Gavekal Capital: Chinese Corporate Balance Sheets Continue to Deteriorate

Tuesday, October 15, 2013

Chinese Corporate Balance Sheets Continue to Deteriorate

There has been much discussion in recent years of the leverage buildup in the Chinese corporate sector and the problems (or not) that this will (or won't) create, so we thought we'd chime in with some quantitative data and let the reader make his or her own conclusions. The below table is a time series analysis of annual data for non-financial, non-utility CSI 300 constituents. The ratios below are constructed from an aggregation of all individual corporate financial statements. The goal is to see how the listed sector’s balance sheet and profits (in aggregate) have evolved over the last decade. From examining the table below a few things stand out:

  1. Operating cash flow margin has fallen by 65% since 2002
  2. Total liabilities % of equity has risen by 60%
  3. Financial leverage has risen by 26%
  4. Total non-financial working capital (which is (Current Accounts-Cash)+(Current Liabilities-Short-term Debt), and used to detect “channel stuffing”) has risen by 105%
  5. Net debt is flat (which makes us question the validity of the "Cash" line on Chinese balance sheets)

We are not making a judgment on whether this is sustainable or opining on what kinds of problems this buildup in leverage might create, just observing that certain important measures of profits and leverage have shown persistent deterioration since 2002, and especially since 2009.

Moreover, when comparing the most recent data point across various other Asian EMs it is clear that Chinese companies in aggregate are more levered than their Asian peers, except for Indian companies. The reliance on working capital by Chinese firms to finance sales could be considered high, at least.