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Deleveraging Trend is Set to Pause for China’s Rated Corporates

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Deleveraging Trend is Set to Pause for China’s Rated Corporates

Rated Chinese companies will have trouble maintaining their deleveraging trend now that the earnings rally has faded. However, corporate spending appetite remains restrained, and Chinese authorities are committed to deleveraging for state-owned enterprises. That's according to a report S&P Global Ratings published today titled, "Slower Earnings Growth Drags On Deleveraging For Corporate China."

"We project that debt leverage for our rated portfolio of Chinese companies will increase slightly in 2018, reversing the downward trend in 2017," said S&P Global Ratings credit analyst Chang Li.

Earnings growth is decelerating after a commodities-fueled boost over the past two years, and amid generally tougher economic and financial conditions.

By our estimates, EBITDA will expand by 10% on average for our rated portfolio this year, down from a heady 25% in 2017. Among large sectors in our portfolio, property and mining drove the earnings recovery in 2017. For example, EBITDA jumped 41% in the property sector and 43% in the mining sector. However, EBITDA growth in these two sectors will shrink to 24% and 2% respectively in 2018.

China's deleveraging campaign has contributed to slower investment spending by local governments, supply-glut heavy industries, and property companies. This combined with a crackdown on "shadow banking" and rising U.S.-China trade tensions will lead to slower average revenue and profit growth in 2018.

Chinese authorities have recently begun to fine-tune their financial-risk reduction measures to support corporate financing. This comes amid rising stress and higher default rates, especially for private enterprises.

"We believe easing efforts could take pressure off some Chinese companies facing difficulties in refinancing their debt maturities, especially state-owned enterprises that rely on borrowing new funds to pay off old debt," said Mr. Li.

However, in our view, the most vulnerable borrowers, in particular private enterprises, will continue to face higher refinancing and default risk.

Overall, we have a modest negative net bias in our portfolio, due to deteriorating liquidity, especially for companies in capital goods, metals and mining, and local government financing vehicles.

As of July 2018, our list of "weakest links" and "fallen angels" within the China corporate portfolio has expanded slightly, to nine companies. Four of these companies are in real estate, reflecting this sector's heightened vulnerability to tightening liquidity and refinancing risk.