CHINA’S MANUFACTURING SECTORTHE END OF A GREAT GROWTH ERA?

CHaINANovember 7, 2012

Shanghai, China

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ECONOMIC SLOW DOWN BUT STILL LEADING THE PACK…

“With China’s interest rate cuts and the reduction in the reserve ratio, as well as the recent announcement of stimulating infrastructure investment, we are very confident that we’ll see a soft landing in China. The Chinese government is taking the appropriate steps to drive a rebound in economic growth by the fourth quarter of this year and in 2013”

- Kevin Thieneman, Country Manager of Caterpillar China, India and ASEAN

• The growth rate in Q2 2012 marked the sixth consecutive quarter of decline and was the slowest pace since the first quarter of 2009

• Earlier this year, China reduced its GDP target for 2012 to 7.5% down from 8% in the face of a persistent slump in the United States and spreading debt woes in the European Union

• To buy the economy, China has adopted a string of pro-growth measures, including lowering banks’ reserve ratio to boost lending, subsidizing energy-saving household electrical appliances and speeding up approval for major construction projects

2010 2011 2012 (Q1) 2012 (Q2)

Source: Solidiance Research

… BUT IS THERE “TOO MUCH STIMULATION”?

AT FIRST: IT WORKED!• i.e “year of the train”. The Railways Ministry announced that it would spend Rmb700 billion on laying track that year,

creating 6 million jobs. The Beijing-to-Shanghai bullet train line alone would cost $30 billion, making it the single-most expensive construction project since 1949. By 2011 it had put down 10,000km of high-speed rail, four times more than Japan

BUT WOULD THE INFRASTRUCTURE EVER BE ABLE TO PAY FOR ITSELF? • Even the Ministry of Railways admitted that its flagship Beijing-Shanghai line wouldn’t break-even “in the short term”• Performance: Trains were breaking down or experiencing lengthy delays and of course the terrible crash in Wenzhou last

year• Corruption: February last year, Liu Zhijun, the Railways Minister, was detained having amassed Rmb1 billion

MOUNTING DEBT• Ministry of Railways by now has debt of Rmb2 trillion, an unprecedented amount• But a greater worry are the “Local Government Financing Vehicles”. Setup to borrow from state banks to finance local

infrastructure spend, a classic off-balance sheet exercise• The central bank concluded that local governments were on the hook for at least Rmb14 trillion of financing vehicle debt

(much more, say others)

Source: Solidiance Research

Not only foreign companies are feeling the slowdown

Key Performance Indicators (KPI) & Remarks

• Growth at Sany Heavy was extremely rapid up until the end of 2011, with purchases of Putzmeister bringing sales into Europe.

• Equipment sales forecasts have been slashed in China for 2012.• Recent IPO planned for the HK stock exchange has been halted• The workforce at Sany Heavy has been cut in recent months.

• Zoomlion reported an 8.3% increase in sales in Q1 2012 over Q1 2011• One reason for the increased sales data is that Chinese firms are keeping

revenue buoyant by extending more credit to customers.• At Zoomlion, accounts receivable rose to more than 200% of sales in the first

quarter, up from 90% in June 2010.

• President Zeng Guang’an warned that a consolidation in the industry was imminent as production is cut and companies step up efforts to sell more equipment. “We have too much investment. We need more consumption,” Zeng said in a recent interview. “In China, we are going to slowly change the structure of our economy,” he said, alluding to top-down efforts to stimulate domestic consumption. (WSJ Nov 2012)

• Third quarter net profit falling 85% to US$3.3 million.

DOMESTIC PLAYERS SEEM TO BE COPING BETTER – BUT ARE THEY?

• One reason is State sponsored spending giving Chinese players an edge to win additional projects. In addition, Chinese firms started out the year attempting to maintain revenue growth by extending favorable credit terms to customers

• This move is supported by the Chinese government and that ordered the banks to provide “easier” access to loans/refinancing options.

• It remains to be seen how Chinese companies are going to deal with rapidly expanding Accounts Receivables

As foreign rivals struggle to achieve sales targets, China’s homegrown manufacturers say their businesses are still expanding

Source: Solidiance Research

Source: Solidiance Research

• Reduce capacity (less shifts, force staff to take holidays)• Delay investments• Export to other country markets as a short term destination, to maintain

productivity of Chinese factories• Load distributors with inventory

SHORT TERM FIXES

Acquisitions • Introduce a “B” brand• Remove competition

Move to solution based sales• Increase service offering• Turn key projects

Review sales channels• Optimum mix of direct vs indirect

New markets• Renovation vs new construction• Energy efficiency via JV’s with a

Chinese partner

LONG TERM FIXES…?

Source: Solidiance Research

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