An Analysis Of The Bifurcation Of Chinese Growth In Sales And Debt From A Bottoms Up Perspective by Bryce Coward, Gavekal Capital
To say that Chinese growth is slowing is a correct, yet overly simplistic description of the actual scenario that is playing out on the ground. Chinese growth is slowing, but the data tells us that the growth rates of certain sectors are becoming increasingly bifurcated. The consumer and technology sectors appear to be maintaining their previously seen growth rates while the industrial and energy sectors are experiencing a rather marked drop in their level of top line growth. Because of the out sized weighting of industrial/commercial/energy sectors in the Chinese economy, the growth rate from a bottoms up perspective is rapidly slowing even though the consumer/tech related areas seem to be doing just fine.
Moreover, even though top line growth has slowed dramatically in the industrial/commercial/energy space, the growth rate of liabilities has not shown a commensurate drop off. This fact has us far more concerned than just the slowing of top line growth. After all, a slowdown in top line growth in the industrial space has been baked in the cake for years now as China slowly embarks on its transition from an investment driven growth model to a consumption driven growth model. The big question mark has always surrounded the resistance to this transition, which we feared would manifest itself in debt accumulation as Chinese companies fought to maintain previous rates of growth. This scenario now appears to be playing out.
To illustrate point we’ve aggregated data for all the CSI 300 companies excluding the financials and utilities. We then go one step further and separate the companies into two camps – those that are mostly exposed to the consumer & technology areas of the economy (the area whose share of the economy should increase) and those that are mostly exposed to the industrial, commercial or energy areas of the economy (the area whose share of the economy should decrease). From here we calculate the aggregated year-over-year sales growth and aggregated year-over-year liabilities growth for each year going back to 2003.
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We find that beginning in 2012, sales growth for all companies (ex financials and utilities) took a significant step down. This can be most obviously seen by comparing the 4 year average growth rate (24%) to the two year average growth rate (11%), which we do in the tables below. Meanwhile, the growth rate in liabilities has slowed too, but not nearly as much as sales growth. Herein lies the potential problem. The first two images below illustrate year-over-year growth for sales and liabilities for all CSI 300 companies ex financials and utilities.
These next two images depict the year-over-year growth rates in sales and liabilities for the consumer and technology related companies, again aggregated from a bottoms up perspective. Here we barely see a change in the rate of sales growth as evidenced by the two year average of 25% just about matching the four year average of 26%. The growth rate of liabilities has actually slowed for these companies over the last two years, indicating that they are becoming healthier by this metric.
Finally, we now show the sales and liability growth for the listed industrial and energy related companies. The rate of top line growth has slowed from 30-40% to just 9% over the last two years while the rate of liabilities growth has slowed from 30-40% to just under 20%. In other words, top line growth is 1/3 of what it used to be while liabilities growth is 1/2 of what it used to be. This implies rising leverage in the part of the economy that is slowing dramatically.
As we stated previously, to us it’s never been a question of whether Chinese growth would slow, but rather how that transition would play out. Would companies who have already accumulated a lot of debt (the industrial sector) accumulate yet more debt in an effort to stem tide or would they acquiesce to their new reality? So far it appears the former is scenario playing out, which can only increase risks to stability.
In any event, it may be helpful to look at the Chinese growth situation from the perspective of the different sectors of the economy being impacted rather than from a one-size-fits all view. Taking a more granular approach might inform the sharp drop off in commodities prices of late as well as the relative performance of developed market industrial, materials, and energy stocks with exposure to the Chinese economy.