China's Cramped Cashflows

It would be nice to have something calming to say about China's Jan-Feb industrial and profits data released today, but in truth, they are awful both in general and in detail. At face value, they confirm what the monetary and banking data has been indicating for several months now – that China's corporate cashflows are now cramping very badly, and that this is showing up both in profits and in flows to and from the financial sector.

And I see no reason not to take them at face value, although they are tricky to interpret primarily because 2011 was the first time that they were released on a monthly basis: before that we got them only four times a year. As a result, the analytical community has only a limited history upon which to judge them. However, fools rush in where respectable buy-sides fear to tread, so here goes. . .

During the first two months of the year, industrial sales were up 12.9% YoY, but industrial profits fell by 5.2%. The rise in sales seems about right: during the same period, Rmb exports were up 2.2% YoY, retail sales were up 14.7%, bank lending was up 14.9% and bank deposits were up 12.5%. The problem is that China's extraordinary sustained investment spending means it's capital stock is growing at around 19% a year (estimated by discounting all investment over a 10 year period). So if topline growth falls much below 19% YoY, the result is that asset turns must fall, and with it, most likely, will fall RoE and cashflows.

This is recorded in the 5.2% YoY fall in profits. The collapse in profits to around 5%, down from 6% in the same period last year. This margins squeeze is not yet quite of the scale we saw in late 2008, but the similarities are obvious to see, and are not explained simply by seasonal factors. 

(A word of warning: China began publishing this data monthly only last year. Before then, it was issued once every three months. Therefore, period to 2011, the monthly line has been produced by interpolating between the three-month data points. We don't know what impact this interpolation has had on the monthly line, but it will have had none on the 12m line.)

That's not all: the cashflow crunch shows up in other ways too, most worryingly in the rise in receivables. In the year to end-February, the receivables recorded by China's industrial sector rose by 1,077bn yuan, whilst total sales rose by 1,378 bn yuan. On that data, it seems that on a net basis, the rise in receivables is equivalent to 78% of the rise in sales: only 22% of the marginal increase in sales during the year to February has been paid for in cash. Receivables are likely to be a highly seasonal number, but if anything the situation seems to be getting worse. Between November 2011 and February 2012, receivables fell by 473.1bn yuan: during the same period in the previous year, receivables fell by 720.1bn yuan.

There is a similar story in inventories of finished goods, which were up 19.6% YoY by end-Feb. Moreover, between November 2011 and Feb 2012, they had fallen by only 91.4bn yuan, which compares to a fall of 172bn yuan in the same period in the previous year. In short, inventories of finished goods have risen relative to sales, and they continue to clear the market at roughly half the pace they did last year.

So the story is: slowing sales, falling margins, surging receivables and rising inventories. Apart from that, everything's fine.