Tuesday, October 14, 2014

It's Not 2008 For Chinese Companies — It's Worse

What this tells us is that demand has broadly collapsed somehow and while failing firms will be recapped or merged, there is no clear reason to understand if demand will recover.

This appears to be the expected long stagnation period that China needs to pass through as the population base strengthens and accumulates wealth sufficient to end this natural consolidation.

The State really cannot do much else as stimulus is merely sucked into unproductive real estate.

The economy can now transition to a natural consumption based system that spends heavily on services. This is happening anyway but it is a solid road to internal growth and capital absorption.

It's Not 2008 For Chinese Companies — It's Worse

By Linette Lopez – Fri, 19 Sep, 2014 1:38 PM EDT

If you think we saw bad things out of China this week, brace yourselves. It's going to get worse.

A recent slew of economic data out of the country showed that industrial production had slowed to its lowest level since 2008.

Retail, investment, housing — all the numbers pointed to a slow down. The Chinese government responded by injecting about $81 billion into the top five Chinese banks, a targeted move that isn't meant to be more than a quick tiny jolt.

So conditions will remain as they are, and for Chinese companies, those conditions are bad and getting worse.

In a recent report Morgan Stanley described a grim future for corporates, especially in sectors like mining, property development, and industrials. The picture is pretty bad all around, but these industries are the most vulnerable given market conditions.

Companies in these sectors are seeing lower profit margins, excess capacity, and eroding pricing power. To make up for that, they're spending too much cash while levering up.

China's corporates took on 5.4 times more leverage than they had before in the first half of 2014 alone, according the Morgan Stanley's report, bringing leverage up to levels unseen since 2006.

What may  be the worst part of this is that Chinese companies are trying to avoid this to no avail.

"The deterioration is also, for the most part,  unintentional: debt growth has generally been decelerating,  reflecting slower spending (yes, there are exceptions), but it’s  just not enough," said the report.

This isn't sustainable, especially with the Chinese government insisting that it's not going to rescue the economy with big stimulus anymore. On Tuesday the government's publication, Xinhua News Agency, accused those calling for fresh stimulus after the weekend's bad data dump of "failing to clearly see the Chinese economy's new normal."

That means credit will be tight, and Morgan Stanley thinks that puts Chinese companies in a similar, terrible position to the one they were in in 2008 and 2011.

"Both periods saw decelerating growth  and were preceded by tightening credit conditions," said the report.

So expect defaults, expect credit events, expect strong companies to survive in this environment and weak companies to get wiped out.

In fact, as you can see in the Morgan Stanley table below, it's already started.

Morgan Stanley

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