Rich in volumes, poor in margins

By Patrick Chong

The conventional business wisdom for foreign companies in China is: get each Chinese consumer to spend a dollar and “Viola!” $1.3 billion in sales; never mind whether per day or per year. The figures coming in to analysts are, by all counts, soaring so much so that the likes of Goldman Sachs and Nomura to forecast share price increases of 30% and 20+% respectively.

Other reasons cited by China bulls: Chinese companies are cheaper than have been in the past year and cheaper than similar companies in other parts of the world. Additionally, they have performed b

adly this year. Thus the catch-up is imminent.

But do these reasons stand up to scrutiny? Yet another possibility that Chinese stocks are cheap is due to the market noticing the indications of some serious underlying problems. Witness the data collected: sales rose by a staggering 42% year-on-year in the first half of 2010 but margins have been on the decline with no sign of stabilizing.

In some industries conditions are horrible. Exporters' margins are often less than 2%, so says China's minister of commerce. Firms in the southern Chinese manufacturing belt are being painfully squeezed. A shoe exporter who recently returned after a long absence found his old Taiwanese suppliers had all left, having been crushed by rising costs. In their place were tough locals who de

manded the full price for their products regardless of glitches. The shoe exporter has been threatened, and is thinking of hiring a bodyguard. His tale is far from unique.

The Chinese government is phasing out subsidies to industry and relaxing energy-price controls. Workers are demanding higher salaries. Environmental standards, too, are being tightened. All these trends hurt profits, yet the government is happy for them to continue.

The government wants to allow ordinary people to enjoy more of the fruits of growth. How far it will go remains

to be seen, however. Will it allow the (artificially low) interest rates that banks pay depositors to rise? That would reduce the transfer of wealth from savers

to well-connected corporations, which enjoy cheap credit. Will it allow the yuan to appreciate, thus walloping exporters but boosting consumers' spending power?

That is the question that seemingly seeks an ever illusive answer.

Source: Economist Intelligence Unit