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.

Saturday, August 19, 2017

Chinese Export Prices to the U.S. Fall 0.9% in July, 2017.

The aggregate prices of products imported into the United States from China across all industries in July declined 0.9% over the last twelve months, according to the United States Bureau of Labor Statistics (EIUCOCHNTOT). The U.S. dollar appreciated 1.4% against the Chinese renminbi over the same period. This means that, broadly speaking, producing in China and selling into the United States is more profitable on a renminbi-basis than it was a year ago.

On a five-year basis, the compound annual growth rate of aggregate Chinese import prices into the United States has also been 0.9%. Over the same period, the U.S. dollar has appreciated against the Chinese renminbi 1.2% per year. Despite massive amounts of artificial credit creation in the Chinese banking system over the last five years, that new money has not flowed into domestic consumption that would drive up the prices of exports. Instead, that new money has flowed into excess capacity to supply a greater amount of goods.

The artificially suppressed price of money within China has funded a decades-long expansion of capacity within China far and above the needs of China’s domestic market or the international economy. In order to inhibit further expansion of capacity, the price of products exported from China will have to fall faster than the depreciation of the renminbi. Existing firms will not add capacity and new firms will not be created to supply markets with declining prices. The adjustment process will require a decline in the value of the renminbi to increase input costs for Chinese producers. As goods become less profitable, firms will supply fewer goods to the market. At the same time, prices within China need to fall further to allow consumer surpluses inside and outside of China to soak up the excess supply.

Wednesday, August 16, 2017

THTI Reports Losses, Negative Cash Flow, and More Debt in the Second Quarter of 2017.

THT Heat Transfer Technology Inc. (Nasdaq: THTI) is a total solution provider in the heat exchange industry with primary operations in China. In the three months ended June 30, 2017, the company generated sales of $7.5 million, down 3.4% over the same period in the prior year.

In addition to negative top-line growth, the company booked US$732K in negative net income and generated negative cash flow from operations. The company disclosed that it had repaid in full a one-year loan for CNY32 million at 4.78% interest with Agricultural Bank of China (HKEX:  1288) in May, 2017. However, in June, 2017, Agricultural Bank of China extended another one-year loan for the same amount at the same interest rate to the company. The company reported the U.S. dollar value of this loan as $4.7 million. As of June 30, 2017, a few weeks after the loan was granted, the company only had $4.2 million in cash on hand, meaning its entire cash position came from that one loan.

Agricultural Bank of China is rolling over its own loan at the same interest rate and collateral to a non-profitable company with a negative cash flow from operations. Without the ability to expand artificial credit at suppressed interest rates, the bank would not be able to support further misallocation of capital. Without this loan, the company would have insufficient cash on hand. To correct its cash position, it will need to reverse the $4.1 million increase in net inventories and $1.1 million decrease in accounts payable during the six months ended June 30, 2017. Although that will help in the short term, its position in the Chinese heat exchange technology industry might not be profitable.

Tuesday, August 15, 2017

Debt and Negative Free Cash Flow Drives Chinese Auto Industry in Second Quarter of 2017.

In the second quarter of 2017, the Chinese auto industry has seen significant growth in sales, but many companies have not been able to convert this into free cash flow. Both banks and suppliers are providing the industry with artificial credit that is misallocating capital.

China Auto Logistics, Inc. (Nasdaq:  CALI) reported $138.7 million in net sales in China during the three months ended June 30, 2017, up 47.9% over the prior year. However, the company had negative net income and generated negative cash flows from operations. Loan agreements from two Chinese banks facilitated these results. Agricultural Bank of China (HKEX:  1288) loaned the company CNY35.0 million, bearing interest at a rate of 4.79% over a borrowing period of six months. China Zheshang Bank (HKEX:  2016) loaned the company CNY54.0 million, bearing interest at a weighted average rate of 5.50% over six-month borrowing periods.

SORL Auto Parts, Inc. (Nasdaq:  SORL) generated US$70 million in China during the three months ended June 30, 2017, up 25.9% over the same period in the prior year. Sales within China accounted for 77.6% of total sales. Although the company reported US$14.2 million in net income, a US$16.8 million increase in accounts receivables was the largest contributor to negative US$3.2 million operating cash flows. To accommodate this, the company increased short-term bank loans from US$27.4 million on December 31, 2016 to US$47.0 million on June 30, 2017. These short-term loans were obtained from Bank of China (HKEX:  3988), Bank of Ningbo (Shenzhen:  002142), Agricultural Bank of China, China Zheshang Bank, and China Construction Bank (HKEX:  0939). The annualized interest expenses paid in the three months ended June 30, 2017 equate to an average interest rate of 4.6% on those loans.

China Auto Logistics, Inc. generated impressive sales growth, but was unable to due so profitably or convert that growth into free cash flow. SORL Auto Parts, Inc. grew sales revenue quickly and profitably, but grew debt faster and generated negative free cash flow. This indicates that the growth in the Chinese auto industry is disproportionately driven by cheap credit, which in this case was particularly driven by China Zheshang Bank.