Stuck in intervention rut; An upward manipulation of corporate earnings may be next on the agenda for Beijing as it continues to support tumbling stock markets

Cathy Holcombe

4 August 2015 South China Morning Post

We can criticise Beijing for intervening in the stock market, but while up on that soapbox we might as well pull out the telescope and look to what’s coming next. Which is likely this: an upward manipulation of corporate earnings.Beijing did not throw money at a neglected, undervalued market. They have supported and continue to support a stock market that remains highly valued, even after the crash that began in June. This has been undertaken against a backdrop of easing monetary policy and moderate fiscal stimulus, which in ideal circumstances should feed through to stronger sales and bigger earnings for Chinese companies. But circumstances are not ideal. The country is trying to deleverage from a credit-fuelled investment binge while simultaneously transitioning towards a consumption-led economic model. It is not an easy transition, at least not for companies’ bottom lines. Core earnings for non-financial A shares were down 24 per cent year on year in the first quarter of the year, according to Merrill Lynch, and revenue growth declined for the first time since 2009. In the past three quarters, consensus earnings numbers for the A-share market have been consistently downgraded. Yet Beijing ordered banks to lend money to brokerages and fund management firms who then bought A shares, with a gun to their heads. They are stuck in now. Having performed one highly questionable intervention, authorities are now under pressure to pull off another. There are plenty of ways to boost earnings, even as headline economic growth slows or flatlines. Just look at the US stock market, where earnings per share have benefited from a frenzy of buybacks in recent years. Since the A-share market crashed, a number of firms, including the country’s biggest real estate company, Vanke, have announced share repurchases. That said, Chinese firms tend to have small free-floats, which may limit the scope for aggressive buyback action. The government can also directly inject cash into firms through tax cuts, subsidies and grants; indeed, these practices are quite common. In past times, for example, state energy companies enjoyed special tax breaks to offset the effects of burdensome regulations, such as costly price controls. And state-owned firms are not the only historic beneficiaries of such largesse. Of 50 private sector listed firms examined by the research group Fathom China two years ago, 45 had received subsidies. These subsidies were usually awarded by local authorities, and favoured firms with plans for hefty local capital expenditures. Geely is a stand-out example – the carmaker at one point enjoyed subsidies equal to half its profits. Then there are grants. To paraphrase fictional Wall Street character Gordon Gecko, grants are good. Consider as an example China Railway Signal & Communication Corp (CRSC), a state-owned rail switches and signal maker which has a dominant market share in the country’s extensive train-transport market. CRSC, which just raised US$1.4 billion in a Hong Kong listing, has been the recipient of generous government research grants in recent years. Its initial public offering document shows that these grants were equivalent to 67 per cent of earnings in 2012, 70 per cent in 2013, 16 per cent in 2014 and 37 per cent for the first quarter of 2015. Another quick path to juicing sales and profits? Just lift curbs on sectors facing prohibition or quotas due to long-term economic planning preferences. Take cars – a very hard hit sector at the moment, thanks partly to the introduction of stricter quotas on new car licences in big cities. There is a reason for these quotas – to combat gridlock and pollution. But if lifted, one could see frustrated buyers rushing in before the window closed again. After taking great pains to rein in the residential property bubble, Beijing is now trying to inflate that market again. After exhorting heavily indebted provinces to tighten their belts, Premier Li Keqiang is now exhorting them to spend more. Who knows – we might even start to see wine flowing at government banquets again and cadres sporting flashy watches? Whatever it takes to boost economic activity. Through profit-engineering, giveaways and accommodative policies, China’s listed universe may be able to pull off a number of positive earnings surprises in the coming quarters. Meanwhile, of course, the long-term risks multiply. Which is why Chinese officials should not have intervened. But they’re stuck in now.