By Kang Yi (康怡)
News, Cover
Issue No. 531, Aug 8, 2011
Translated by Zhu Na
Original article: [Chinese]

Centrally-administered state owned enterprises are often thought of as being the backbone that helps give shape to China Inc., they're often called upon to play an important role in stabilizing the economy during tough economic times and they also have an advantage over their competitors when it comes to getting access to capital or winning contracts. Despite these advantages and the perceived strength of these companies, many centrally-administered state-owned enterprises, or COEs, are likely to experience difficulties over the coming months as both increasing business costs and an uptick in the amount of money owed by their customers begins to take their toll.

Tighter Capital

COEs have started to encounter the same difficulties as many small and medium-sized enterprises (SMEs); their accounts receivables are beginning to increase. In the first half of 2011, accounts receivables at the 100-odd SOEs that fall under the control of the State-owned Assets Supervision and Administration Commission (SASAC) exceeded 1 trillion yuan, a historic high.

SASAC released data revealing that the accumulated operating revenue of all COEs is around 9.68 trillion yuan, which means that in the first half of 2011, accounts receivable as a proportion of operating revenue had already exceeded 10 percent, much higher than the level at most listed companies, which in 2009 averaged 6.43 percent and was at 5.24 percent in 2008.

An employee with one COE told the EO that one large but unspecified COE with annual operating revenue in excess of 10 billion yuan, now had 4 billion yuan in outstanding bills, which was a new record for the company.

A source from a commercial bank told the EO, that he noticed that COEs had started to pay more visits to the bank since the second quarter of the 2011. This can be viewed as a sign that some COE are being squeezed and are finding it difficult to get access to capital.

Business Costs Rise

Tight capital is only one side of the coin, the business costs of COEs are also increasing.

According to statistics obtained by the EO, the prime operating costs of COEs rose by 25 percent compared with the same period in 2010 and the operating costs of local state-owned enterprises increased by 27 percent. The two main factors that are pushing up business costs are raw materials and labor.

"Considering that some COE, especially those connected with infrastructure construction, have hired a large number of workers, this would have flowed through to increases in labor costs in the first half of the year," Zhao Qingming, a senior researcher with the China Construction Bank said.

In addition, for COEs that already have sizable debts, the increased cost of financing this debt is also putting them under increased pressure. China's central bank has increased interest rates three times and increased required reserve ratios six times in order to put a lid on inflation. The one-year lending rate for RMB denominated loans reached 6.56% at the time this article was written.

An industry insider told the EO that, "when you consider that over half of the COE have average debt-to-assets ratios of over 65 percent, then obviously the increase in official interest rates is going to have a big impact on their financing."

Issuing More Corporate Bonds

In order to cope with the increased cost of capital, aside from increasing the frequency of their visits to the bank, COE are also issuing more corporate bonds.

According to data revealed to the EO, in the first half of the 2011, 99 COEs issued bonds, raising a total of nearly 455 billion yuan, a year-on-year increase of 16 percent, which is about the same as the 457 billion yuan in accumulated net profit that all the COEs made in the first half of the year.

"Although COEs have always been the main customers of the commercial banks, now that the constant flow from the banks is drying up by the day, it's unrealistic to think that this once never ending stream of credit is ever likely to return," Zhao Qingming explained.

Zhao, who is optimistic about the COEs' use of the bonds market to raise capital, went on to note, "COEs have relatively high credit ratings, therefore the cost of financing is quite low, in addition, this can help to reduce the tight hold that banks have over COEs."

On July 13, China Huaneng Group (華能集團公司) successfully issued their third tranche of short-term financing bonds for the year. Huaneng sold 4 billion yuan worth of one-year bonds with a 5.09 percent coupon, which, even after taking account of other expenses, meant the cost of raising funds was still only around 5.49 percent, 1.07 percentage points less than the benchmark lending rate.

"By doing so, we were able to save 42.8 million yuan," a person with ties to the Huaneng Group told the EO.

Although SASAC has been encouraging COEs to raise funds through the issuance of bonds, the regulator has also begun to warn companies of the associated risks.

At the start of July last year, SASAC established a supervision and regulation system aimed at keeping track of bonds being issued by COEs. SASAC said the purpose of setting up this system was to get a general understanding of the bond issuance, strengthen management and to prevent and control risks.

Tough Times Ahead

The phrase "tough times" got quite a bit of use three years ago during the 2008 financial crisis. Executives at some COEs told the EO that they're worried that the tough times will be even worse than those faced in 2008. Many COEs only managed to make it through the depths of the financial crisis thanks to the 4 trillion yuan stimulus package unveiled by the central government at the end of 2008.

It's unlikely that they'll be so lucky this time as there appears little interest in introducing any major policy initiatives aimed at supporting the large state-owned groups.

Some experts are worried that a few COE might have their funding channels cut off completely - with the example of the problems that hit Huayuan Group in 2005 still fresh in many analysts' minds.

"Once the funding channels of some COEs are blocked, they will be very close to bankruptcy," said Zhu Boshan (祝波善), General Manager of Shanghai Tacter Consulting Management Corporation

Mr. Zhu said, "some of the COEs operating in the construction sector, have local governments as their major customers. A large part of the increasing size of these COEs' accounts receivables are owed by local governments who are operating on very tight budgets."

Mr. Zhu also went on to note that, "COEs have maintained rapid growth almost every year for so many years, we need to reconsider whether this trend can continue and whether it's sustainable. SASAC needs to offer some direction on this point, on the one hand they're requiring COEs to quicken the pace of reforming the model of economic development, on the other hand, they're also asking COE to maintain growth, but they need to provide clear directions on how businesses should balance these goals."