In the black

China’s capital city has just closed its last coal-fired power station, a plant that burned 1.76 million tonnes of coal a year, according to Xinhua.

Critics of Beijing’s smog say that power generation is simply being moved to nearby areas, but the authorities are promising more cutbacks in coal-fired power as part of a major revamp into renewable energy at a national level. Wind, solar and hydropower are expected to generate 30% of China’s electricity within three years.

So perhaps it seems counter-intuitive that China Shenhua Energy, China’s leading coal producer, should declare a record dividend to shareholders this month.

In part it’s a sign that the prospects for coal are limited – Shenhua is giving back cash to shareholders, rather than investing for growth.

But commentators have been suggesting that the payout points the way for other state-owned enterprises (SOEs) to be more responsive to market pressures, and that investors in listed state giants can now hope for better returns, as Shenhua’s unexpectedly generous dividend seems to have sent a signal that more SOEs are on the verge of change.

Why were investors so excited by Shenhua’s payout?

Analysts were expecting an improvement in the company’s profits but not the special dividend. News that the world’s largest coal miner, which also operates coal-fired power plants and railways, would pay Rmb59 billion ($8.6 billion) to shareholders, led its shares almost a fifth higher in the session following the announcement.

Most of the cash is coming in the form of a special dividend of Rmb2.51 per share, but there’s also a regular dividend of Rmb0.46 that is up substantially on its previous level. Together the payouts translate to an annual yield of about 20% (based on the pre-announcement share price) and are worth more than twice Shenhua’s 2016 net profit, which has climbed 41% from 2015.

This is Shenhua’s first profit growth in four years as the energy giant has benefited from government efforts to eliminate smaller and older mines in which policymakers cut capacity by 290 million tonnes and limited the number of days on which the remaining mines could operate. Production dropped about 9% across the industry as a whole last year but Shenhua sold more coal, cashing in on a spike in prices that held firm even after some of the restrictions were relaxed later in the year.

Was the dividend a signal of something more significant?

Analysts turned their attention to other SOEs that might deliver higher payouts to shareholders, with Steven Sun, head of Chinese equity strategy at HSBC, describing Shenhua as a “dividend trailblazer”.

The speculation was that a policy directive could be in play and that companies with stable earnings, low gearing ratios, strong cashflows and declining capital expenditures were most likely to deliver.

As more earnings reports were announced, dividends did seem to be growing. Insurer Ping An raised its full-year payout to just over a fifth of earnings, up three percentage points from 2015, citing strong performance in its core business. China Telecom also pushed up its dividend to a record high, although its 2016 net profit has actually declined, and Sinopec increased its dividend to a record payout ratio of 65% this week.

Investors in China Mobile were also hopeful about a windfall of their own. But a special dividend wasn’t forthcoming last week and the stock gave up some of its pre-announcement gains, despite an increase in the payout ratio from 43% to 46% in a year when profits were flat.

And even after reporting a 78% decline in net profit to Rmb7.86 billion, PetroChina announced a final dividend of Rmb0.038 per share (versus its basic earnings per share of Rmb0.04). That comprises a Rmb0.02 per share special dividend, together with an interim dividend declared for its fiscal first-half. The South China Morning Post says PetroChina’s total dividend for the year amounts to 231% of its net profit booked last year, versus a “long-standing payout policy of 45% since the oil giant went public in 2000)”.

Have the SOEs become more market-driven?

Away from the profit calculations, analysts have been pondering the policy implications, particularly the view that the payouts demonstrate greater professionalism at the companies concerned, and a new willingness to reward their shareholders.

Ling Wen, president of Shenhua’s listed vehicle, hailed the bumper distribution as a response to investor demands. Indeed a greater focus on returns to shareholders may signal the reversal of a trend in which the state enterprises have served more as tools of government policy, crowding out the private sector on the back of billions of yuan in state subsidies and cheap loans after the global financial crisis.

Since then Xi Jinping’s administration has talked about turning the tide in favour of the private sector by letting market forces play a more “decisive” role. Under an initiative first announced four years ago the SOEs were supposed to be made more market-oriented, with a more diverse group of shareholders and greater expectations of improved financial returns. Our first mentions of the mood change included talk about how executives were going to be incentivised (see WiC234), the debate on ‘mixed ownership’ of private and public capital, and the speculation that Sinopec (see WiC251) and Citic (see WiC253) would pioneer the new approach.

Xi then appeared to backtrack on the policy push by insisting that the state enterprises should retain a “dominant role” in certain sectors. Measures were introduced that cut the salaries of SOE managers to drive them closer to those of government officials of the same rank, sidelining the issue of making managerial compensation more of a factor in the reform agenda.

More recently the debate on transforming the state firms has played second fiddle to ‘supply side reforms’ – cutting capacity in industries saddled with excess production.

The result is that the early impetus on shaking up the SOEs has been lost, with a lament this month from Fu Chengyu, formerly chairman of Sinopec, that the push for mixed ownership has been “excessively timid and cautious”.

“Lots of people are watching from the sidelines and not many people are doing anything; most enterprises are waiting and few enterprises are actually trying something,” he complained, in remarks reported by Xinhua.

A new study from researchers at the National Development and Reform Commission, which guides policy in key sectors like industry and energy, comes to similar conclusions. The head of the commission, He Lifeng, and his deputy, Liu He, are said to be close allies of Xi Jinping, although the report is direct in its findings, referring to the pace of reform at the state enterprises as “quite sluggish”. The authors revisit the standard complaint that SOEs are resisting the plans to transform their industries. But they also take aim at an unexpected target. “Currently, a bigger reason why reforms in some of our country’s key sectors have had difficulty moving forward may lie in the thinking behind the top-level design of these reforms,” the report says, adding that “the source of the obstructions lies in the policymaking.”

Won’t increasing dividends make the SOEs more market-focused?

Proponents of SOE reform argue that the payouts for shareholders are a reflection of a change in approach. Industry regulators have been pushing for the state firms to distribute more cash as a means of encouraging cost control and as a way of stopping firms from splashing out on non-core activities like property development and punts on the stock market.

Stock exchange bosses also hope that higher payouts will temper the speculative instincts of investors as well, by encouraging them to hold their shares for the longer term. Given regulators are likely to loosen the restriction this year to allow more pension funds (controlled by local governments) to invest in the stock market, the Economic Observer suggests SOE bosses will find themselves under bigger pressure to raise divided payouts.

The same message has spread to the stock market in general, following instructions from the government that firms should be paying out a minimum of 30% of their earnings.

State companies such as Sinopec, Ping An and China Mobile are leading the way in this regard, although others have been falling short, paying out much less than peers in other markets.

But the lion’s share of SOE dividends goes to…

Under the “grasp the large, release the small” slogan, the privatisation push under Zhu Rongji in the 1990s targeted SOEs owned by provincial governments. The top state enterprises were more protected and they weren’t required to pay any dividends at all until well into the next decade.

Cases of well-connected bosses hoarding cash or wasting it on excessive or corrupt spending prompted a change of policy and the central government has been ratcheting up the demand for dividends in more recent years, based on the profitability of the companies concerned (see WiC90).

But by definition, state-owned enterprises are controlled by the state and the main shareholders at many of the firms in question are their state-owned parents.

Shenhua exemplifies the point: it is 73%-owned by the unlisted Shenhua Group, which is owned by the State-Owned Assets Supervision and Administration Commission (Sasac). Just 17% of the shares are floated on the Hong Kong market, with the remainder in Shanghai.

In the same way it is the government that has been grabbing the lion’s share of the largesse in most of the payouts of the last few weeks. In Shenhua’s case, there was a clear case of payback, adds China Securities News, after the miner did so well out of the cuts to coal capacity over the past year and a half. “The listed company just paid back the money to daddy,” the newspaper explains.

Capital Weekly also described Shenhua’s special dividend as a thank you for another key group: state-controlled entities that bought shares in the coalminer during the market panic of 2015. Five of the top 10 shareholders were the “firemen” who came to the rescue, it says. Also known as the ‘national team’ (see WiC325), investors like these piled into shares in China’s blue chips during the crisis and now they are getting a reward for their loyalty.

Which is the invisible hand at work?

Ling of Shenhua rebuffed suggestions that his firm was merely following government orders, claiming its dividend policy was “solely based on our group’s own decision”.

Of course, Sasac – the controlling shareholder – could be classified as part of the company or part of the government, depending on the interpretation. It manages 102 of the largest SOEs, getting access to their profits and recycling the cash into restructurings, mergers and corporate investment. And as the primary beneficiary of payouts like these, how it uses the funds is a key consideration. Xiao Yaqing, its head, made his priorities clear recently, reiterating that SOEs have to pay more dividends as part of government moves to restructure their sectors.

Economic Information Daily reported in February that Sasac had drawn up a detailed timetable to diversify ownership of the companies under its control by the end of this year. The themes were hardly new: the next round of reforms will introduce private capital and strategic investment, promote mergers and acquisitions, and encourage the “overall listing” of SOEs on stock exchanges.

Proving the point, of course, will require Sasac to step back by relinquishing ownership control. And in the meantime, the deluge of dividends doesn’t add up to a convincing case that the state-owned giants are heading in a direction in which the market becomes their master. In fact, they are more subject to the guiding hand of the government, which has been helping some of the biggest firms become even more powerful through consolidation in the railways (see WiC253), shipping (see WiC305) and steel (see WiC332).

This week there was speculation in the media that Sasac is pushing for a merger for Shenhua too – in its case between its state parent and the power generator China Datang, creating a utility giant with about Rmb1.66 trillion of assets. At heart this is a choice about how China’s government makes changes in crucial areas of its economy and the evidence of the moment is that it is making it a priority to improve the SOEs through centralised control, rather than the discipline of the market. And for those looking for fresh evidence of the revolving door between SOE management and local government, Shenhua’s name cropped up again this week. On Monday Zhang Yuzhou, the boss of Shenhua’s unlisted parent, was transferred to Tianjin, where he became a member of the municipality’s Party Standing Committee.

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