NATIXIS China Corporate Monitor 2024 - Pressure in profitability can further intensify under Trump 2.0

Chinese corporates have been suffering from weak economic growth with pressure on profitability. After the frenzy and cool-down in China's stock markets following the hype of stimulus, corporate performance may improve if the RMB 10 trillion clean-up plan successfully repairs local government balance sheets and boosts confidence. Despite a more accommodative policy stance, credit risks stay elevated illustrated in the higher share of zombie firms. Externally, China will face greater external headwinds from Trump's comeback, hurting its export engines.In our eighth Natixis China Corporate Monitor, we analyze 3,000 Chinese and 3,000 global corporates. Through our bottom-up analysis, we draw conclusions on the health of Chinese listed companies as well as sectoral developments, focusing on debt dynamics, revenue generation and return on capital. Our assessment of the health of China Inc. helps us draw more rooted conclusions on the state of the economy.Five key themes in 2024China's macro reality is the growth prospects remain challenging with cyclical and structural challenges. Unless the announced stimulus manages to clean up bad debts with more to come to boost consumption, it is unlikely to see an immediate recovery of corporate profitability. While regulations may not tighten further and real estate policies are loosening, headwinds from disinflation, weak confidence, and geopolitics will continue to stay and possibly exacerbate in 2025 and beyond.Weaker return on capital, impact beyond real estate and higher zombie ratiosOur analysis shows that China's corporate health worsened in H1 2024, compared to 2023, mainly due to pressure on revenue generation. On a global level, Chinese corporates see worse decline in revenue generation but with more favorable funding conditions. As such, the gap between China and global peers has remained steady.The result highlights three important challenges. First, there is a significant difference between China's rapidly declining return on capital and the ongoing improvement worldwide. This probably explains why business sentiment in China is bearish, and foreign direct investment has contracted since 2022 after years of expansion.Second, China’s real estate sector is a key drag to corporate health, but it is not alone in deterioration.  China's corporate repayment ability has fallen even when excluding real estate developers. EBITDA-to-interest expense of Chinese corporates fell from 7.6x in 2023 to 7.2x in H1 2024. The multiple is slightly better when excluding real estate developers, falling from 8.8x from 8.7x. This is lower than the global level at 9.0x in H1 2024, which also dropped from 9.4x in 2023.Third, the overall share of zombie firms (defined as EBITDA-to-interest expense lower than 1 for two consecutive years) has risen sharply from 8% in 2023 to 14% in H1 2024. The situation looks slightly better when excluding real estate at 11%, but it is still up from 7% for the same period. Globally, the share of zombie firms stands at 6%.Profitability is the biggest problemDue to the desynchronized interest rate cycle, the direct pressure from debt is limited for Chinese firms. Despite the slower loan growth in the banking sector, Chinese firms (ex. real estate) have stepped up their leverage thanks to favorable interest rates.  However, the additional leverage is not reflected in CAPEX, which has only grown 2% YoY in H1 2024. On revenue generation, China's corporate net income has been falling for two consecutive years. The poor profitability has led to a much worse return on capital, negatively impacting businesses and investors' sentiment.Conclusion: Fixing return on capital is key to boost confidenceDue to the persisting challenges, it is hard to see how China’s corporate health may rebound quickly in 2025. The announced debt restructuring of local governments is positive, but it will take more stimulus to boost corporate confidence and profitability. With Trump's disruptive trade and investment policies, the quickest fix is to lower the debt burden by cutting rates might it will not be enough to turn the page on low profitability. This is specially the case if deflationary pressures remain in place as the US – and possibly others – further close their doors to China’s exports. Policies to improve Chinese corporates’ return on capital seem more urgent than ever.