Production upgrade ‘can better SOE credit ratings’

The credit profiles of some of China’s state-owned enterprises (SOEs) could improve as they invest more in advanced, highend manufacturing as part of a push by Beijing to upgrade production capabilities, according to credit rating agencies.

The central government has urged SOEs to shift their investment focus from infrastructure construction to hi-tech manufacturing in areas such as robotics, pharmaceuticals, mining and clean energy.

Because of this, Fitch expects to see an increase in their capital expenditure this year, which could affect credit metrics. Leverage could increase if such moves are debt-funded.

But there would probably be “only a moderate increase of capital expenditure intensity in the near term by most central SOEs,” as investments in key sectors were “likely to be selective and must meet certain return criteria,” Wang Ying, managing director of Asia-Pacific corporates at Fitch, told the Post.

In a note on Monday, Wang said: “If SOEs are able to pick and integrate the right targets, control risk effectively and promote innovation, outcomes should be credit-positive for the firms involved and beneficial for China’s growth.”

She said any increase in their leverage was likely to be limited, especially if the investments were partly funded by equity flotations, thanks to a recent trend towards higher valuations for central SOEs listed on domestic stock exchanges.

Since most central SOEs had critical importance to national security and self-sufficiency, Wang said “their ratings are equalised with or notched down from the China sovereign rating” to reflect their potential for strong state support.

“Hence, their ratings will remain unchanged, even if their leverage increases,” she said.

Through constant merging and restructuring, the number of central SOEs had dropped by half from about 190 between 2003 and 2022, according to Mike Zhu, vice-president and senior analyst for the corporate finance group at Moody’s Investors Service.

He too believed the SOE reforms could “have a positive impact” on their credit quality.

“Many backward production capacities have been eliminated and the market share of central SOEs has increased,” he said at the Moody’s & CCXI China Credit Outlook Conference in Beijing on Tuesday.

“We expect more mergers and acquisitions within the same industry in the next few years, and the same for upstream and downstream industrial chains. The operating efficiency of central SOEs will also improve.”

As the State-owned Assets Supervision and Administration Commission required central SOEs to maintain a certain leverage ratio, Zhu said that the ratio “has basically remained at a relatively stable level in the past five years.”

He added that hybrid securities and the provision of guarantees for non-related parties as required by regulators would boost SOEs’ risk management. Mixed ownership would also help improve governance levels and investment efficiency.

And as SOEs became more important to the government, it would benefit their credit rating, Zhu said.

Beijing’s focus on certain hi-tech industries will boost demand in those areas, and elevate the income and profits of companies in those sectors.

On Monday, investment bank China International Capital Corporation, or CICC, said there was potential for a correction in the valuations of SOEs as they had “significant discounts” compared to their overseas counterparts, particularly in the banking, construction, and oil and gas sectors.

For instance, the Industrial and Commercial Bank of China has a valuation of US$244.15 billion, while JP Morgan is valued at US$399.59 billion. Similarly, China State Construction is valued at US$42 billion compared to Vinci ADR, a French construction company, US$71 billion value.

Companies leading the pack in key technology sectors, those with low valuations but expected to undergo reform, firms in state-supported sectors, and those with strong cash flow “should be investment targets,” CICC said.