Mao Money, Mao Problems

Goodyear Tire’s 2017Q3 Volume, Debt Decline in China.

2017-10-28T09:03:00.001-07:00

The Goodyear Tire & Rubber Company (NASDAQ: GT) reported sales of US$3.9 billion in the three months ended September 30, 2017. Compared to the same period last year, sales grew 1.9%, but net income as a percent of sales declined from 8.3% in the third quarter of 2016 to 3.3% in the third quarter of 2017.

Globally, the company was not able to convert price inflation into sales revenue. According to the U.S. Bureau of Labor Statistics (BLS), the import price of rubber products increased 3.2% over the year ended September, 2017, but the company was only able to increase sales 1.9%. The company was able to limit the impact of commodity price inflation. According to the World Bank (WB), the price of rubber increased 18.1% over the year ended September, 2017, but the company’s cost of goods sold only increased 12.2%.

Within China, the company did not benefit from China accounting for half of world vehicle sales growth in the three months ended September 30, 2017. Unit Sales in the Asia Pacific region decreased 1.5% over the same period in the prior year. The Goodyear Tire & Rubber Company disclosed that original equipment tire volume declined 2.9% in the first nine months ended September 30, 2017 compared to the prior year, primarily driven by its consumer business in China.

Despite significant credit growth in China, the company decreased both its unused available funds and amount outstanding in its China credit facility. The amount outstanding declined from US$315 million on December 31, 2016 to US$247 million on September 30, 2017. The interest rate on the amount outstanding increased from 4.68% at the end of 2016 to 4.81% at the end of the third quarter of 2017. This is most likely the result of extending repayment terms further out. The unused available amount decreased from US$252 million at the end of last year to US$218 million as of September 30, 2017. This would indicate that the company is not looking to use the artificial credit created in the Chinese banking system to expand capacity.

The company is positioned in an industry with rising finished good prices, but input prices are rising even faster. The Goodyear Tire & Rubber Company has a cost advantage over its competitors because of its size. Considering that it is not further expanding capital expenditures to covert variable costs into fixed costs, it is likely to benefit disproportionately when the credit cycle busts and commodity prices drop much faster than finished good prices.

Micron Technology Converts China Growth Into Cash in FY2017.

2017-10-27T23:18:00.002-07:00

Micron Technology, Inc. (NASDAQ: MU), a global manufacturer of semiconductors, reported US$20.3 billion in sales for the fiscal year ended August 31, 2017. The company was able to derive most of this growth in China without sacrificing cash flow. A few issues stand out about Micro Technology, Inc.’s relationship with China.

First, the company is operating in an industry experiencing falling finished good prices and rising raw material prices. According to the U.S. Bureau of Labor Statistics (BLS), the import price of semiconductors and other electronic components from China experienced the second largest drop on a year over year basis of all the four-digit categories tracked. As of August, 2017, semiconductor import prices had fallen 1.1% over the previous twelve months and 2.9% on an annualized basis over the last five years. According to the United States Geological Survey (USGS), the average U.S. spot price for silicon metal in August, 2017 was 39% higher than the same month in the previous year. Despite this, Micro Technology, Inc. was able to grow global sales revenue by 63.9% between fiscal 2017 and fiscal 2016, but only incur a 20.1% increase in the cost of goods sold.

Second, the company derives more than half of its sales from customers in China, but has minimal transactions in renminbi. Sales in China reached $10.3 billion in fiscal 2017, or 51.1% of global sales. However, it only mentioned the euro, Singapore dollar, New Taiwan dollar, and yen as currencies other than the U.S. dollar that the company’s global operations have significant transactions and balances.

Third, despite selling more to Mainland China, Micro Technology Inc. reduced its net property, plant, and equipment in China on both a nominal and relative basis. Sales to customers in China increased 96.0% from the prior year and growth in China accounted for 64.2% of global 2017 growth. However, net property, plant, and equipment in China declined 7.7%, or $38 million, from the prior year. On a relative basis, 3.3% of the company’s net property, plant, and equipment was located in Mainland China as of September 1, 2016, but this proportion dropped to 2.3% as of August 31, 2017.

In the fiscal year ended August 31, 2017, Micron Technology, Inc. disproportionately benefited from new credit creation and had fantastic performance on a cash flow basis. The company’s U.S. dollar denominated sales in China exceeded the growth in the Chinese money supply and appreciation of the renminbi. Despite global sales increasing US$7.9 billion and China sales increasing US$5.0 billion in fiscal 2017, accounts receivables only increased by US$1.6 billion. On sales of US$20.3 billion, the company generated net income of US$5.0 billion and operating cash flows of US$8.1 billion. New sales did not come at the expense of higher working capital or lower profitability.

Schnitzer Steel Returns to Profitability, Bleeds Cash in 2017.

2017-10-25T19:01:00.000-07:00

Schnitzer Steel Industries, Inc. (NASDAQ: SCHN) is one of North America’s largest recyclers of ferrous and nonferrous scrap metal. Worldwide steel production levels drive demand for the company’s products. In the fiscal year ended August 31, 2017, the company generated almost US$1.7 billion of sales globally. Compared with the previous year, sales grew 24.8% and increased more than US$335 million. The company is benefiting from the recent massive credit creation in China, but its ability to generate cash flow is worsening.

Sales to China increased to US$216 million from US$150 million, or 43.6%. The growth of sales to China was almost double the growth rate of global sales. The increase in sales to China accounted for 19.6% of global growth for the fiscal year. There are two ways the company is benefiting from artificial credit creation in China.

First, Schnitzer Steel Industries, Inc. notes that Chinese “steel producers are generally government-owned and may therefore make production decisions based on political or other factors that do not reflect free market conditions.” State owned enterprises have the easiest access to new funds from the Chinese banking system, which they can use to buy products from Schnitzer Steel Industries, Inc.

Second, sales outside of China benefit from higher global commodity prices. The company deals with iron, aluminum, copper, lead, and zinc. According to the World Bank, in the twelve months ended August, 2017, copper increased 36.5%, zinc increased 30.8%, lead increased 27.9%, iron increased 24.9%, and aluminum increased 23.8%. Yesterday, General Motors Company reported global vehicle sales data indicating China accounted for more than half of the world’s growth in vehicle sales. That should mean China is driving demand for industrial metals. Much of this demand has been fueled by the massive increase in corporate demand deposits in China.

Schnitzer Steel Industries, Inc. used this windfall to return to profitability after two years of negative net income and reduce debt, but had poor cash flow execution. Net cash provided by operating activities increased from the prior year by only slightly more than one million dollars. Had accounts payable remained flat, the company’s operating cash flow would have been more than 30% lower than the previous year.

Similar to other companies with significant operations in China, Schnitzer Steel Industries, Inc. has generated impressive revenue growth, but worsening cash flow. Although the company did not provide information on the global market for its products, China contributed significantly to its year-over-year growth. The company’s under-performance during the economic expansion indicates the company will also under-perform during the coming economic contraction.

GM: China Drove Half of the World's 2017Q3 Growth in Vehicle Sales.

2017-10-24T23:02:00.000-07:00

General Motors Company (NYSE: GM) competes in the Chinese market through a number of joint ventures under its global Buick, Chevrolet, and Cadillac brands and its local Baojun and Wuling brands. In the three months ended September 30, 2017, the company’s joint ventures in China generated US$12.1 billion in sales. That represents an 11.1% growth rate over the same period in the previous year. Although the company increased estimated market share to 14.2%, up 90 basis points from the third quarter of 2016, the company is performing poorly in China on a profitability and cash flow basis.

Within China, the company’s 11.1% increase in sales only generated a 0.8% increase in net income. Net income as a percent of revenues declined from 8.7% in the third quarter of 2016 to 7.9% in the third quarter of 2017. The company is selling more, but less profitably.

In addition to lower profitability, the company’s cash flows are suffering. In the first nine months of 2017, General Motors generated US$34.1 billion in sales and earned US$2.9 billion in net income in China. However, since the end of 2016, cash and cash equivalents in China declined by US$709 million, despite debt increasing US$145 million. This would indicate the company is funding sales to its customers by increasing its accounts receivables.

The company also reported global data of interest. General Motors Company estimates 23.1 million vehicles were sold worldwide in the third quarter of 2017, up 0.7 million from the third quarter of 2016. Based on the company’s estimates of regional sales, we can calculate that 53.5% of the world’s growth in vehicle sales came from China. That seems unbalanced.

General Motors Financial Company also reported results for the three months ended September 30, 2017. It did not provide China-specific data, but did state: “Equity income in our China joint venture increased due primarily to growth in asset levels driven by increased retail penetration.”

While General Motors Company is financing vehicle sales with its own cash, General Motors Financial Company is also financing consumer debt to purchase vehicles. Both of these activities are driven by artificial credit creation. When China's artificial credit boom ends, the worldwide auto industry will experience a bust.

WABCO is Paying More to be Paid Now in China.

2017-10-23T22:09:00.001-07:00

WABCO Holdings Inc. (NYSE: WBC) is primarily a manufacturer of braking systems for commercial vehicles. In the three months ended September 30, 2017, the company generated US$827.8 million in sales globally, up 22.5% over the same period last year. In the first three quarters of 2017, the company generated US$250.2 million in net income, up 47.6% over the same period last year. Although sales and net income have increased, the company’s cash flows have suffered.

Globally, the company generated US$226.6 million in cash flow from operations in the nine months ended September 30, 2017. This is a decrease of 21.4% or US$62 million. The primary contributor to the decease in cash flow from operations was a US$68.2 million increase in accounts receivables.

Sales in China, which grew 43.4%, were financed at an increasing cost to the company. In the first nine months of 2016, WABCO had discounted with banking institutions or transferred to suppliers in China US$83.6 million worth of notes receivables. In the first nine months of 2017, that amount had more than doubled to US$182.7 million. Not only is the company waiting longer to be paid, the company’s expenses related to discounting these notes have increased at an even higher rate, from US$0.2 million to US$1.6 million.

Although discounting expense is increasing, it is probably safer to transfer the risk of account receivable repayment from a state-owned or public enterprise to a bank. This will allow more cash to be available at a sooner, more certain date. Many other companies are simply recording the sale today and then hoping to collect accounts receivable at an unknown future date.

Nike's Sales in China Come at the Expense of Cash Flow.

2017-10-15T22:46:00.000-07:00

Nike, Inc. (NYSE: NKE) revenues in Greater China grew 8.6% in the three months ended August 31, 2017, compared to the same period last year. The company gave details on accounts receivables, inventory, fixed assets, product types, and distribution channels within Greater China. Even though the company’s sales have grown faster than Mainland China’s gross domestic product and have exceeded the consumer price index for apparel, the company did so less profitably with significantly higher pressures on cash flow.

Of the US$1.1 billion in sales that Nike, Inc. generated in Greater China during the three months ended August 31, 2017, footwear accounted for 68.6%, apparel accounted for 27.8%, and equipment accounted for the balance. Apparel sales grew twice as fast as footwear sales. Equipment sales were negative. Even though the company increased sales by 8.6%, EBITDA only increased 6.2%. This means the company is growing sales by reducing margins, not capturing more value or benefiting from economies of scale.

About two-thirds of Nike, Inc.’s sales in Greater China are sold to wholesale customers, whereas the balance goes to direct customers. Sales to wholesale customers increased only 5.0%. Despite this slower growth, accounts receivables increased 24.4% over the same period. Sales to direct customers grew 16.3%. This is an impressive growth rate, but it must have fallen below the company’s expectations because inventories increased 25.5% over the same period. Although sales are increasing, the company is having to commit proportionally more working capital to support these sales. One positive aspect is the fact that property, plant, and equipment only increased 2.2%, which is much lower than the increase in sales. Asset utilization improved over the period.

Nike, Inc.’s sales in Greater China for the three months ended August 31, 2017 exceeded overall economic indicators and industry-specific indicators for comparable periods in Mainland China. However, the company captured these sales at a lower EBITDA margin and committed working capital at a higher rate than the comparable period last year.

ICBC (Asia) Limited Increases China Exposure, Maintains Renminbi Short Position as of June 30, 2017.

2017-09-26T22:45:00.001-07:00

The Industrial and Commercial Bank of China (Asia) Limited reported today that it had total assets of HK$849.1 billion as of June 30, 2017, of which HK$483.1 billion were deposits from customers. The bank generated HK$9.7 billion in interest income and paid HK$5.2 billion in interest expense during the six months ended June 30, 2017. Three issues stand out for the period covered.

First, the bank increased its total exposure in Mainland China to HK$387.1 billion, up 7.7% since December 31, 2016. This is an annualized increase of 15.9%. On-balance-sheet exposure accounted for most of that, at HK$325.0 billion, and increased 7.3% over the same period. Contingent liabilities, growing 10.7%, were worth HK$60.7 billion. The value of foreign exchange and derivative contracts, valued at only HK$1.3 billion, declined 18.1%. Although these growth rates seem impressive, they are just barely keeping up with the overall increase in corporate demand deposits in China.

Second, the bank increased exposure to counterparties directly inside China, as opposed to financing firms outside of China for investment within the country. Exposure to non-government counterparties described as “[People’s Republic of China] nationals residing in Mainland China or other entities incorporated in Mainland China and their subsidiaries and [joint ventures]” increased 9.9%, whereas exposure to non-government counterparties described as “[People’s Republic of China] nationals residing outside Mainland China or entities incorporated outside Mainland China where the credit is granted for use in Mainland China” only grew 8.3%. This would imply that there will be less inbound foreign exchange flows into China, because the funding has already occurred within China. This should put less pressure on the renminbi to appreciate.

Lastly, the bank’s net short position in the renminbi decreased from HK$1.7 billion as of December 31, 2016 to HK$0.3 billion as of June 30, 2017. The bank’s net long position in the U.S. dollar also decreased from HK$23.8 billion as of December 31, 2016 to HK$15.7 billion as of June 30, 2017. The bank is still short the renminbi and long the U.S. dollar, but to a significantly lesser degree than six months ago. Its positions seem to indicate that the bank believes appreciation in the renminbi will not continue to occur.

The trend of more exposure within China, as opposed to China-inbound exposure, will likely mean less pressure on the renminbi to appreciate. The bank has positioned its short position in the renminbi and long position in the U.S. dollar to benefit from further depreciation of the renminbi.

Trio-Tech International Shifts Capital Expenditures from East China to Southeast Asia.

2017-09-20T21:22:00.001-07:00

Trio-Tech International (AMEX: TRT) is engaged in testing services, equipment manufacturing, and distribution for the semiconductor industry (SIC: 3559). The company generated global sales of US$38.5 million in the year ended June 30, 2017, up 11.8% over the previous year. Net income for the year was US$1.4 million, up 37.1% from the prior year. Free cash flow was 120.5% of net income for the year, whereas free cash flow was negative in the previous fiscal year. Although the company seems to have turned around its operations, events in China that were outside of the company’s control drove these results. At the same time, there are significant opportunities within China to improve future free cash flow.

To support an 11.9% increase in revenue, the company’s cost of goods sold increased 13.2%. The company was not able to control costs. Only the testing segment was able to both grow sales and increase gross margin year-over-year.

The company increased income from continuing operations before income taxes by US$499K year-over-year. However, almost all of that came from a US$467K favorable increase in foreign exchange transactions. The company transacts in the Singapore dollar, Malaysian Ringgit, Thai baht, Chinese renminbi, and Indonesian rupiah. According to the Monetary Authority of Singapore, the renminbi devalued against the U.S. dollar more than the four other currencies during the relevant period. This positively impacted the company’s cross-currency invoicing, but was completely out of the company’s control.

Globally, the company increased additions to property, plant, and equipment by 52.5% year-over-year. However, all of this increase occurred in Southeast Asia. Capital expenditures declined year-over-year at the Tianjin facility, but specific amounts were not disclosed. Although the company had overall decent execution on accounts receivables, the Tianjin subsidiary signed an agreement with a bank for an Accounts Receivable Financing facility for approximately US$871K. This would indicate the company is having cash flow issues in China.

Despite the fact that the company is engaged in the semiconductor industry, about 7.3% of the company’s total non-current assets as of June 30, 2017 were composed of depreciated investment properties in Chongqing, China that were acquired in 2008 and 2010. The current market value of these properties is likely much higher than the book value. The proceeds from these sales, as well as the $4.0 million in cash the company had on its balance sheet, could be deployed elsewhere. If this capital is taken out of China, the company could expand its geographic or product diversification. If this capital is kept in China, the company could expand the testing segment’s capabilities at the Suzhou facility or reduce the need for bank credit at the Tianjin facility.

U.S. Import Prices from China Drop 0.7% in the 12 Months Ended August, 2017.

2017-09-19T22:55:00.000-07:00

The price of imports from China to the United States dropped 0.7% in August compared to the prior year. None of the categories published by the Bureau of Labor Statistics exceeded the appreciation of the U.S. dollar against the renminbi over the same period. Chinese manufacturers were not able to pass on changes in the value of the renminbi to customers in the United States.

Chemical, plastic, and rubber product prices saw the largest increase in prices among the categories published, but only by slightly more than 2.0% over the last year. Over the last five years, plastic and rubber product prices declined 1.9% per year, so a 2.0% increase over the last 12 months was a significant increase in price pressures.

Computer and electronic product prices experienced the largest decrease in prices among the categories published, but only by slightly less than 2.0% over the last year. This was in line with its five-year compound annual decline of 2.2%. Apparel saw the largest negative divergence of prices over the last year compared to the last five years. Apparel prices dropped almost 0.6% over the last 12 months, despite increasing 0.4% per annum for the last five years.

As revenues from sales to the United States decline and input costs in China increase, there should be two effects on production capacity in China. First, entrepreneurs will not add additional capacity to China. Second, producers within China will shift their output to servicing domestic markets, where prices are generally rising. Both trends will contribute further to the de-globalization of the division of labor.

Lightpath’s Operating Cash Flow Suffers in China During FY2017.

2017-09-17T21:52:00.002-07:00

Lightpath Technologies, Inc. (Nasdaq: LPTH), a manufacturer of optical components (SIC: 3674), generated US$28.3 million globally in the year ended June 30, 2017, growing 64.2% over the prior year. The company earned US$7.7 million in net income, compared to US$1.4 million in the prior year, an increase of 450%. Despite this increase, cash flow from operations in the fiscal year ended June 30, 2017 was only 64.8% of net income, compared to 107.8% in the previous year. Based on statements made in the company's annual report, activities in China are driving down operating cash flow.

The company did not provide revenue information specific to China, but it did state that it extinguished all net operating loss carryforwards in China during fiscal 2016 and did not accrue any in fiscal 2017. It did mention, "Revenue from our [high volume precision molded optics] product group had been derived from the industrial tool market in China, which had experienced six years of declining growth." Even though the company is in a declining market, it was profitable this year.

Lightpath Technologies, Inc. did mention China-specific issues related to its operating cash flow. Net assets in China increased from US$9.9 million as of June 30, 2016 to US$12.3 million as of June 30, 2017. The company begins to calculate allowance for accounts receivables starting at the 60-day mark in the United States, but waits until the 120-day mark in China. This implies the company's China-based customers have extended payment terms.

On a global basis, Lightpath Technologies, Inc. is growing revenue and net income, but has poor operating cash flow performance. Much of that seems to stem from China operations, where taxes are being incurred on operations in a declining market, supported by higher net assets, and repaid at extended payment terms.

China’s Excess Liquidity Will Find Ways Around ODI Restrictions.

2017-09-16T17:20:00.001-07:00

China’s foreign currency reserves (excluding gold) ended August, 2017 at almost US$3.1 trillion, down $18 billion, or 0.62%, from a year ago. Over the last five years, China’s foreign exchange reserves have decreased at an annualize rate of 0.72%, so the rate of decline in August was slower than that in previous years. However, since the end of 2016, China’s foreign exchange reserves have increased US$61.5 billion. More than half of China’s gains in foreign exchange reserves came from limiting out-bound direct investment (ODI).

The Chinese authorities have sought to restrict overseas investment projects by Chinese firms. In August, the State Council announced it would limit investment in property, hotels, entertainment, sports clubs, and film industries.

In the first eight months of 2017, China’s out-bound direct investment declined 41.8% compared to the same period in the prior year, to US$68.7 billion. Over the same period, China’s foreign direct investment declined only 0.2%. Had out-bound direct investment maintained the prior year’s level, an additional US$49.3 billion would have left the country.

The change in foreign exchange reserves has mirrored trends in the value of the renminbi against the U.S. dollar. Over the last five years, the U.S. dollar has appreciated against the renminbi at an annualized rate of 0.9%. Over the last 12 months, the U.S. dollar has appreciated 3.1% against the renminbi. However, that trend has reversed since the end of 2016, with the U.S. dollar depreciating 3.7% against the renminbi.

Nothing has changed structurally to reverse the outward flow of China's excess liquidity. If the policy towards outbound direct investment changes soon, we can expect the renminbi’s depreciation against the U.S. dollar to resume. If the policy towards outbound direct investment does not change soon, we can expect excess liquidity in China to find other ways out of the country, such as through the current account.

Corporate Demand Deposits in China up 16.8% in July, 2017.

2017-08-20T18:00:00.000-07:00

Corporate demand deposits in China rose to CNY44.3 trillion at the end of July, according to the People's Bank of China. This is an increase of 16.8% over the previous year. Currency in circulation increased 6.1% over the same period, to CNY6.7 trillion. Both of these rates of increases are higher than the devaluation of the Chinese renminbi to the U.S. dollar and the increase in the Chinese consumer price index over the same period. This means that newly created money is mostly remaining within China, but is not flowing into consumer goods.

Over the last five years, the compound annual growth rate of corporate demand deposits has been 13.7% and the compound annual growth rate of currency in circulation has been 6.2%. July’s number for the growth of currency in circulation was slightly below the longer-term average, but the number for the growth in corporate demand deposits was higher than the longer-term average. This means that firms are receiving the majority of new credit creation, and this is being put into excess capacity creation, not consumption.

Chinese Export Prices to the U.S. Fall 0.9% in July, 2017.

2017-08-19T21:13:00.000-07:00

The aggregate prices of products imported into the United States from China across all industries in July declined 0.9% over the last twelve months, according to the United States Bureau of Labor Statistics (EIUCOCHNTOT). The U.S. dollar appreciated 1.4% against the Chinese renminbi over the same period. This means that, broadly speaking, producing in China and selling into the United States is more profitable on a renminbi-basis than it was a year ago.

On a five-year basis, the compound annual growth rate of aggregate Chinese import prices into the United States has also been 0.9%. Over the same period, the U.S. dollar has appreciated against the Chinese renminbi 1.2% per year. Despite massive amounts of artificial credit creation in the Chinese banking system over the last five years, that new money has not flowed into domestic consumption that would drive up the prices of exports. Instead, that new money has flowed into excess capacity to supply a greater amount of goods.

The artificially suppressed price of money within China has funded a decades-long expansion of capacity within China far and above the needs of China’s domestic market or the international economy. In order to inhibit further expansion of capacity, the price of products exported from China will have to fall faster than the depreciation of the renminbi. Existing firms will not add capacity and new firms will not be created to supply markets with declining prices. The adjustment process will require a decline in the value of the renminbi to increase input costs for Chinese producers. As goods become less profitable, firms will supply fewer goods to the market. At the same time, prices within China need to fall further to allow consumer surpluses inside and outside of China to soak up the excess supply.

THTI Reports Losses, Negative Cash Flow, and More Debt in the Second Quarter of 2017.

2017-08-16T18:30:00.000-07:00

THT Heat Transfer Technology Inc. (Nasdaq: THTI) is a total solution provider in the heat exchange industry with primary operations in China. In the three months ended June 30, 2017, the company generated sales of $7.5 million, down 3.4% over the same period in the prior year.

In addition to negative top-line growth, the company booked US$732K in negative net income and generated negative cash flow from operations. The company disclosed that it had repaid in full a one-year loan for CNY32 million at 4.78% interest with Agricultural Bank of China (HKEX: 1288) in May, 2017. However, in June, 2017, Agricultural Bank of China extended another one-year loan for the same amount at the same interest rate to the company. The company reported the U.S. dollar value of this loan as $4.7 million. As of June 30, 2017, a few weeks after the loan was granted, the company only had $4.2 million in cash on hand, meaning its entire cash position came from that one loan.

Agricultural Bank of China is rolling over its own loan at the same interest rate and collateral to a non-profitable company with a negative cash flow from operations. Without the ability to expand artificial credit at suppressed interest rates, the bank would not be able to support further misallocation of capital. Without this loan, the company would have insufficient cash on hand. To correct its cash position, it will need to reverse the $4.1 million increase in net inventories and $1.1 million decrease in accounts payable during the six months ended June 30, 2017. Although that will help in the short term, its position in the Chinese heat exchange technology industry might not be profitable.

Debt and Negative Free Cash Flow Drives Chinese Auto Industry in Second Quarter of 2017.

2017-08-15T21:25:00.000-07:00

In the second quarter of 2017, the Chinese auto industry has seen significant growth in sales, but many companies have not been able to convert this into free cash flow. Both banks and suppliers are providing the industry with artificial credit that is misallocating capital.

China Auto Logistics, Inc. (Nasdaq: CALI) reported $138.7 million in net sales in China during the three months ended June 30, 2017, up 47.9% over the prior year. However, the company had negative net income and generated negative cash flows from operations. Loan agreements from two Chinese banks facilitated these results. Agricultural Bank of China (HKEX: 1288) loaned the company CNY35.0 million, bearing interest at a rate of 4.79% over a borrowing period of six months. China Zheshang Bank (HKEX: 2016) loaned the company CNY54.0 million, bearing interest at a weighted average rate of 5.50% over six-month borrowing periods.

SORL Auto Parts, Inc. (Nasdaq: SORL) generated US$70 million in China during the three months ended June 30, 2017, up 25.9% over the same period in the prior year. Sales within China accounted for 77.6% of total sales. Although the company reported US$14.2 million in net income, a US$16.8 million increase in accounts receivables was the largest contributor to negative US$3.2 million operating cash flows. To accommodate this, the company increased short-term bank loans from US$27.4 million on December 31, 2016 to US$47.0 million on June 30, 2017. These short-term loans were obtained from Bank of China (HKEX: 3988), Bank of Ningbo (Shenzhen: 002142), Agricultural Bank of China, China Zheshang Bank, and China Construction Bank (HKEX: 0939). The annualized interest expenses paid in the three months ended June 30, 2017 equate to an average interest rate of 4.6% on those loans.

China Auto Logistics, Inc. generated impressive sales growth, but was unable to due so profitably or convert that growth into free cash flow. SORL Auto Parts, Inc. grew sales revenue quickly and profitably, but grew debt faster and generated negative free cash flow. This indicates that the growth in the Chinese auto industry is disproportionately driven by cheap credit, which in this case was particularly driven by China Zheshang Bank.

China-Related Annual Reports for the Week Ended 2017-08-11.

2017-08-14T21:43:00.000-07:00

Maxim Integrated Products, Inc. (Nasdaq: MXIM) designs, develops, manufactures, and markets linear and mixed-signal integrated circuits. In the year ended June 24, 2017, the company generated $843.3 million worth of net revenues from unaffiliated customers in China, its largest geographic reporting segment. Compared to the prior fiscal year, revenues grew 0.7%. The company stated that almost all of its global sales are denominated in U.S. dollars.

Landec Corporation (Nasdaq: LNDC) designs, develops, manufactures and sells differentiated health and wellness products for food and biomaterials markets. In the year ended May 28, 2017, the company generated sales of $12.1 million in China, up 45.7% over the prior fiscal year.

2017 Relaunch.

2017-08-13T21:11:00.000-07:00

Mao Money, Mao Problems is being relaunched. The primary goal of this effort is to provide readers with timely updates and analysis of China’s business cycle asrelevant data becomes available. The basic framework of these writings is that China, like all other economies, has a structure of production that is more important than the size of aggregate economic activity. A re-adjustment is overdue, and that adjustment will most likely manifest itself in a massive devaluation of the Chinese renminbi. When that adjustment happens, a few quality companies and assets will be excessively undervalued. Ideally, those opportunities are identified early.

On a monthly basis, readers will have updates on the stock market valuation, private sector interest rates, relative price trends, and money supply data. On a daily basis, readers will have updates on China-related disclosures of U.S.-listed companies.

Flashback: "Two Prisms for Looking at China's Problems"

2016-08-11T08:00:00.000-07:00

Introduction: The Chinese economy began to show signs of a downtrend in the business cycle long before the current troubles. Instead of welcoming the adjustments, Chinese policy makers opted for more Keynesian stimulus. Did lower interest rates, more artificial credit, and more fiscal spending delay the adjust process? Yes. Did it eliminate the need to adjust? No.

The New York Times - August 11, 2012 - Tyler Cowen - "Two Prisms for Looking at China's Problems"

China is confronting some serious economic problems, and how Beijing does — or doesn’t — respond to them could bend the course of the global economy.

First, China’s real estate bubble is deflating. But its economy also seems to be suffering from what we economists call excess capacity — an overinvestment in capital goods, whether in factories, retail stores or infrastructure. So what now? The answer depends in part on your school of economic thinking.

Keynesian economics holds that aggregate demand — the sum of all consumption, investment, government spending and net exports — drives stability, and that government can and should help in difficult times. But the Austrian perspective, developed by the Austrian economists Ludwig von Mises and Friedrich A. Hayek, and championed today by many libertarians and conservatives, emphasizes how government policy often makes things worse, not better.

Economists of all stripes agree that China may be in for a spill. John Maynard Keynes emphasized back in the 1930s the dangers of speculative bubbles, and China certainly seems to have had one in its property market.

Keynesians would argue that Beijing has the tools to stoke aggregate demand. It could, for example, adjust interest rates and bank reserve requirements, instruct state-owned banks to maintain lending, or deploy some of its $3 trillion in foreign exchange reserves. The government also appears to have many shovel-ready construction and infrastructure projects that could help the economy glide to a soft landing and then bounce back.

The Austrian perspective introduces some scarier considerations. China has been investing 40 percent to 50 percent of its national income. But it is hard to invest so much money wisely, particularly in an environment of economic favoritism. And this rate of investment is artificially high to begin with.

Beijing is often accused of manipulating the value of its currency, the renminbi, to subsidize its manufacturing. The government also funnels domestic savings into the national banking system and grants subsidies to politically favored businesses, and it seems obsessed with building infrastructure. All of this tips the economy in very particular directions.

The Austrian approach raises the possibility that there is no way for China to make good on enough of its oversubsidized investments. At first, they create lots of jobs and revenue, but as the business cycle proceeds, new marginal investments become less valuable and more prone to allocation by corruption. The giddy booms of earlier times wear off, and suddenly not every decision seems wise. The combination can lead to an economic crackup — not because aggregate demand is too low, but because the economy has been producing the wrong mix of goods and services.

To keep its investments in business, the Chinese government will almost certainly continue to use political means, like propping up ailing companies with credit from state-owned banks. But whether or not those companies survive, the investments themselves have been wasteful, and that will eventually damage the economy. In the Austrian perspective, the government has less ability to set things right than in Keynesian theories.

Furthermore, it is becoming harder to stimulate the Chinese economy effectively. The flow of funds out of China has accelerated recently, and the trend may continue as the government liberalizes capital markets and as Chinese businesses become more international and learn how to game the system. Again, reflecting a core theme of Austrian economics, market forces are overturning or refusing to validate the state-preferred pattern of investments.

For Western economies, the Keynesian view is much more popular than the Austrian view among mainstream economists. The Austrian view has a hard time explaining how so many investors can be fooled into so much malinvestment, especially given the traditional Austrian perspective that markets are fairly effective in allocating resources. But China has had such an extreme and pronounced artificial subsidization of investment that the Austrian perspective may apply there to a greater degree.

The optimistic view is that Chinese excess capacity and overbuilding are manageable — that the current overextensions of investment will be propped up, but they won’t have to be propped up for long. In this view, the Chinese economy will fairly soon grow rather naturally into supporting its current capital structure, and its downturns will be mere hiccups, not busts.

The pessimistic view is that the problems are so large that the government’s attempts to prop up its investments with further subsidies could so limit consumption, and so distort resource allocation, that the Chinese economy will stagnate. In this view, the political means for allocating investment would grow to dominate market forces, the proposed “economic rebalancing” of the Chinese economy toward domestic consumption would become a distant memory, and China would have an even tougher time opening its capital markets and liberalizing its economy. Given that China already faces competition from nations where wages are lower, and that its population is aging, the country might not return to its previous growth track.

The jury is out. But to my eye, we may well find a significant and lasting disruption, closer to what the Austrian theory would predict. Consider a broader historical perspective: How often in world history have countries enjoyed 30-plus years of extremely rapid growth without a major economic tumble somewhere along the way? One can be optimistic about China for the long term and still be fearful for the next turn in its business cycle.

In any case, China has surprised the world many times before — and is likely to surprise it again.

Apparently, the China Century Already Ended.

2016-01-31T12:06:00.003-08:00

Back in June, 2015, I asked the question: "Will the China Century end in 2019?" That article analyzed International Monetary Fund projections to point out in that year China will contribute less nominal gross domestic product than the United States.

According to Bloomberg, this already happened in 2015.

For the first time in almost a decade, China has lost ground in catching up with the U.S. economy, when output is measured in dollars.

U.S. gross domestic product increased $590 billion in 2015 from a year earlier, according to data released Friday. China’s economy, while reporting 6.9 percent growth for the year, added $439 billion, as a weaker yuan sapped the value of output gains in dollar terms, according to data compiled by Bloomberg. [Read more...]

Bloomberg: "Devaluation Watch May Force China to Pay Premium on Dim Sum Debt"

2015-11-23T08:00:00.000-08:00

Fion Li. Bloomberg. November 22nd, 2015.

China is set to pay more to sell sovereign bonds in Hong Kong than in the onshore market for the first time, as investors brace for the possibility of another yuan devaluation.

The Ministry of Finance will sell 14 billion yuan ($2.2 billion) of Dim Sum notes in the city this week, including 2 billion yuan to individuals. The yield on offshore yuan securities due 2020 was 3.39 percent on Nov. 20, 25 basis points higher than debt of the same maturity in Shanghai, suggesting the government will have to pay more to borrow outside of the country.

2015-10 Relative Price Trends

2015-11-22T08:00:00.000-08:00

In October, consumer prices increased by 1.3% from the same month last year, and purchaser prices decreased -6.9% over the same period. The rate for consumer prices was the lowest increase in five months, and the rate for purchaser prices was the lowest since 2009. Based on this metric, the Chinese business cycle is in its 47th month of contraction.

2015-10 Stock Market Valuation

2015-11-08T08:00:00.000-08:00

The Chinese stock market bounced back in October to 0.28 gold ounces, up 0.04 ounces since the end of September. It was primarily valuation driven, because the price-to-earnings ratio increased faster than the gold price. Despite being down from the peak, the index is still up 46% over the last 12 months, and has seen positive growth for 34 consecutive months.

2015-10 Relative Equity Performance

2015-11-01T08:00:00.000-08:00

In October, the exchange traded fund tracking the consumer goods sector, CHIQ, fell -0.58% over the trailing twelve months. The materials sector equivalent, CHIM, fell -10.79% over the same period. This is the second month in a row that CHIQ has outperformed CHIM, and is close to being positive over the trailing twelve months. This trend should continue if the cost of raw materials continue to fall at an accelerating rate while consumer prices are essentially flat.

2015-09 Interest Rate Trends

2015-10-25T08:00:00.000-07:00

In September, the overnight interbank rate and private lending rate saw a continuation of the previous divergence in rates.

The Shanghai Interbank Offer Rate ended September at 1.99%, up 19 basis points from August. Despite central bank policy, nominal rates have continued to rise over the last five months, although this September was still 57 basis points below the trailing average for September of 2.56%.

The Wenzhou Comprehensive Index ended September at 19.20%, down one basis point from August. September's rate was 71 basis points tlower than the trailing average for Septembers.

According to Reuters, the situation for smaller enterprises is only getting worse:

The central bank has cut official lending rates five times since November by a total of 1.4 percentage points to 4.6 percent. But instead of falling, lending rates to SMEs have risen by 2 percentage points as willing lenders become scarce.

The Wenzhou index, which tracks private lending, shows the rate for 1 year or more has risen to 18 percent from around 16 percent in November. In April, rates were as high as 24 percent.

The state-dominated banking sector has become more selective in issuing loans in general, as non-performing loans increase in the economic slowdown. China's big-four banks all reported a rise in non-performing loans in the latest quarter.

China's economy is heading for its weakest growth in 25 years, and a recent run of poor data suggests it is struggling to meet its 7 percent target for 2015.

So only the brave are stepping in to lend to its most vulnerable firms - small, medium and micro businesses. That is reflected in central bank figures showing that while overall lending in China has risen, new loans to small businesses fell in the first half of the calendar year compared with the same period in 2014.

2015-09 Relative Price Trends

2015-10-18T08:00:00.000-07:00

In September, consumer and purchaser prices maintained their previous levels. Consumer prices increased 1.6% over the last twelve months. This rate of increase came down from 2.0% in August. Purchaser prices fell 6.8% over the same period, which exceeded the rate of 6.6% seen in August. This is the fastest decrease since November, 2010.

Based on this metric, China has been in a recession for 46 months. The other metrics followed on this blog, such as relative equity trends and stock market valuations, are also showing declines in economic activity.