Industrial profit growth led by stimulus-driven sectors

Analysts warn that rosy picture may fade as state support is withdrawn

Industrial profit growth led by stimulus-driven sectors

(ATF) Recovery in China’s industrial firms’ profits quickened in June due to a favourable base with stimulus-driven sectors posting the fastest acceleration over the previous month in a signal that a rebound in the world’s second-largest economy remained on track.

Profits at China's industrial firms in June rose 11.5% on the year to 666.55 billion yuan ($95.27bn), the quickest profit growth since March 2019.

That was the second-straight expansion; May marked the sector's first monthly growth in earnings since November, before the onset of the coronavirus pandemic.

“This looks quite incredible, but it's not that amazing,” said Iris Pang, Chief Economist, Greater China at ING Bank. “Covid-19 has subsided a lot in China, and therefore social distancing measures have also reduced substantially.

“This is positive for domestic demand and for related manufacturing activity in China. Some recovery from Covid-19 in parts of the rest of the world will also have helped China's manufacturing output and profitability in June.”

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She said that steel and non-ferrous metals profit growth had been boosted by stimulus spending, a factor that would drive other sectors in the near future.

“We expect that as infrastructure projects began to pick up speed in June, infrastructure projects should be able to bring some profit growth to building material sectors in the coming months,” Pang said.

For January-June, industrial firms' profits fell 12.8% year-on-year to 2.51 trillion yuan, but easing from a 19.3% dive in the first five months.

After a record slump early in the year, China's economy rebounded more than expected in the second quarter as virus lockdown measures ended and policymakers ramped up stimulus. But analysts warn that the rebound is heavily reliant on state-led investment, while domestic and global demand remain weak.

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Industrial revenue growth accelerated in June to 4% from 1.6% in May. The implied real industrial sales growth in June was 7.2%, versus 5.5% in May and stronger than the industrial production growth in June.

“The higher year-over-year growth of real industrial sales compared with industrial production suggest a continued de-stocking trend: the sales-to-production ratio in the industrial sector improved in June,” Goldman Sachs analysts Maggie Wei, Hui Shan and Yu Song said in a report.

Upstream industries' profit growth improved though still remained below downstream industries' profit growth, they wrote. Upstream industries' profit growth in June was 7.8% on the year versus a 28.7% decline in May; downstream industries' profit growth was 14.2% versus 30.7% in May.

Goldman Sachs estimates showed ferrous metal smelting and pressing profit growth improved to 27.1% growth from a 51% contraction in May. Profit growth in utilities improved to 33.1% from 10.1% in May.

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Steel, oil and gas extraction, oil refining and non-ferrous metals saw significant improvements in profit in June with manufacturing costs easing and demand improving, said Zhu Hong, an official at the statistics bureau, in a statement published alongside the data.

But Zhu warned the outlook was clouded as demand remains weak amid the effects of the COVID-19 pandemic and the international trade situation is "complex and severe," so uncertainties remain over the sustainability of profit growth.

“Looking forward, as industrial activity has largely recovered, sequential industrial activity growth may slow from the fast increase since March,” the Goldman Sachs analysts wrote in the report. “On the other hand, we expect PPI deflation to narrow by Q4 this year, which could be less of a drag on industrial profit growth.”

Producer prices

Major manufacturers of raw pharmaceutical ingredients and medical equipment, including Zhejiang Nhu and Zhejiang Yueyue, said they expect stronger profit for the first six months on better sales.

Gauges ranging from factory surveys to producer prices have all reflected signs of a further pickup in manufacturing, but analysts say factories could have a tough time maintaining momentum as pent-up demand wanes, exports struggle and heavy flooding disrupts construction and other economic activity in the Yangtze Delta.

“The recent flooding is not over yet, even if it is not actually getting worse,” said ING’s Pang. “Reconstruction following the flood will increase industrial activity, and hopefully, bring some profit to industries that have not been beneficiaries of infrastructure projects.

“But this may not be enough to cover the economic loss from the flood, which has damaged a lot of buildings, dams, and agricultural land.”

Rising inventories and sluggish demand could also weigh on profit margins.

Earnings at China's state-owned industrial firms were down 28.5% in the first six months, after slumping 39.3% in January-May, the statistics bureau data showed.

Liabilities at industrial firms rose 6.4% on an annual basis at end-June, versus 6.6% growth as of end-May.

Private-sector profits fell 8.4% in January-June, narrowing from January-May's 11% fall.

The industrial profit data covers large firms with annual revenue of more than 20 million yuan from their main operations.

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