By Hayden Briscoe, Shamaila Khan and Jenny Zeng
Based on insights from our team’s recent trip to China, we noted that the country is likely headed for a long economic landing. What does that mean for its infrastructure and commodity sectors?
Infrastructure: High Growth, but Some Challenges
Infrastructure, particularly railways and subways, remains a high-growth sector because of a shortage of cargo and passenger capacity. A key issue from our perspective: state-owned enterprises in the sector need to improve their net profit margins and returns on equity, which can be as low as 2% and the low teens, respectively.
Another challenge the sector faces is delays in payments from local government clients. This is actually old news, and the prevailing sentiment is that payments will eventually be made. We haven’t yet heard of any cases of nonpayment, and we don’t expect to. If this happened, though, it would be a serious issue—and not just for construction companies.
The company managers we spoke with—including those at a railway construction company involved in railway-related property development to boost profitability—are broadly positive about the property industry. From their perspective, the sector is in a short-term structural downturn and correction, with a positive medium- to long-term outlook based on China’s continuing urbanization. Railway builders enjoy an advantage when it comes to land acquisition; nevertheless, we think that the strategy of growing their property businesses carries high execution risk.
Commodities: Feeling the Squeeze
For the coal sector, the challenge is to cut capacity and costs; coal prices may have bottomed but there appears to be little upside, as shown in the Display below. High fixed costs make shutting down mines uneconomical, unless it’s done permanently; the alternative is to maintain production but sell at a loss, including “dumping” into overseas markets.
In the cement industry, the overall tone was less negative but still cautious. One company described the pickup in infrastructure as weaker than expected, while the property sector remained sluggish. Sales volume year to date was flat, and managers didn’t expect improvement in the fourth quarter—usually the peak period for cement producers. Oversupply isn’t considered severe, given current inventory levels and the highly regionalized nature of the industry. Firms also reported no problems in rolling over bank loans. Like construction companies, however, cement companies were experiencing longer payment cycles as a result of their exposure to the infrastructure sector.
Our view on the aluminum sector is mixed. One company we spoke with was increasing capacity while its competitors were cutting theirs. The privately owned company had a positive outlook on sales volume and average sales price in light of steady demand for smartphones and tablets, social housing and autos. We expect corporate earnings in the sector to diverge over the next 12–18 months due to a wide range of cost curves, reflecting such factors as access to bauxite, power costs and distance from customers.
Selective Investments Still Rewarding
These assessments—combined with our already published views on banks and property—support our view that China is in for a long economic landing rather than a hard or soft one. We expect the prospects for this to firm up over the next 12–18 months as a number of developments play out:
- Defaults in stressed commodity-related industries, such as the steel sector, in which banks (the lifeblood of the Chinese economy) are reducing their exposures
- Banks remaining in reasonable shape, taking advantage of the targeted flexibility provided by the government to help them avoid a liquidity crisis
- An acceleration in infrastructure spending next year as the initial shock of the anti-corruption campaign subsides
- The property sector muddling through its challenges
This is all predicated, of course, on the government continuing to pursue its reform agenda with only limited and targeted support for economic growth. But we think that path is highly likely. While the short- to medium-term outlook for China is mixed and involves risks, we believe select investments in China can be rewarding for investors.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Hayden Briscoe is Director of Asia-Pacific Fixed Income, Shamaila Khan is a Portfolio Manager in Emerging Markets Corporate Bonds and Jenny Zeng is a Research Analyst in Corporate Credit, all at AllianceBernstein (NYSE:AB).
