Chinese companies under fire as side bets on stocks turn sour
During the most intense phase of China’s coronavirus outbreak, Anhui Huamao’s cotton spinning and garments business held up, reporting a small loss of Rmb25.6m ($3.6m) over the first three months of the year.
But it was another part of the textiles company — a non-core unit making bets on stocks and other financial products — that really hit trouble. Losses from Huamao’s financial investments were more than six times greater, hitting Rmb168m in the first quarter.
The company is one of nearly 500 listed Chinese groups that posted losses on their financial investments in the first quarter of the year, up from just 165 in the same period last year, according to data from Wind Financial Information.
The groups lost a collective Rmb11.2bn ($1.6bn) on their financial investments as the public health crisis caused China’s stock market to drop, along with other major bourses around the world.
$1.6bn
Combined first-quarter losses on financial investments by nearly 500 listed groups
Now investors are turning a closer eye on these speculative activities, as tens of billions of dollars in foreign funds flow into the market following China’s 2018 inclusion in MSCI’s flagship emerging markets index.
Some fund managers have criticised the companies for attempting to boost earnings from their stock portfolios — even as their core operations struggle.
“Listed companies should not make stock investment their main business,” said Liao Zhiming, chief banking analyst at Tianfeng Securities. “They should worry about how to make their main businesses bigger and stronger, rather than spending too much energy speculating on stocks.”
Like many listed Chinese companies, Huamao does not provide a detailed guide to its portfolio of financial investments. But such investments generally comprise stocks and wealth management products, two areas that have suffered this year during the pandemic.
China’s benchmark CSI 300 index plummeted in February and finished the first quarter down by about 11 per cent. Wealth management and trust products, common destinations for corporate cash reserves, have faced a series of defaults this year.
Taking big punts on financial investments has become common across both private sector and state-owned companies. For many private groups, access to bank loans and other forms of liquidity is tight, forcing them to hoard funds. Low rates on cash deposits then push the companies to invest in higher-risk investments in an effort to boost returns.
Most state-owned companies, meanwhile, have ample access to cheap bank loans but often face poor prospects in their core lines of business. With excess cash on hand, such companies often get into high-return shadow banking products, or even launch their own lending businesses.
The biggest loser on financial investments in the first quarter was state-controlled China Yangtze Power, which lost Rmb524m. Another state group, Shanghai Construction, lost Rmb382m.
“On one end, it’s low-risk cash management and on the other it can be more speculative with the aim of generating higher profits,” said Gabriel Wilson-Otto, BNP Paribas Asset Management’s head of stewardship in the Asia Pacific region.
He added that outsized investment portfolios can raise questions over a company’s core competence. “Are they a manufacturing company or a financial investment company?”
Heavy investments by one listed company into several others can cause unexpected volatility in the market, according to one Shanghai-based investment manager at a foreign asset manager, who declined to be identified.
Bad news for one group can spill over to others that have bought its stock, regardless of the company’s underlying business performance, the person said. In many cases, companies have pledged the stock they hold for new loans and can face margin calls that lead to forced sales and sharp drops in share prices. “It can become a vicious circle,” the person said.
Such quirks of the Chinese market are becoming more important to global investors as MSCI increases the country’s weighting in its EM index.
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Many of the companies that have recorded big losses on financial investments, including Yangtze Power and Shanghai Construction, are constituents of that index.
Increased financial investments among listed companies and a surge in losses are bad signs for corporate China, said Li Haitao, an associate dean at Cheung Kong Graduate School of Business.
“If you have tonnes of growth opportunities, why would you buy other companies’ stock?” Prof Li said. “It’s a sign that the real economy is not doing very well and they don’t have real business opportunities.”
Still, while the big losses this year have garnered negative attention, Mr Wilson-Otto pointed out that people rarely complain when investment portfolios give a boost to aggregate profits.
“This practice gets more headlines when it works against a company,” he said. “There is typically less focus on the issue when the market is up.”