircut events, which is important to keep deleveraging reform not turning into crisis like event. In short, the central government is using market tools to deal the debt problem but not allowing the market to take control of the speed.”