Schnitzer Steel Returns to Profitability, Bleeds Cash in 2017.

Schnitzer Steel Industries, Inc. (NASDAQ: SCHN) is one of North America’s largest recyclers of ferrous and nonferrous scrap metal. Worldwide steel production levels drive demand for the company’s products. In the fiscal year ended August 31, 2017, the company generated almost US$1.7 billion of sales globally. Compared with the previous year, sales grew 24.8% and increased more than US$335 million. The company is benefiting from the recent massive credit creation in China, but its ability to generate cash flow is worsening.

Sales to China increased to US$216 million from US$150 million, or 43.6%. The growth of sales to China was almost double the growth rate of global sales. The increase in sales to China accounted for 19.6% of global growth for the fiscal year. There are two ways the company is benefiting from artificial credit creation in China.

First, Schnitzer Steel Industries, Inc. notes that Chinese “steel producers are generally government-owned and may therefore make production decisions based on political or other factors that do not reflect free market conditions.” State owned enterprises have the easiest access to new funds from the Chinese banking system, which they can use to buy products from Schnitzer Steel Industries, Inc.

Second, sales outside of China benefit from higher global commodity prices. The company deals with iron, aluminum, copper, lead, and zinc. According to the World Bank, in the twelve months ended August, 2017, copper increased 36.5%, zinc increased 30.8%, lead increased 27.9%, iron increased 24.9%, and aluminum increased 23.8%. Yesterday, General Motors Company reported global vehicle sales data indicating China accounted for more than half of the world’s growth in vehicle sales. That should mean China is driving demand for industrial metals. Much of this demand has been fueled by the massive increase in corporate demand deposits in China.

Schnitzer Steel Industries, Inc. used this windfall to return to profitability after two years of negative net income and reduce debt, but had poor cash flow execution. Net cash provided by operating activities increased from the prior year by only slightly more than one million dollars. Had accounts payable remained flat, the company’s operating cash flow would have been more than 30% lower than the previous year.

Similar to other companies with significant operations in China, Schnitzer Steel Industries, Inc. has generated impressive revenue growth, but worsening cash flow. Although the company did not provide information on the global market for its products, China contributed significantly to its year-over-year growth. The company’s under-performance during the economic expansion indicates the company will also under-perform during the coming economic contraction.

GM: China Drove Half of the World's 2017Q3 Growth in Vehicle Sales.

General Motors Company (NYSE:  GM) competes in the Chinese market through a number of joint ventures under its global Buick, Chevrolet, and Cadillac brands and its local Baojun and Wuling brands. In the three months ended September 30, 2017, the company’s joint ventures in China generated US$12.1 billion in sales. That represents an 11.1% growth rate over the same period in the previous year. Although the company increased estimated market share to 14.2%, up 90 basis points from the third quarter of 2016, the company is performing poorly in China on a profitability and cash flow basis.

Within China, the company’s 11.1% increase in sales only generated a 0.8% increase in net income. Net income as a percent of revenues declined from 8.7% in the third quarter of 2016 to 7.9% in the third quarter of 2017. The company is selling more, but less profitably.

In addition to lower profitability, the company’s cash flows are suffering. In the first nine months of 2017, General Motors generated US$34.1 billion in sales and earned US$2.9 billion in net income in China. However, since the end of 2016, cash and cash equivalents in China declined by US$709 million, despite debt increasing US$145 million. This would indicate the company is funding sales to its customers by increasing its accounts receivables.

The company also reported global data of interest. General Motors Company estimates 23.1 million vehicles were sold worldwide in the third quarter of 2017, up 0.7 million from the third quarter of 2016. Based on the company’s estimates of regional sales, we can calculate that 53.5% of the world’s growth in vehicle sales came from China. That seems unbalanced.

General Motors Financial Company also reported results for the three months ended September 30, 2017. It did not provide China-specific data, but did state: “Equity income in our China joint venture increased due primarily to growth in asset levels driven by increased retail penetration.”

While General Motors Company is financing vehicle sales with its own cash, General Motors Financial Company is also financing consumer debt to purchase vehicles. Both of these activities are driven by artificial credit creation.  When China's artificial credit boom ends, the worldwide auto industry will experience a bust.