Saturday, October 28, 2017

Goodyear Tire’s 2017Q3 Volume, Debt Decline in China.

The Goodyear Tire & Rubber Company (NASDAQ:  GT) reported sales of US$3.9 billion in the three months ended September 30, 2017. Compared to the same period last year, sales grew 1.9%, but net income as a percent of sales declined from 8.3% in the third quarter of 2016 to 3.3% in the third quarter of 2017.

Globally, the company was not able to convert price inflation into sales revenue. According to the U.S. Bureau of Labor Statistics (BLS), the import price of rubber products increased 3.2% over the year ended September, 2017, but the company was only able to increase sales 1.9%. The company was able to limit the impact of commodity price inflation. According to the World Bank (WB), the price of rubber increased 18.1% over the year ended September, 2017, but the company’s cost of goods sold only increased 12.2%.

Within China, the company did not benefit from China accounting for half of world vehicle sales growth in the three months ended September 30, 2017. Unit Sales in the Asia Pacific region decreased 1.5% over the same period in the prior year. The Goodyear Tire & Rubber Company disclosed that original equipment tire volume declined 2.9% in the first nine months ended September 30, 2017 compared to the prior year, primarily driven by its consumer business in China.

Despite significant credit growth in China, the company decreased both its unused available funds and amount outstanding in its China credit facility. The amount outstanding declined from US$315 million on December 31, 2016 to US$247 million on September 30, 2017. The interest rate on the amount outstanding increased from 4.68% at the end of 2016 to 4.81% at the end of the third quarter of 2017. This is most likely the result of extending repayment terms further out. The unused available amount decreased from US$252 million at the end of last year to US$218 million as of September 30, 2017. This would indicate that the company is not looking to use the artificial credit created in the Chinese banking system to expand capacity.

The company is positioned in an industry with rising finished good prices, but input prices are rising even faster. The Goodyear Tire & Rubber Company has a cost advantage over its competitors because of its size. Considering that it is not further expanding capital expenditures to covert variable costs into fixed costs, it is likely to benefit disproportionately when the credit cycle busts and commodity prices drop much faster than finished good prices.

Friday, October 27, 2017

Micron Technology Converts China Growth Into Cash in FY2017.

Micron Technology, Inc. (NASDAQ: MU), a global manufacturer of semiconductors, reported US$20.3 billion in sales for the fiscal year ended August 31, 2017. The company was able to derive most of this growth in China without sacrificing cash flow. A few issues stand out about Micro Technology, Inc.’s relationship with China.

First, the company is operating in an industry experiencing falling finished good prices and rising raw material prices. According to the U.S. Bureau of Labor Statistics (BLS), the import price of semiconductors and other electronic components from China experienced the second largest drop on a year over year basis of all the four-digit categories tracked. As of August, 2017, semiconductor import prices had fallen 1.1% over the previous twelve months and 2.9% on an annualized basis over the last five years. According to the United States Geological Survey (USGS), the average U.S. spot price for silicon metal in August, 2017 was 39% higher than the same month in the previous year. Despite this, Micro Technology, Inc. was able to grow global sales revenue by 63.9% between fiscal 2017 and fiscal 2016, but only incur a 20.1% increase in the cost of goods sold.

Second, the company derives more than half of its sales from customers in China, but has minimal transactions in renminbi. Sales in China reached $10.3 billion in fiscal 2017, or 51.1% of global sales. However, it only mentioned the euro, Singapore dollar, New Taiwan dollar, and yen as currencies other than the U.S. dollar that the company’s global operations have significant transactions and balances.

Third, despite selling more to Mainland China, Micro Technology Inc. reduced its net property, plant, and equipment in China on both a nominal and relative basis. Sales to customers in China increased 96.0% from the prior year and growth in China accounted for 64.2% of global 2017 growth. However, net property, plant, and equipment in China declined 7.7%, or $38 million, from the prior year. On a relative basis, 3.3% of the company’s net property, plant, and equipment was located in Mainland China as of September 1, 2016, but this proportion dropped to 2.3% as of August 31, 2017.

In the fiscal year ended August 31, 2017, Micron Technology, Inc. disproportionately benefited from new credit creation and had fantastic performance on a cash flow basis. The company’s U.S. dollar denominated sales in China exceeded the growth in the Chinese money supply and appreciation of the renminbi. Despite global sales increasing US$7.9 billion and China sales increasing US$5.0 billion in fiscal 2017, accounts receivables only increased by US$1.6 billion. On sales of US$20.3 billion, the company generated net income of US$5.0 billion and operating cash flows of US$8.1 billion. New sales did not come at the expense of higher working capital or lower profitability.

Wednesday, October 25, 2017

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.

Tuesday, October 24, 2017

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.

Monday, October 23, 2017

WABCO is Paying More to be Paid Now in China.

WABCO Holdings Inc. (NYSE:  WBC) is primarily a manufacturer of braking systems for commercial vehicles. In the three months ended September 30, 2017, the company generated US$827.8 million in sales globally, up 22.5% over the same period last year. In the first three quarters of 2017, the company generated US$250.2 million in net income, up 47.6% over the same period last year. Although sales and net income have increased, the company’s cash flows have suffered.

Globally, the company generated US$226.6 million in cash flow from operations in the nine months ended September 30, 2017. This is a decrease of 21.4% or US$62 million. The primary contributor to the decease in cash flow from operations was a US$68.2 million increase in accounts receivables.

Sales in China, which grew 43.4%, were financed at an increasing cost to the company. In the first nine months of 2016, WABCO had discounted with banking institutions or transferred to suppliers in China US$83.6 million worth of notes receivables. In the first nine months of 2017, that amount had more than doubled to US$182.7 million. Not only is the company waiting longer to be paid, the company’s expenses related to discounting these notes have increased at an even higher rate, from US$0.2 million to US$1.6 million.

Although discounting expense is increasing, it is probably safer to transfer the risk of account receivable repayment from a state-owned or public enterprise to a bank. This will allow more cash to be available at a sooner, more certain date. Many other companies are simply recording the sale today and then hoping to collect accounts receivable at an unknown future date.

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.