Thursday, February 12, 2009

Profit Alerts Signal More Pain In China

BEIJING -- A string of dire profit warnings has signaled a rapid deterioration in the financial health of Chinese companies on which the world's third-biggest economy heavily depends, putting more pressure on the government to enhance its stimulus efforts. Corporate investment is hugely important to China's economy, where capital spending accounts for more than 40% of annual output, one of the highest ratios in the world.

The profit decline will have major effects across the economy as companies have less money to buy new equipment or expand their businesses.Weaker private-sector investment means China's growth this year will be even more dependent on the success of the government's big spending plans -- which many observers say need to be beefed up. With global and domestic economic growth both continuing to weaken, China's profit outlook for this year is likely to be at least as bad.

"Profits and profitability in 2009 will be very poor, and this is the key reason why I do not expect much private investment -- especially in the manufacturing sector where China suffers from an overcapacity problem," said Wang Qing, China economist for Morgan Stanley. He's expecting zero growth in manufacturing investment this year and a 12% drop in real-estate investment.

The profit warnings are coming weeks ahead of China's official corporate reporting season, as companies are required to give advance notice of particularly big swings in profits. The warnings have come from a range of industries, but companies tied to shrinking global trade are particularly badly hit. China Shipping Container Lines Co. Ltd. has warned investors annual profits for 2008 fell more than 50%.

The world's largest producer of shipping containers, China International Marine Container, said its annual profit likely dropped about 53% to 1.5 billion yuan ($219 million). Output of its main product, dry-bulk containers, "basically stopped in the fourth quarter," CIMC said. Businesses focused on China's domestic market are also in trouble. SAIC Motor Corporation Ltd., the biggest local auto maker by sales, warned of a profit decline of more than 50% on weaker sales.

Most steelmakers are losing money as construction dries up. Financial giant China Life Insurance Co., hammered by the stock market decline and tougher competition, also said it expects a more than 50% drop in profits. Broader official surveys back up the trend. Profits of industrial companies plunged 27% in the three months to November, according to government statistics, a sharp reversal from a years-long string of 20% to 40% growth.

Economists have long warned that Chinese companies' heavy reliance on retained profits would tend to exaggerate swings in the nation's investment cycle. Official statistics show that 63% of investment in China last year was financed by what are called "internally generated" funds, which include retained profits. That's up from just below 50% a decade ago.

During boom times, high profits get plowed back into new projects -- evidenced by the plethora of shiny new corporate headquarters that dot big cities such as Beijing and Shanghai. Now, some of those investments don't look as smart, and shrinking profits are making it more difficult for companies to fund different ones.

Avoiding that boom-bust cycle was one reason why organizations such as the World Bank had argued that China's government should collect dividends from the companies it owns, which include most of the country's biggest corporations. From the late 1990s, the government allowed state companies to retain all their profits -- money the enterprises were naturally reluctant to yield during the recent boom.

But after an intense political wrangle, a dividend system was put in place by early 2008. Details of the system are sketchy, but the programs financed from those payments had a budget last year of 54.78 billion yuan. That suggests the companies owned by the central government are paying average dividends of 7% to 8% of their profits. Still, that move came too late to ease the peak of the investment cycle, since business was already starting to worsen early in 2008.

The expected downturn in corporate investment this year is one reason many investors are skeptical that the Chinese government's four trillion yuan stimulus plan will be able to maintain an expansion at the speed to which China is accustomed. The plan, announced in November, is encumbered by its dependence in part on corporate spending. The IMF is now forecasting China's economy to expand 6.7% this year, which would be the slowest rate in two decades.

Some other estimates are even lower."It is inconceivable that the government could spend enough to make up for the collapse that is likely to result from this unprecedented period of overinvestment," said Joseph Taylor, emerging markets strategist at Loomis, Sayles & Co., a Boston fund manager. He thinks that lost capital spending this year could be as much as 15% of China's annual gross domestic product.

Some government-controlled companies are doing their patriotic duty and boosting investment plans during the downturn. Offshore oil producer CNOOC Ltd. plans to increase capital expenditure by 19% this year, to $6.76 billion, as it tries to boost output. Telecom companies are also spending big this year to roll out new mobile-phone networks that use high-speed 3G technology.

But many other companies will struggle just to use the capacity they already have, and are unlikely to want to add to it. China's steelmakers collectively had the capacity to produce 600 million tons of crude steel by the end of 2008, but managed to sell only just over 500 million tons last year. Squeezed by falling demand and high costs, Angang Steel Co. warned investors last month that its annual profit is likely to fall by 55% to 3.42 billion yuan.

Article from Jesper Lee - Cimb

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