Corporate health hurt by lower profit margin but supported by cheaper funding

Although China's real GDP growth looks stable at around 5% in the last three quarters, persisting deflationary pressure and lower nominal growth are taking a toll on corporate profitability. While firms can digest debt through active deleveraging, the hurdle to raising profits is higher than it would have been under inflation. The trends have altered China's investment strategy from a broad-based growth story to a more selective one. In our China Corporate Monitor Series 2025 – the ninth release of Natixis annual flagship report covering 10,000 companies – we address questions relating to Chinese corporates’ health and how it compares with their global peers.Credit risks from a higher share of zombie firmsChina's corporate health has remained stable on an aggregate basis, with unchanged repayment ability in 2024. However, there is growing polarization between large and small firms. This explains why companies’ confidence levels remain weak. Credit risk is also on the rise, with the share of zombie firms increasing from 6% in 2018 to 12% in 2024. This deterioration in credit risk, especially for smaller companies, is happening notwithstanding the lower interest rates, thanks to supportive monetary policy. The main reason is sinking revenue and profit margins.Forget leverage, it is now a revenue problemAlthough debt fueled by excessive leverage was the biggest concern for Chinese firms, this is no longer the case now. In fact, Chinese and global firms both deleveraged, but for different reasons. For Chinese firms, the leverage ratio declined from a peak. However, this comes simultaneously with lower interest rates, reflecting weak credit demand and uncertainty about the future. In turn, global peers have declining and lower leverage than China as a response to the higher and elevated interest rates.What distinguishes China's corporate health from that of its global peers is revenue generation. There is an evident decline in the performance of Chinese firms, as measured by median income growth and profit margins. China's corporate income growth dropped from 17.3% in 2018 to -3.2% in 2024, while profit margin declined from 8.1% to 5.1% during the same period. It shows the bulk of the improvement is concentrated in a few large firms and sectors. Economic growth may be stable, but it is difficult for most firms to generate profits.Structurally weaker return on capital has now restricted investmentThe weaker revenue generation has had consequences on the return on capital (ROC). Deflation is, among other factors, a consequence of price wars, especially in manufacturing stemming from stagnant consumption. This is very specific to China with global peers enjoying a higher profit margin across the board. More specifically, Chinese corporations’ average ROC declined from 8.2% in 2018 to 6.5% in 2024, while that of global peers increased slightly from 10.3% to 10.7%. As such, the lower return on capital has led to self-correcting behavior in terms of lower investment. More specifically, Chinese companies’ CapEx is decelerating. Still, R&D remains an area where Chinese firms continue to invest despite the headwinds.Weak confidence because of the gap between growth and corporate profitsAll in all, there is a divergence between the seemingly stable real economic growth and declined corporate profits in China, explaining why any recovery in business confidence has remained subdued. The low profit margin is the number one concern for Chinese firms now, and this issue will likely persist, especially if Trump’s tariffs remain in place and other countries impose similar tariffs. Unless there is a recovery in nominal growth, opportunities in China’s corporate world will remain selective.