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Earnings slump betrays shaky state of China economy

SHANGHAI/HONG KONG In early May, Chinese heavy machinery maker Sany Heavy Industry was on the receiving end of some pointed public criticism. A local securities newspaper implied the company was not moving quickly enough to streamline its operations, alluding to U.S. competitor Caterpillar's announcement of plans to close five plants in the U.S. and cut 820 jobs.

Although Sany is the world's biggest producer of concrete mixers and No. 1 in loading shovels in China, it booked a net profit of just over 100 million yuan ($15.3 million) in 2015, down sharply from 2.9 billion yuan in 2013 and plunging nearly 80% in each of the last two years. During the January-March quarter of 2016, the company registered 90.1 million yuan in net profit, comparable to the whole of 2015, but this was the result of an asset liquidation, without which the company would have fallen into the red.

Sany is not the only one suffering. Half of its local peers either saw their net profit fall or sink into the red in 2015. And for China Inc. as a whole, the news was even worse.

PAIN ALL AROUND Earnings data compiled by research company Dazhihui showed that the total net profit of mainland-listed Chinese companies fell 1.1% to 2.47 trillion yuan in 2015. This was the first contraction since 2008.

At nonfinancial companies, aggregate net profit in 2015 declined 15.7%. The big three oil companies, all state-owned, contributed significantly to the decline. Their combined net profit tumbled 60% to 88 billion yuan in 2015, wiping off over 130 billion yuan from 2014.

PetroChina's net profit dipped to 35.5 billion yuan, the lowest since its listing in 2000. The company took a hit from the slump in the global oil market and worsening profitability at the Daqing oil field, China's largest. With earnings also reeling at CNOOC and China Petroleum & Chemical (Sinopec), the trio saw their combined net profit sink to the lowest level since 2002.

This profit decline has forced them to cut investment. After slashing spending on pipelines, plant expansion and drilling rights by 30% in 2015, PetroChina has decided on a further 10% cut this year. Sinopec and CNOOC also plan to reduce capital outlays. These cutbacks will deal a blow to oil production service companies and other related businesses, such as plant engineering, steel and machinery outfits.

The country's three largest telecom carriers -- China Mobile, China Unicom (Hong Kong) and China Telecom -- are also cutting back on their capital spending this year. Their combined investment is expected to be 358.2 billion yuan, down 18.3% from last year. This is partly because they have made substantial progress in building up their 4G mobile networks.

Another factor, however, is the rapid rise of popular smartphone voice messaging app WeChat by internet services company Tencent Holdings. State-owned telecom carriers claim their profitability has suffered as more and more local mobile users communicate via WeChat instead of the carriers' voice services. While China Telecom's net profit rose 13.4% to 20 billion yuan, market leader China Mobile's dipped 1% to 108.5 billion yuan and China Unicom's fell 12.4%.

The overall profit contraction dragged on into the January-March quarter.

STRICKEN STEEL Some of the worst performances came in the steel industry. Shanghai-based industry leader Baoshan Iron & Steel saw its net profit plunge 83% last year to 1 billion yuan. Of the 34 listed steelmakers in mainland China, only 14 were profitable.

Wuhan Iron and Steel incurred a net loss of 7.5 billion yuan. With the equity-capital ratio of Chongqing Iron and Steel falling to a little more than 10% on a net loss of 5.9 billion yuan, the municipal government has begun to study measures to bail it out. Baoshan President Dai Zhihao said the industry has entered an "ice age."

The main reason Chinese steelmakers remain in the doldrums is overcapacity. According to the World Steel Association, capacity is over 1.1 billion tons a year, while annual demand in China is less than 700 million tons.

With a supply glut fueling intense price cutting, steel is cheaper than Chinese cabbage. That's no overstatement -- steel products for construction goes for less than 2,000 yuan per ton, while cabbage is available for a little over 1 yuan per 500 grams.

China's steel industry, dominated by state-owned enterprises, is a typical example of the chronic overcapacity plaguing the country.

Under Premier Li Keqiang, the central government vowed to trim capacity by between 100 million and 150 million tons, or 10%, by 2020, and shut down "zombie" companies, which continue operating only thanks to injections of government cash.

According to the Organization for Economic Cooperation and Development, the world's excess steel capacity is more than 700 million tons, equivalent to more than 30% of total global capacity in 2015. About 430 million tons, or roughly 60%, of this excess is attributable to China, according to the American Iron and Steel Institute.

"Unless China starts to take timely and concrete actions to reduce its excess production and capacity in industries including steel, and works with others to ensure that future government actions do not once again contribute to excess capacity, the fundamental structural problems in the industry will remain," U.S. Secretary of Commerce Penny Pritzker and U.S. Trade Representative Michael Froman said in a joint statement on April 18. With steelmakers' earnings and employment taking a hit around the world, affected governments "will have no alternatives other than trade action."

Home appliance makers have also become mired in price wars, the result of their failure to produce innovative, recognizable brands.

Chinese home appliance makers have grown on the back of rapid urbanization and government subsidies to promote their products in rural villages. But the so-called population bonus is running dry as the nation's working-age population begins to peak and the pace of migration to cities slows. TV maker TCL, air conditioner maker Gree Electric Appliances and white goods producer Qingdao Haier booked double-digit falls in net profit in 2015.

"Chinese companies, ours included, still face a considerable innovation gap when compared with those in advanced economies," TCL Chairman and CEO Li Dongsheng told The Nikkei in March.

Other consumer goods markets are also becoming increasingly saturated and diverse. Tingyi Holding, the biggest maker of instant noodles in China, logged a 36% fall in net profit to $256 million in 2015. While the company's beef-flavored noodles have been a bestseller in China for more than a decade, urban consumers have become less loyal recently because the ingredients and flavor have changed little.

Another Hong Kong-listed, Taiwan-based food company in China, Want Want China Holdings, reported its earnings fell for the second consecutive year, declining 12.6% to $542 million in 2015. Revenue declined more than 9% on the year to $3.43 billion, as sales of dairy products, which make up more than half of its total revenue, fell 13.6%.

Yeeman Chin, director at Fitch Ratings, said that changing consumer tastes in the much more competitive food market in China, along with a sharp increase in food imports, are posing immense challenges to traditional local players like Want Want. "Chinese consumers, especially the middle class, tend to upgrade their spending and look for alternatives," Chin said.

Other local players are in the same boat. China Mengniu Dairy, the largest dairy manufacturer by market share, is suffering as domestic formula milk loses out to foreign imports. The company saw its net profit last year grow only 0.7% to 23.6 billion yuan, while revenue slipped 2% to 490 billion yuan.

"Of the existing 4,000 milk formula brands in China, I'm afraid 75% will eventually go out of business," Yashili International Holdings CEO Lu Minfang told reporters in Hong Kong. Lu put this down to price wars as well as the changing preferences of Chinese consumers.

The sluggish economy and intense competition have hurt beer sales as well. China Resources Beer, the leader by market share, is counting on the premium segment to boost margins as its revenue growth slowed to 1% at 34.8 billion Hong Kong dollars ($4.48 billion) last year, and sales volume contracted 1.3%.

No. 1 diaper and sanitary napkin maker Hengan International Group is also aiming upmarket. The company's full-year net profit rose 3.4% to HK$4.05 billion, on revenue growth of 2.6% to HK$24.5 billion.

Xu Shuishen, the company's chief operating officer and deputy CEO, said the group will focus more on mid- to high-end diaper sales, which rose 22% despite the slowing domestic economy. Meanwhile, sales of low-end diapers fell 23% due to fierce competition. "China's living standards have improved. It is now time to turn around and go upmarket," said Xu, adding that the end of China's one-child policy, announced last October, will boost demand for quality child care products.

CURRENCY CONCERNS Another drag on growth is the weaker yuan. Hengan nearly tripled its foreign exchange loss to HK$429 million, but it is airlines in particular, which hold substantial dollar-denominated debt to cover aircraft purchases and other expenses, that took a hit from the Chinese currency's depreciation.

China's big three state-owned airlines logged a combined foreign exchange loss of nearly $3 billion last year. Flag carrier Air China, which booked an 83% rise in net profit to 7.1 billion yuan, hopes to lower its dollar debt ratio to about 60% this year. Guangzhou-based China Southern Airlines, whose net profit almost doubled to 3.7 billion yuan, intends to lower its ratio to half. Shanghai-based China Eastern Airlines cut its ratio of dollar debt to 50% as of the end of March, down from 81% in 2014.

With the weaker yuan eating into gains from plunging oil prices, all three see an urgent need to change their liability structure. Unlike overseas rivals such as Singapore Airlines and Hong Kong's Cathay Pacific Airways, China's carriers do not typically hedge against fluctuations in fuel prices.

BRIGHT SPOTS Internet shopping is one of the winners. New York-listed Alibaba Group Holding saw its turnover for the year through March rise 33% to 101.1 billion yuan, while net profit jumped 193% to 71.3 billion yuan.

"In this challenging time for the global economy, Alibaba is bucking the trend," Executive Vice Chairman Joe Tsai said on May 5. Focusing on the accumulated wealth in mainland China, rather than on the recent slowdown, he pointed to the country's aggregate household cash reserves of over $4.6 trillion as proof that Chinese consumers have "an ability to spend."

That purchasing power is also one reason the automobile sector has continued to shine, posting a 6% gain in sales and a 10% rise in net profit in 2015. Although government subsidies created an artificial uplift in demand for eco-friendly cars, popular-brand passenger cars are also doing well.

Volkswagen has survived its recent emissions scandal thanks to Chinese consumers, who bought 3.55 million vehicles from the German automaker in 2015. Major local partner SAIC Motor -- foreign companies selling cars in China are required to form joint ventures with a domestic player -- reported a 6.5% increase in net profit last year to 29.7 billion yuan, on revenue growth of 6% to 670 billion yuan.

Including contributions from General Motors, another of its strategic joint venture partners, SAIC sold 5.9 million vehicles in 2015, 5% more than a year before, pushing its market share up to 23.2%.

Real estate companies posted some gains in profit, despite huge inventories totaling more than 700 million sq. meters. Skeptical about the value of the yuan and deterred by dismal stock market performances, Chinese consumers are flocking to property.

China Overseas Land & Investment's net profit last year surged 22.5% to HK$33.3 billion, despite foreign exchange losses rising sharply from HK$20.3 million to HK$2.32 billion. "The property market across mainland China's tier-one cities is in no way toppy," Hao Jianmin, chairman of the mainland developer, told reporters in Hong Kong in mid-March.

The company is pushing ahead with its expansion plans. It will acquire the entire residential portfolio of Citic, which has a total land bank of 24 million sq. meters, of which 80% is in first- and second-tier cities. The deal, valued at 31 billion yuan, will be funded chiefly by granting 1.096 billion shares to Citic.

Huaneng Power International, the Hong Kong-listed arm of state-owned power generator China Huaneng Group, expects its domestic power generation this year to fall by 1.7% to 315 billion kilowatt-hours -- its lowest target since 2011. Liu Guoyue, the group's executive director and president, said China's power market has entered a stage of "low-speed growth" of 1-2% this year.

This means that electric power, one of Premier Li's benchmark metrics, is hinting at much slower growth than the official figure of 6.5-7%.

Nikkei staff writers Jennifer Lo and Joyce Ho in Hong Kong, Tetsuya Abe in Beijing and Yu Nakamura in Guangzhou contributed to this story.

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