China’s A-Shares Earnings Lost Momentum In 1Q

Chinese A-share companies’ earnings enjoyed a turnaround in 2013, but it rapidly lost momentum by the first quarter this year. The headwinds facing the market will remain strong over the next few quarters at least, says a report by Bank of America Merrill Lynch Global Research.

China’s A-share non-financial companies’ core earnings declining by 2.7% year-on-year. Chinese banks’ earnings growth also continued to decelerate.

Not surprisingly, the market has revised down its 2014 earnings estimate by about 5% since March, after holding its market earnings per share (EPS) forecast fairly steady since Sept 2012.

BofA Merrill says it expects more negative revisions to come, given a lack of major stimulus and the unsettled shadow banking sector and property market.

The bank warns the risks in China’s financial stocks. For the 16 listed Chinese banks, which represent about 93% of the country’s total commercial banking assets, revenue/earnings growth is slowing down, non-performing loan (NPL) is picking up, NPL coverage ratio is declining, loan-to-deposit ratio is going up and their reliance on whole-sale deposits or borrowed funds has gone up.

The only bright spot appears to be a declining assets/equity ratio, but much of this depends on assets quality.

For the non-financial A-share companies, earnings are weak as well. Profit grew by 13.0% year-on-year in 2013, a sharp turnaround from a decline of 14.3% in 2012.

Nevertheless, total profit was still below the peak reached in 2011 and growth declined to 3.9% year-on-year. Core earnings also dropped 2.7% in the first quarter. The fourth quarter 2013 to first quarter 2014 earnings growth deceleration is the largest on record.

Cashflow continued to deteriorate as well. For non-financials, operating cash flow turned negative in the first quarter, the first time since 2006 when the bank started tracking this data. Inventories days, receivable days and conversion cycle days all reached all-time highs in the first quarter.

Leverage also rose. Net debt to equity ratio rose to 52% by the first quarter, up from 48% in the first quarter last year, and 44% in the first quarter 2012.

In the first quarter, real estate, capital good, chemicals and coal sectors leveraged up rapidly. Consumer durables, telecom and utilities were the only three sectors that managed to de-leverage, says the report.