Talking Point

Lost its zoom?

What two of Changsha’s biggest firms tells us about China’s slowing economy

Down tools: how much of Zoomlion's vendor financed sales will go bad?

The mayor of Changsha this week compared his city with Detroit. Some might consider this an unfortunate choice. As recently as 2010, TIME magazine referred to Detroit as a “crippled city”, a reference to its economic stagnation.

Mayor Zhang Jianfei didn’t have this image in mind. Instead he was telling the China Daily about his plan to make Changsha as famous for construction machinery as Detroit has long been for cars. He reckons that by 2015 a third of the world’s construction machinery will be made in his city (versus 9% today).

Certainly, the capital city of Hunan province deserves attention, as home to 30 construction equipment manufacturers. Two of the firms – Sany and Zoomlion – rank six and seven globally in sales terms. And recently, they were joined in the spotlight by Broad Group, an air-conditioning manufacturer now making a new name for itself by building towers at breakneck speed. As we mentioned in WiC155, Broad’s subsidiary finished a 30-storey building in the city in just 360 hours, and it now has plans to erect the world’s tallest building in Changsha, with a 220-storey tower to be completed in just seven months.

But Zoomlion won’t mind being out of the headlines for a while, after a bleak few weeks of stories about short-sellers, phantom sales and an application for a gigantic $22 billion in new credit.

And then this week there was potentially alarming news about its counterpart Sany too…

Why the bad press for Zoomlion?

The news flow started earlier this year, with reports that Zoomlion’s stock is a favourite for short-sellers in Hong Kong. The data in May was that 20% of the company’s free float on the city’s stock exchange was out on loan to traders. Why so? They were punting that China’s economic slowdown will lead to a drop in demand for Zoomlion’s main products, primarily cranes and concrete pumps.

Shortly afterwards, Zoomlion was in the newspapers again, after the release of a research report suggesting that more than half of the equipment it sold in the first quarter in Jiangsu province had never been switched on. The speculation was that cash-strapped customers have been signing contracts on credit with Zoomlion, but then putting the purchases straight into storage. Their next move is to offer the kit as collateral for loans that they are taking out themselves. We’ve mentioned similar schemes before (for instance, borrowing against warehouses of copper bought on credit; see WiC103) but the implication for the construction sector is that the practice could explain why Zoomlion’s sales are up (8% so far this year) even as the property market slows sharply in many cities.

The other inference is that sales practices across the industry are pursuing a worrying trend, as firms chase growth from lower quality customers, many of which may not turn out to be creditworthy.

In this context, an announcement in May that Zoomlion wanted to borrow an eye-popping Rmb140 billion ($22 billion) in new loans from local banks sent shockwaves through the investor community. Understandably, they wondered why such a huge sum was required. As a result, the company’s share price fell sharply in the following week.

But Zoomlion rejects suggestions of financial distress?

Shareholders met in Changsha last Friday to approve the new financing strategy and management got what it wanted. Near unanimous votes supported the key resolutions: one gave the okay to borrow up to Rmb140 billion; another requested Rmb40 billion of new credit for the company’s financial leasing divisions.

But executives are insisting that the vote on the huge new credit line shouldn’t be taken as a sign of financial weakness. In fact, they are arguing the contrary: Sun Changjun, a vice-president, told the Sanxiang Metropolis Daily last week that the arrangements reflected Zoomlion’s strength, as well as its prospects for further growth.

Anderson Chow, who covers the sector for HSBC, agrees that the new financing plan seems to have been misinterpreted by the markets. The Rmb140 billion is a credit facility, Chow says, and Zoomlion has made no commitment to drawing down the full amount. Last year it had access to a similar facility for Rmb116 billion, of which it drew down less than half. Nor does it cost anything to have the credit available until the funds are accessed.

Why the anxiety about financial leasing?

About a fifth of Zoomlion’s sales last year were paid for up-front, with a further 15% paid on an instalment basis by major customers with long-term relationships.

But the majority of Zoomlion’s sales involved financing for its customers, either in conjunction with a bank (which loans the money to the buyer, and takes on most of the financial risk) or through financing offered by the company itself (on which it make an interest rate spread of 3-4% over its own borrowing cost).

Most customers make a down payment of 20-30% and then get a loan for the remainder of the purchase price, although Zoomlion says that there is nothing unusual in this approach, which it has copied from peers in developed markets.

Nonetheless, newspapers like South Weekend have been speculating that the construction equipment makers may have been getting more aggressive in the terms that they offer, requiring smaller down payments or even no cash up-front at all. Vendor financing has become a “time bomb”, the newspaper warns.

That impression wouldn’t have been helped by a war of words between another Zoomlion vice-president, Chen Xiaofei, and Liang Linhe, an executive at rival firm Sany in April. Chen was annoyed by comments on Liang’s weibo that Zoomlion was getting into risky territory by offering deeply discounted payment terms. “I’m deeply honoured that Mr. Liang is paying attention to Zoomlion’s sales,” he scoffed. “But speaking of an aggressive sales strategy, Sany did the same in the past, which we recall vividly today.”

Having vented his spleen, Chen then opted for a little Changsha camaraderie. “Zoomlion and Sany are brothers,” he pleaded. “Why can’t we get along with one other?”

The wider concern is that a greater reliance on vendor financing is putting a strain on the balance sheets of both companies, a factor mentioned last autumn in WiC123 in discussion of Sany’s attempts to IPO in Hong Kong (it is still trying to complete its listing in the city).

This business model means that Zoomlion is profitable but often cash poor, and accustomed to periods in which operating cash flow is negative. This might also suggest why it wants to ensure lines of credit are ready if they are required.

Fortunately, Zoomlion has good relations with the local banks, HSBC’s Chow suggests, which are more comfortable lending to large companies with state-owned shareholdings (as Zoomlion does).

So is there a financing danger?

Zoomlion’s vendor finance-backed sales have grown significantly, from 4.3% of turnover in 2007 to 31% in 2010. But Chow says that although late payments did increase last year, there was no dramatic surge in defaults.

He also says that operating cashflow for the year turned positive in May, which he expects to remain the case for the remainder of the year.

What about the broader commercial outlook?

Industry analysts tend to watch China’s fixed asset investment numbers closely, as the construction equipment sector has seen revenue growth of about 25% a year between 2001 and 2010 (according to data from the China Construction Machinery Association). That pretty much matches the annual increases in fixed asset investment over a similar period.

A specific positive for Zoomlion is that the two business areas that make up the large majority of its revenues and profits – concrete machinery and cranes – look more resilient than sales of earth-moving equipment such as excavators, segments it is less active in.

Still, that shouldn’t negate concerns that companies in the sector will be hit by the property slowdown. Cement makers Anhui Conch and CR Cement have both issued profit warnings recently, while Lonking, a direct competitor to Zoomlion, did the same last month.

“This reflects slower growth in China’s fixed asset investment, the changes in (the) macroeconomic environment resulting in fewer infrastructure projects, as well as the completion of projects funded by the 2009 stimulus plan,” Lonking advised.

News that demand for excavators fell sharply in the first months of the year should also be causing concern. Excavator sales make up just 3% of Zoomlion’s revenues but they tend to be a leading indicator of demand for cranes and concrete mixers, which are typically used later in the construction cycle.

If the declines persist, Zoomlion may find it tougher going later in the year.

Despite this, Zoomlion still anticipates solid revenue growth this year. Sales of cranes have been soft but concrete machinery is selling well, and the general expectation is that business will pick up as approvals for new projects are fast-tracked in the second half of the year (we discussed the prospects for a new ‘mini-stimulus’ in WiC152).

In terms of property construction, much of Zoomlion’s new business is coming from third and fourth tier cities, and it is also expecting to capitalise on the rapid construction of social housing, where the central government is aiming to complete about 36 million units between 2011 and 2015.

Bigger picture trends like urbanisation are also a positive for the industry, especially for those who see plenty of scope for further waves of investment in China’s infrastructure.

For HSBC’s Chow, shifts in the types of spending are relevant too. Fifteen years ago, much of the focus was on building highways; then more complex projects in railways and urban mass transit provided new impetus; and now the prediction is a shift to areas like sewage and water projects, as well as an upgrading of the power grid.

Another sweet spot is the Go West campaign, as policymakers promote investment in energy, water and transportation in the west of the country.

Zoomlion claims to be well positioned here, says the Xiaoxiang Morning Herald, following its purchase of Shaanxi Xin Huanggong, a manufacturer of earth-moving equipment in the northwestern province of Shaanxi, four years ago. The acquisition is now serving as a springboard into the region and last month company bosses were trumpeting what they say is the largest order in industry history – the sale of two hundred 36-tonne excavators to Inner Mongolia Qiantai Group, a mining firm from Erdos.

So Zoomlion’s prospects look reasonable?

Together, these various initiatives mean that HSBC is forecasting sales growth for Zoomlion of a little above 14% for the full year.

Of course, that is a slower pace than the frenetic days of 2009 and 2010, when the Rmb586 billion stimulus plan and relaxed lending conditions saw an explosion of new investment in roads, rail, malls and housing.

But another positive for Zoomlion is that construction equipment tends to need replacing more quickly in the Chinese market (because kit is operated up to three times longer each month than in other markets, says HSBC). Daily operating hours this year are down on previous peaks but replacement times are still shorter, at about 10 years.

Fortunately for Zoomlion, concrete machinery is being replaced most rapidly of all. That’s because competition between leasing firms and cement depots for new customers is boosting demand for the newest models.

Chinese firms have also been looking to make acquisition overseas, with a view to gaining technological know-how and international scale.

Sany paid $475 million in January for German concrete-pump maker Putzmeister and Zoomlion has said that it wants to increase its overseas sales from 5% of current revenues to 30% by 2015.

That looks like a challenging target, especially as Zoomlion’s main move so far came in 2008, when it bought a controlling stake in CIFA, an Italian manufacturer of concrete machinery.

In recent weeks there have been rumours that Zoomlion is considering a bid for Case Construction, a leading equipment maker in the United States.

But company sources denied the claim again last week, saying that there had been no contact with Case.

But still reasons for concern?

On Wednesday news broke that Sany – Zoomlion’s main rival and “brother” company in Changsha – had cut its workforce by almost a third. The International Finance News – an arm of The People’s Daily – broke the news.

The report cited former employees as sources, with one telling the newspaper some had been sacked for offences that would in the past have been greeted with a blind eye (“sleeping on the job” was WiC’s favourite).

But it added that sackings were not the only reason for the fall in headcount. Others had quit the firm because of a new performance-based pay scheme. This has reportedly seen monthly salaries for many workers fall from Rmb4,000 to Rmb2,500.

Sany spokespeople, however, denied the news, saying levels of staff turnover were “normal” .

Keeping track: in WiC157 we profiled construction equipment maker Zoomlion. The Changsha-based firm was then the most heavily shorted stock on the Hong Kong market – analysts were particularly worried about the large amounts of credit the firm was offering to its clients. The speculation hasn’t gone away. This week an anonymous letter was sent to regulators alleging Zoomlion was inflating its sales with fictious revenues. The company described the claim as “false, groundless and misleading”. However, its stock fell 6.4% on news of the letter, suggesting investors remain worried. (Jan 11, 2013)


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