Sunday, October 15, 2017

Nike's Sales in China Come at the Expense of Cash Flow.

Nike, Inc. (NYSE:  NKE) revenues in Greater China grew 8.6% in the three months ended August 31, 2017, compared to the same period last year. The company gave details on accounts receivables, inventory, fixed assets, product types, and distribution channels within Greater China. Even though the company’s sales have grown faster than Mainland China’s gross domestic product and have exceeded the consumer price index for apparel, the company did so less profitably with significantly higher pressures on cash flow.

Of the US$1.1 billion in sales that Nike, Inc. generated in Greater China during the three months ended August 31, 2017, footwear accounted for 68.6%, apparel accounted for 27.8%, and equipment accounted for the balance. Apparel sales grew twice as fast as footwear sales. Equipment sales were negative. Even though the company increased sales by 8.6%, EBITDA only increased 6.2%. This means the company is growing sales by reducing margins, not capturing more value or benefiting from economies of scale.

About two-thirds of Nike, Inc.’s sales in Greater China are sold to wholesale customers, whereas the balance goes to direct customers. Sales to wholesale customers increased only 5.0%. Despite this slower growth, accounts receivables increased 24.4% over the same period. Sales to direct customers grew 16.3%. This is an impressive growth rate, but it must have fallen below the company’s expectations because inventories increased 25.5% over the same period. Although sales are increasing, the company is having to commit proportionally more working capital to support these sales. One positive aspect is the fact that property, plant, and equipment only increased 2.2%, which is much lower than the increase in sales. Asset utilization improved over the period.

Nike, Inc.’s sales in Greater China for the three months ended August 31, 2017 exceeded overall economic indicators and industry-specific indicators for comparable periods in Mainland China. However, the company captured these sales at a lower EBITDA margin and committed working capital at a higher rate than the comparable period last year.

Tuesday, September 26, 2017

ICBC (Asia) Limited Increases China Exposure, Maintains Renminbi Short Position as of June 30, 2017.

The Industrial and Commercial Bank of China (Asia) Limited reported today that it had total assets of HK$849.1 billion as of June 30, 2017, of which HK$483.1 billion were deposits from customers. The bank generated HK$9.7 billion in interest income and paid HK$5.2 billion in interest expense during the six months ended June 30, 2017. Three issues stand out for the period covered.

First, the bank increased its total exposure in Mainland China to HK$387.1 billion, up 7.7% since December 31, 2016. This is an annualized increase of 15.9%. On-balance-sheet exposure accounted for most of that, at HK$325.0 billion, and increased 7.3% over the same period. Contingent liabilities, growing 10.7%, were worth HK$60.7 billion. The value of foreign exchange and derivative contracts, valued at only HK$1.3 billion, declined 18.1%. Although these growth rates seem impressive, they are just barely keeping up with the overall increase in corporate demand deposits in China.

Second, the bank increased exposure to counterparties directly inside China, as opposed to financing firms outside of China for investment within the country. Exposure to non-government counterparties described as “[People’s Republic of China] nationals residing in Mainland China or other entities incorporated in Mainland China and their subsidiaries and [joint ventures]” increased 9.9%, whereas exposure to non-government counterparties described as “[People’s Republic of China] nationals residing outside Mainland China or entities incorporated outside Mainland China where the credit is granted for use in Mainland China” only grew 8.3%. This would imply that there will be less inbound foreign exchange flows into China, because the funding has already occurred within China. This should put less pressure on the renminbi to appreciate.

Lastly, the bank’s net short position in the renminbi decreased from HK$1.7 billion as of December 31, 2016 to HK$0.3 billion as of June 30, 2017. The bank’s net long position in the U.S. dollar also decreased from HK$23.8 billion as of December 31, 2016 to HK$15.7 billion as of June 30, 2017. The bank is still short the renminbi and long the U.S. dollar, but to a significantly lesser degree than six months ago. Its positions seem to indicate that the bank believes appreciation in the renminbi will not continue to occur.

The trend of more exposure within China, as opposed to China-inbound exposure, will likely mean less pressure on the renminbi to appreciate. The bank has positioned its short position in the renminbi and long position in the U.S. dollar to benefit from further depreciation of the renminbi.

Wednesday, September 20, 2017

Trio-Tech International Shifts Capital Expenditures from East China to Southeast Asia.

Trio-Tech International (AMEX: TRT) is engaged in testing services, equipment manufacturing, and distribution for the semiconductor industry (SIC: 3559). The company generated global sales of US$38.5 million in the year ended June 30, 2017, up 11.8% over the previous year. Net income for the year was US$1.4 million, up 37.1% from the prior year. Free cash flow was 120.5% of net income for the year, whereas free cash flow was negative in the previous fiscal year. Although the company seems to have turned around its operations, events in China that were outside of the company’s control drove these results. At the same time, there are significant opportunities within China to improve future free cash flow.

To support an 11.9% increase in revenue, the company’s cost of goods sold increased 13.2%. The company was not able to control costs. Only the testing segment was able to both grow sales and increase gross margin year-over-year.

The company increased income from continuing operations before income taxes by US$499K year-over-year. However, almost all of that came from a US$467K favorable increase in foreign exchange transactions. The company transacts in the Singapore dollar, Malaysian Ringgit, Thai baht, Chinese renminbi, and Indonesian rupiah. According to the Monetary Authority of Singapore, the renminbi devalued against the U.S. dollar more than the four other currencies during the relevant period. This positively impacted the company’s cross-currency invoicing, but was completely out of the company’s control.

Globally, the company increased additions to property, plant, and equipment by 52.5% year-over-year. However, all of this increase occurred in Southeast Asia. Capital expenditures declined year-over-year at the Tianjin facility, but specific amounts were not disclosed. Although the company had overall decent execution on accounts receivables, the Tianjin subsidiary signed an agreement with a bank for an Accounts Receivable Financing facility for approximately US$871K. This would indicate the company is having cash flow issues in China.

Despite the fact that the company is engaged in the semiconductor industry, about 7.3% of the company’s total non-current assets as of June 30, 2017 were composed of depreciated investment properties in Chongqing, China that were acquired in 2008 and 2010. The current market value of these properties is likely much higher than the book value. The proceeds from these sales, as well as the $4.0 million in cash the company had on its balance sheet, could be deployed elsewhere. If this capital is taken out of China, the company could expand its geographic or product diversification. If this capital is kept in China, the company could expand the testing segment’s capabilities at the Suzhou facility or reduce the need for bank credit at the Tianjin facility.

Tuesday, September 19, 2017

U.S. Import Prices from China Drop 0.7% in the 12 Months Ended August, 2017.

The price of imports from China to the United States dropped 0.7% in August compared to the prior year. None of the categories published by the Bureau of Labor Statistics exceeded the appreciation of the U.S. dollar against the renminbi over the same period. Chinese manufacturers were not able to pass on changes in the value of the renminbi to customers in the United States.

Chemical, plastic, and rubber product prices saw the largest increase in prices among the categories published, but only by slightly more than 2.0% over the last year. Over the last five years, plastic and rubber product prices declined 1.9% per year, so a 2.0% increase over the last 12 months was a significant increase in price pressures.

Computer and electronic product prices experienced the largest decrease in prices among the categories published, but only by slightly less than 2.0% over the last year. This was in line with its five-year compound annual decline of 2.2%. Apparel saw the largest negative divergence of prices over the last year compared to the last five years. Apparel prices dropped almost 0.6% over the last 12 months, despite increasing 0.4% per annum for the last five years.

As revenues from sales to the United States decline and input costs in China increase, there should be two effects on production capacity in China. First, entrepreneurs will not add additional capacity to China. Second, producers within China will shift their output to servicing domestic markets, where prices are generally rising. Both trends will contribute further to the de-globalization of the division of labor.

Sunday, September 17, 2017

Lightpath’s Operating Cash Flow Suffers in China During FY2017.

Lightpath Technologies, Inc. (Nasdaq:  LPTH), a manufacturer of optical components (SIC:  3674), generated US$28.3 million globally in the year ended June 30, 2017, growing 64.2% over the prior year. The company earned US$7.7 million in net income, compared to US$1.4 million in the prior year, an increase of 450%. Despite this increase, cash flow from operations in the fiscal year ended June 30, 2017 was only 64.8% of net income, compared to 107.8% in the previous year.  Based on statements made in the company's annual report, activities in China are driving down operating cash flow.

The company did not provide revenue information specific to China, but it did state that it extinguished all net operating loss carryforwards in China during fiscal 2016 and did not accrue any in fiscal 2017. It did mention, "Revenue from our [high volume precision molded optics] product group had been derived from the industrial tool market in China, which had experienced six years of declining growth."  Even though the company is in a declining market, it was profitable this year.

Lightpath Technologies, Inc. did mention China-specific issues related to its operating cash flow. Net assets in China increased from US$9.9 million as of June 30, 2016 to US$12.3 million as of June 30, 2017.  The company begins to calculate allowance for accounts receivables starting at the 60-day mark in the United States, but waits until the 120-day mark in China. This implies the company's China-based customers have extended payment terms.

On a global basis, Lightpath Technologies, Inc. is growing revenue and net income, but has poor operating cash flow performance. Much of that seems to stem from China operations, where taxes are being incurred on operations in a declining market, supported by higher net assets, and repaid at extended payment terms.

Saturday, September 16, 2017

China’s Excess Liquidity Will Find Ways Around ODI Restrictions.

China’s foreign currency reserves (excluding gold) ended August, 2017 at almost US$3.1 trillion, down $18 billion, or 0.62%, from a year ago. Over the last five years, China’s foreign exchange reserves have decreased at an annualize rate of 0.72%, so the rate of decline in August was slower than that in previous years. However, since the end of 2016, China’s foreign exchange reserves have increased US$61.5 billion. More than half of China’s gains in foreign exchange reserves came from limiting out-bound direct investment (ODI).

The Chinese authorities have sought to restrict overseas investment projects by Chinese firms. In August, the State Council announced it would limit investment in property, hotels, entertainment, sports clubs, and film industries.

In the first eight months of 2017, China’s out-bound direct investment declined 41.8% compared to the same period in the prior year, to US$68.7 billion. Over the same period, China’s foreign direct investment declined only 0.2%. Had out-bound direct investment maintained the prior year’s level, an additional US$49.3 billion would have left the country.

The change in foreign exchange reserves has mirrored trends in the value of the renminbi against the U.S. dollar. Over the last five years, the U.S. dollar has appreciated against the renminbi at an annualized rate of 0.9%. Over the last 12 months, the U.S. dollar has appreciated 3.1% against the renminbi. However, that trend has reversed since the end of 2016, with the U.S. dollar depreciating 3.7% against the renminbi.

Nothing has changed structurally to reverse the outward flow of China's excess liquidity. If the policy towards outbound direct investment changes soon, we can expect the renminbi’s depreciation against the U.S. dollar to resume. If the policy towards outbound direct investment does not change soon, we can expect excess liquidity in China to find other ways out of the country, such as through the current account.

Sunday, August 20, 2017

Corporate Demand Deposits in China up 16.8% in July, 2017.

Corporate demand deposits in China rose to CNY44.3 trillion at the end of July, according to the People's Bank of China.  This is an increase of 16.8% over the previous year. Currency in circulation increased 6.1% over the same period, to CNY6.7 trillion. Both of these rates of increases are higher than the devaluation of the Chinese renminbi to the U.S. dollar and the increase in the Chinese consumer price index over the same period. This means that newly created money is mostly remaining within China, but is not flowing into consumer goods.

Over the last five years, the compound annual growth rate of corporate demand deposits has been 13.7% and the compound annual growth rate of currency in circulation has been 6.2%. July’s number for the growth of currency in circulation was slightly below the longer-term average, but the number for the growth in corporate demand deposits was higher than the longer-term average. This means that firms are receiving the majority of new credit creation, and this is being put into excess capacity creation, not consumption.