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DBS Group Research: Equity - Accelerating SOE Reforms

Core Content

The document outlines the ongoing and accelerating reforms of State-Owned Enterprises (SOEs) in China, emphasizing the structural supply-side issues that have been exacerbated by past credit booms. It argues that these reforms are beneficial for the market and highlights four key groups of companies that stand to gain from the changes. The report also draws comparisons with the successful SOE reform experiences in other countries, particularly Singapore, to support the view that China is on the right track.

Main Points

• Accelerating SOE Reforms: China is accelerating SOE reforms to address structural supply-side problems, including overcapacity in key industries.
• Root Causes of Supply-Side Issues:
  • Inefficient capital allocation, with SOEs receiving preferential treatment from state-owned banks.
  • Distorted input prices, especially in sectors like coal, which receive significant subsidies.
  • Low dividend payments by SOEs, which are often reinvested to expand capacity rather than distribute to shareholders.
  • Local protectionism, which hinders industry consolidation and leads to overcapacity.
• Financial System Stress: The declining Return on Invested Capital (ROIC) of SOEs and their high debt levels pose a risk to the financial system, necessitating reform to prevent systemic issues.
• Past Reforms: SOE reforms in China have been a punctuated and incremental process since 1978, with notable progress under Zhu Rongji, who implemented a 3-year restructuring plan and pushed for privatization and efficiency improvements.
• Current Reform Focus: The current round of reforms (2016–2020) emphasizes mixed ownership, corporate governance, and asset restructuring rather than full privatization.
• Market Impact: SOE reforms are seen as positive for the market, especially for the following four groups:
  • Companies that benefit from supply cuts.
  • Companies with potential for asset restructuring and mergers.
  • SOEs with early implementation of employee share incentive schemes.
  • SOEs with inefficient balance sheets that can be improved through better governance.

Key Information

• Demographics and Compensation Fund: China's demographic changes and a Rmb100bn compensation fund make it easier to cut redundant workers.
• Reform Success in Other Countries: The report references successful SOE reforms in other countries, such as Singapore's GLCs, suggesting that China's current approach is aligned with global best practices.
• Market Reaction: Recent SOE reform announcements have generally been positive for share prices.
• Four Groups of Beneficiaries:
  1. Supply Cut Beneficiaries: Companies that benefit from reducing overcapacity, such as Anhui Conch Cement, CR Cement, China Hongqiao Group, and Angang Steel.
  2. Potential Asset Restructuring and Mergers: Firms like China Railway Group, CRCC, China Everbright Ltd, CGN New Energy, and CGN Power are likely to benefit from restructuring and mergers.
  3. Early Employee Share Incentive Schemes: Banks and companies like CMB, BoCom, Sinopharm Group, and China Mengniu are expected to benefit from employee share incentives.
  4. Balance Sheet Improvement Potential: Companies such as Cosco International, China Comm Services, China Machinery Engr., and China Railway Sig. & Cor. are seen as having room for improvement in their financial structures.

Analysts and Research Teams

• Alexander Lee CFA, Market Strategy
• Janice Chua, China/Hong Kong Research Team
• Chris Leung, Banking & Finance
• Shujin Chen CFA, China Property
• Alfred He, Environmental, Industrial
• Mark Kong CFA, Healthcare
• Rachel Miu, Automobile, Infrastructure, Machinery
• Tam Tsz-Wang CFA, Telecom
• Dennis Lam, Small Mid Caps

Summary of Reform Roadmap (2016–2020)

• Reform Directives: Under Xi Jinping, reforms are focused on mixed ownership, corporate governance, and asset restructuring.
• Reform Cases: Recent cases include mergers, asset restructuring, and introduction of mixed ownership.
• Strategic Focus: The reforms aim to address inefficiencies, reduce overcapacity, and improve profitability and efficiency through market mechanisms.

Conclusion

The report concludes that SOE reforms are essential for addressing structural issues in China's economy and that the current reforms, though not full privatization, are a positive step toward a more efficient and sustainable market environment. The four groups of companies identified are expected to benefit significantly from these reforms.