Declining corporate profitability fuelled Shanghai share market correction: S&P

HONG KONG - The declining profitability of China's corporate sector over several years contributed to the recent correction in the Shanghai Stock Exchange, according to Standard & Poor's. “We forewarned three years ago that the average profitability of the largest Chinese corporates was declining,” said S&P credit analyst Terry Chan.

“Indeed, the financial risks of listed companies worsened over the five years to 2014 before steadying recently," he said.

S&P says the impact of China’s market correction on corporates will be dependent on their reaction to it and the central Government's efforts to shore up the market and economy.

"Ironically, if Chinese corporates become overly conservative towards investing, the feedback loop from a contraction in overall business activity could undermine their credit profiles," Chan said.

S&P is predicting that the impact of China’s market correction could be felt in three waves.

First, corporates may be reluctant to issue shares until the stock market settles, but S&P says the lack of issuance is unlikely to change many credit profiles over the next 12 months. “Any delay in equity-raising may mean higher leverage, particularly if corporates source new debt to finance acquisitions.”

Second, any easing of market liquidity and government encouragement of investments may benefit corporates over the near term. However, the adequacy of returns on any additional investment is less certain.

Finally, the most significant impact would be if companies view the stock market correction and the Government's response as signals that prospects for the Chinese economy may be less bright than previously assumed, the pace of investment may slow.

"A slowdown in investment activity could bring about the reduced prospects the corporates fear, given China’s still high dependence on investments to drive economic growth. This self-reinforcing spiral would negatively affect corporate credit profiles," said Chan.

With corporates viewing the equity issuance window as being closed, at least temporarily, they would have to rely on debt funding to support growth.

Apparently recognising this, China's central bank announced on Tuesday that it will further cut lending interest rates by 25 basis points and lower the reserve requirement ratio for banks by 50 basis points. www.standardandpoors.com (ATI).