China corporate bond defaults were identifiable from financial ratios
Overlooked, a wave of companies are increasing dividend payouts
While the consensus has found itself accommodating stable Chinese growth rather than a slowdown, the headlines have been dominated by corporate bond defaults. This should not have been too surprising observing the liquidity and leverage scores of the affected defaulted companies. Overlooked, a wave of companies are increasing their dividend payouts.
For once, media stories have not been about trade disputes or macro data but bond defaults. In an US$11 trillion corporate debt market it should not be surprising that some issuers would face default. It is important to differentiate between good balance sheet companies that might be facing a short-term liquidity problem and poor balance sheet companies finding it hard to cover interest payments. If the former was occurring then it would certainly cause spillover risks for the economy. But if it is the latter then the market and policymakers are probably well aware of the problem.
We analysed the balance sheet ratios, solvency scores and interest coverage ratios of the recently defaulted Chinese A share companies. Around half of the companies had net debt-to-equity of around 200%. Altman Z scores (a measure of credit worthiness) that were available for the companies were a little better, with only a few having scores below 1.8. The current ratio (current assets divided by current liabilities) is a measure of a company's liquidity. There were many companies with current ratios below 1.1. This was a very accurate measure of insolvency for the defaulted companies. Equally, the simple debt-to-assets ratio was also a good indicator of credit issues alongside average assets to average equity. The interest coverage ratio (EBIT divided by interest expense) was a less reliable indicator.
Investors appear to have overlooked that Chinese companies had altered their cashflow management to produce much higher free cash flow generation since 2016. With the central government balance sheet having deteriorated over the past 24 months, rising dividend payments has become an important theme to address the fiscal condition. The CSI 300 FCF integer has quadrupled since 2015. Around 64% of companies raised their dividends in FY2017 and 53% raised payout ratios. The forward CSI payout ratios is around 33%
China macro frequent factors since the start of the year have been stable. While there has been a series of corporate bond defaults within the listed equity market, these were identifiable observing their financial ratios. Equally, dividend payments are rising as companies become more comfortable with high free cashflows.
Sean Darby, chief global equity strategist, Jefferies
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14 Jun 2018