Corporate China is in a state of high flux. Our review of 250 top Chinese companies indicate capital expenditure (capex) is rising in certain high-growth sectors, despite a generally anemic environment for investments, while returns on capital are falling. S&P Global Ratings believes China is transitioning to a new economic model, creating strong growth in some sectors, and slowdowns in others.

The effects in one sector knock on to another. Property woes and depressed household sentiment and spending point to moderate consumption growth (see "China Deflation Risks Hinge On Growth Mix," published on RatingsDirect on Jan. 29, 2024). This has made China more reliant on industrial investment and exports, even as countries are countering Chinese goods with trade tariffs and other restrictions.

Chinese enterprises are responding to weak domestic demand by expanding offshore, to tap into higher-growth markets, manage trade restrictions, and to address customer requests for greater supply-chain diversification.

More positively from a credit perspective, entities in policy-favored sectors are generally more disciplined on debt. The gross borrowings of this cohort are expanding at a slower pace than capex. Many firms in these sectors are showing drops in their ratios of gross debt to EBITDA. However, this group of companies are by no means homogenous and they can have significant differences in credit profiles.

We define policy-favored sectors as those having high investment growth. Further, they are in line with policy initiatives to encourage energy transition, industrial upgrading and self-sufficiency. In this report, we view autos, capital goods, solar/lithium batteries, technology hardware, technology software and services, and utilities as belonging to policy-favored sectors.

A Note On Our Sample

This report focuses on 250 Chinese firms that we handpicked as being meaningfully representative of their sectors.

The surveyed entities are all large and prominent firms in their sector. They made up 16% of the total debt of China's nonfinancial enterprises as of year-end 2023. We believe the survey findings are indicative of real trends playing out among the top firms in the country; our finding are moreover consistent with our other research.

This report focuses on 250 firms across 23 sectors. We added three sectors in this report compared with a similar survey done in 2019. Of these, we added solar and lithium battery products to capture China's energy transition. Compared with the 2019 study, the 2024 survey has less focus on the property and infrastructure sectors.

More Spending, Less Debt

Policy-favored sectors are investing heavily. Surveyed entities belonging to the auto, capital goods, solar/lithium batteries, technology hardware, technology software and services, and utilities sectors comprised 42% of the capex of the surveyed entities in 2023. In 2019, the same group was responsible for 34% of capex. China encourages entities in these sectors to invest and expand with myriad measures including subsidies, tax breaks, funding supports, and demand-side stimulus.

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The entities in policy-favored sectors are more disciplined on borrowing. The gross debt of entities in these sectors is expanding at a slower pace than their collective capex, and leverage (gross debt to EBITDA) remains stable or is dropping. These company have taken a more conservative approach to debt financing for their capital structure, which should bolster credit profiles.

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Falling Profitability Points To Overinvestment

Less positively, there are strong indications that the policy-favored sectors are facing overinvestment risk, and that the returns on their investment have been moderate or declining. We find that returns on capital in those sectors have consistently dropped since 2019.

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This finding is supported by our discovery of heavy losses within China's electric vehicle (EV) sector. Among China's top EV makers, only one (BYD Co. Ltd.) has a steady record of profit over the past five years. Most of the others are deeply loss-making (see "China EV Startups Struggling To Stay Afloat," May 28, 2024).

The finding is also supported by a prior survey of China corporates. The research found falling utilization rates and declining profit margins for entities within the raw chemicals, tech hardware, electrical equipment, and auto sectors (see "Where Are China's Overinvestment Risks?" Aug. 7, 2024.

Global Ambitions Remain Strong For China Inc.

Fifty-six percent of the surveyed corporates have offshore revenues. Among them, 53% have higher overseas revenue as a percentage of total sales in 2023, compared with2019.

Policy-favored sectors have the largest share of overseas revenue, specifically: tech hardware and equipment, capital goods, solar and lithium batteries, and autos.

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In moving offshore, firms are likely seeking to avoid foreign sanctions and restrictions on exports. A typical example is the auto sector. Carmakers are diversifying production to Europe and Southeast Asia to avoid a raft of steep import tariffs on Chinese EVs (see "Rated China Carmakers Can Take The Heat From European Tariff Hikes On EVs," June 17, 2024).

Chinese firms are also moving offshore to offset slowing domestic demand. For example, Chinese apparel makers are increasingly looking to access overseas markets amid sluggish growth at home (see "China Consumer Versus Global Peers: More Direct Competition In Restaurants, Apparel, Appliances," July 29, 2024).

Chinese exports of cross-border e-commerce products grew 36.7% year on year in the first half of 2024. This shift was partly driven by the overseas business expansion of large Chinese platforms such as Temu, Shein Group Ltd., AliExpress and TikTok Inc. Temu, the cross-border e-commerce platform of Pinduoduo Inc., is present in about 70 countries, and it contributed about one-fifth of Pinduoduo's revenue in 2023.

Capital goods firms have also pursued overseas expansion, particularly those making construction equipment. This has helped such entities avoid the persistent sales declines seen in the domestic property market. For example, Sany Heavy Industry Co. Ltd. and XCMG Construction Machinery Co. Ltd. derive nearly half their revenue from overseas, and they earn higher margins on these offshore sales.

Chinese domestic suppliers are also moving offshore to match shifts of their downstream foreign customers. For example, we project that Foxconn Industrial Internet Co. Ltd., China's largest manufacturer of high-precision components, will significantly increase capex, most of which will likely be outside of China. Such investments are likely at the request of its largest customers (see "The Shifting Of China Tech Supply Chains: The Hard Part Starts," Sept. 2, 2024).

Who's Who In Our Sample?

This report examines 250 firms across 23 sectors. Consumer products (including consumer durables and apparel, and agriculture/food & beverages) account for 12%, the largest share of the sample size, followed by tech hardware and equipment, utilities, and capital goods.

The Chinese economy is moving toward energy-transition themed sectors, high-end manufacturing, and advanced hardware. This is in line with policy initiatives to encourage green transition and industrial upgrading, and our sample reflects this.

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The top five sectors by assets--utilities, railway and metro, oil and gas, engineering and construction, and real estate and hotels--account for 51% of total assets, down from 54% in 2019. The policy-favored sectors account for 29% of total assets, up from 27% in 2019. We believe these findings reflect real trends playing out in the country.

The portfolio is comprised of more unrated names than rated ones. About three-quarters of the sampled companies are not rated by S&P Global Ratings.

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Sector Ranking Review

The median business risk profile for our 23 sectors is fair, and the median financial risk profile is intermediate. This is because we tend to look at the largest and healthiest firms in each sector.

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Appendix

We strive for balance in our survey. Almost all represented sectors have at least five companies. The only exceptions are the oil and gas, and railway and metro sectors, which each contain four entities in our sample.

Compared with 2019, the sample sectors are more diverse, with three new sectors. Each sector comprises about 4%-5% of the sample, by number of entities. In 2019, each of top-three sectors made up more than, or very close to, 10% of the sample size.

We break down the consumer sector into two subsectors: agriculture and food & beverages, consumer durables and apparel. The subsectors contain 29 enterprises combined. While the consumer sector is most heavily represented in our survey in terms of number of entities, we have still cut this list from 34 in 2019.

Railway and metro, utilities, real estate, oil and gas, and engineering and construction collectively account for about 57% of total assets. Regarding gross debt, railway and metro, utilities, and real estate are leading the sampled sections.

Property has changed from being dominated by privately owned enterprises (POE), to a recent dominance by SOEs. Our sample reflects this shift. The property downturn has favored the state-owned developers, with many POEs in default.

Solar and lithium is the newly added sector in our portfolio for which most constituents are POEs. POEs tend to be the faster movers in China, and have entered this emerging sector more aggressively.

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Writer: Jasper Moiseiwitsch

Digital Designer: Tim Hellyer

Related Research

• The Shifting Of China Tech Supply Chains: The Hard Part Starts, Sept. 2, 2024
• Where Are China's Overinvestment Risks? Aug. 7, 2024
• Rated China Carmakers Can Take The Heat From European Tariff Hikes On EVs, June 17, 2024
• China Consumer Versus Global Peers: More Direct Competition In Restaurants, Apparel, Appliances, July 29, 2024
• China EV Startups Struggling To Stay Afloat, May 28, 2024
• China Deflation Risks Hinge On Growth Mix, Jan. 29, 2024