From the Annual Report Analysis Team of SSE Capital Market Institute
By April 30, 2019, a total of 1,466 companies listed on the Shanghai Stock Exchange (SSE) had released their 2018 annual reports. In 2018, the first year for the full implementation of the spirit of the 19th CPC National Congress, the fight against the “three tough battles” was further advanced, the supply-side structural reform delivered the initial results, the reform and opening up stepped up continuously, and the overall stability and the progress amid stability was realized in the economic operation. In accordance with the requirement for high-quality development, the SSE-listed companies vigorously adapted to the profound changes in the external environment, and made solid efforts in management. With the overall performance growing further, these achievements were hard-won. At the same time, there are still quite a few difficulties and problems in economic operation, such as the tightening general external economic environment, the downward pressure on the domestic economy and the operational troubles for some enterprises, which need to be addressed in a targeted manner, so as to improve the quality of the listed companies.
I. The management quality of the SSE-listed companies is stable with good prospects, demonstrating the characteristics in 7 aspects.
In 2018, the economic development was in an important period of strategic opportunities, and the economic structure was also at a critical stage of improvement and upgrading. As the main force of economic construction, the SSE-listed companies faced up to the difficulties, and their operation performance and quality were encouraging on the whole, demonstrating the characteristics in the following 7 aspects.
(1) With stable growth in performance, the listed companies play a key role in the national economy.
In 2018, taking the initiative to adapt to the new changes in economic restructuring and improving quality and efficiency, the SSE-listed companies recorded an operating income of RMB33.50 trillion, an increase of 11% year-on-year, accounting for about 30% of the GDP in the same period; a total net profit of RMB2.80 trillion was registered, up by 4% year-on-year. On the basis of the already large overall sizes of revenue and net profit, the growth rate slowed down compared with the same period of last year, but the good growth momentum was still maintained. In general, the SSE-listed companies, accounting for less than 0.01% of the total registered enterprises in China, posted a revenue equivalent to about one-third of the national GDP, fully demonstrating the mainstay role in national economy.
In addition, the representative companies in the market included in various blue-chip indexes still showed a sound performance. The companies included in the SSE 50 and SSE 180 indexes that represent the large-sized leading enterprises grew higher in operation than the average level of the SSE-listed companies, recording operating incomes of RMB18.32 trillion and RMB23.66 trillion respectively, both up by 12% year-on-year; their net profits amounted to RMB2.01 trillion and RMB2.44 trillion, increasing by 8% and 7% year-on-year, respectively. Thus it can be seen that the companies played a leading role in the economy.
(2) 90% of the companies are profitable and mostly focus on their main businesses.
Throughout the past three years, in the SSE market there have been more and more companies characterized by excellent operation quality, which have been the mainstream group in the market with continuous focus on the main businesses, sound management and standardized operation. According to statistics, 90% of the SSE-listed companies made profits. Moreover, a vast majority of the companies focused on their main businesses. In terms of the net profit after excluding extraordinary profit and loss which represents the operation quality of the main business, for example, about 1,100 companies realized the net profits after excluding extraordinary profit and loss for 3 consecutive years from 2016 to 2018, accounting for nearly 80% of the total SSE-listed companies. In 2018 the quality companies recorded a total operating income of RMB30.41 trillion, a year-on-year increase of 12%, accounting for 90% of the total operating income of the SSE-listed companies, and registered a total net profit of RMB2.86 trillion, up by 7% year-on-year. Specifically, there were also a number of high-quality blue-chip enterprises characterized by focus on the main business, standardized management and steady growth. About 740 companies achieved growths in both operating income and net profit, accounting for up to 50% of the total SSE-listed companies, and more than 110 companies posted a net profit of more than RMB3 billion. Among these high-quality companies, there were national economic pillars such as PetroChina, China Shenhua and the five major commercial banks, as well as the leaders in manufacturing, consumption and other industries, such as Anhui Conch Cement Company Limited, China National Nuclear Power Co., Ltd., Jiangsu Hengrui Medicine Co., Ltd., Inner Mongolia Yili Industrial Group Co., Ltd. and Foshan Haitian Flavouring and Food Company Ltd.
(3) The companies in the non-financial real economy grow faster than those in the financial industry.
In recent years, China has continuously strengthened the supply-side structural reform, constantly enhanced the capacity of the financial sector for serving the real economy, and made great efforts in revitalizing the real economy. In 2018, the SSE-listed real-economy (non-financial) companies achieved the growths of both income and net profit, further extending the good momentum shown last year. The real-economy companies achieved an operating income of RMB26.53 trillion, a year-on-year increase of 13%, and a net profit of RMB1.15 trillion, up by 7% year-on-year. Moreover, the growth quality of the real-economy companies improved significantly, recording the RMB1.01 trillion net profit after excluding extraordinary profit and loss, a year-on-year increase of 10%. Their net cash flow from operating activities amounted to RMB2.33 trillion, up by 18% year-on-year.
The asset-liability ratio of the real-economy companies remained stable with the expense ratio decreased. In 2018, the asset-liability ratio of the real-economy companies stood at 61.59%, which was the same as the last year on the whole. In addition, driven by de-leveraging, cost reduction and other policies, the asset-liability ratios of traditionally high-leveraged industries of coal and steel were 49.71% and 54.73% respectively, down by 1.93 percentage points and 4.39 percentage points respectively year-on-year; the rates of the sales expenses, management fees and financial expenses of the SSE-listed real-economy companies was 8.28%, down by 1.11 percentage points compared with a year earlier, and their tax burden took up 7.03% of the operating income, down by 0.16% year-on-year.
In 2018, the SSE-listed financial companies attained an operating income of RMB6.97 trillion, a year-on-year increase of 6%, and a net profit of RMB1.65 trillion, up by 2% year-on-year. Among them, the companies in the banking industry achieved a net profit of RMB1.44 trillion, a year-on-year increase of 6%. The performance growth was mainly due to the rebound in net interest margin, with the average net interest margin increased by 0.06 percentage points from the previous year, but the growth rate slowed down, mainly because the banks consolidated the quality of assets in 2018 by increasing the proportion of the provision, with the average provision coverage ratio increased by more than 20 percentage points year-on-year. The securities industry realized a net profit of RMB44.6 billion, a year-on-year decrease of about 49%, mainly due to the decline in income from the brokerage business, the decrease in the revenue from the equity investment and the increase in the retained asset impairment losses. The companies in the insurance industry posted a net profit of RMB158.2 billion, which was the same as the same period in the previous year, mainly due to the performance growth under the pressure and some impact of the implementation of the new financial instrument standards on the relevant investment incomes.
(4) The companies in the upstream and midstream industries record more increases than those in the downstream industries.
In 2018, benefiting from the factors such as the supply-side structural reform, the companies in various upstream and midstream industries extended the growing trend; but under the influence of the factors such as industry cyclicality, financial liquidity and the upstream and downstream structural relationship, the growth slowed down compared with the significant increases registered in previous years. At the same time, with the impact of various factors such as the upstream cost squeeze, the external demand slowdown and the regulation based on the state policies, the performance of the downstream consumer industries declined.
In the upstream industries, benefiting from international politics, economic growth of major economies and other factors, with the callback of the international oil price, the SSE-listed companies in the oil industry achieved rapid growth with a net profit of RMB117.5 billion, a year-on-year increase of 58%. The companies in the non-ferrous industry attained a net profit of RMB9.8 billion, down by 17% year-on-year. However, after excluding Western Mining Co., Ltd. recording huge losses due to investment failure, other companies in the non-ferrous industry realized a net profit of RMB11.9 billion, a year-on-year increase of 5%, mainly benefiting from the supply-side structural reform and other factors. The companies in the coal industry achieved a net profit of RMB85.9 billion, up by 2% year-on-year, which was a small increase mainly due to the coal-electricity linkage and other factors. In the midstream industries, benefiting from the national environmental protection policy, the supply-side structural reform and other factors, the companies in the chemical industry registered a net profit of RMB48.8 billion, a substantial increase of 24% year-on-year; similarly, the companies in the iron and steel industry posted a net profit of RMB61.5 billion, growing significantly by 38% year-on-year.
The rise in raw material prices in the upstream and midstream industries put pressure on the cost side of the downstream industries, coupled with the factors such as the expansion of consumer demand less than expected, and the transformation and restructuring of some industries, making the performance of downstream industries slide rapidly. The companies in the pharmaceutical industry recorded a net profit of RMB31.1 billion, down by 21% year-on-year; under the influence of the slowdown in automobile consumption demand, the companies in the automobile industry posted a net profit of RMB68.2 billion, down by 4% year-on-year; the companies in the home appliance industry registered a net profit of RMB10.3 billion, down by 2% year-on-year; the companies in the wholesale and retail industry attained a net profit of RMB34.8 billion, down by 23% year-on-year. On the other hand, in 2018, the companies in the real estate industry achieved a large growth with a total operating income of RMB1.17 trillion, a year-on-year increase of 20%, and a net profit of RMB102.6 billion, up by 16% year-on-year. Instead of the sales of the housing projects in 2018, the gains mainly stemmed from the earlier advances received from the housing pre-sale that were carried over and confirmed as the income in 2018. In terms of the structure, Poly Developments and Holdings Group Co., Ltd. ,Gemdale Corporation and other large real estate enterprises were leaders in performance with rapid growths achieved, showing that the industrial concentration has been further improved.
(5) Significant growth in R&D investment drives industrial optimization and upgrading.
The SSE-listed companies have vigorously implemented the national strategies, making efforts in both transforming and upgrading traditional industries and fostering and developing emerging industries. In 2018, the SSE listed non-financial sector companies invested about RMB390 billion in R&D, an increase of about 21% year-on-year. Among them, there were more than 60 companies with the R&D investment accounting for more than 10% of operating income, and 230-plus companies more than 5%.
Under the guidance of the innovation strategy, the SSE-listed companies energetically adopted modern high and new technologies, carried out equipment transformation and technology renewal in traditional manufacturing and service industries, strengthened the their core competitiveness, and improved the overall level of the industrial chains. For example, Fuyao Glass Industry Group Co., Ltd. saw the business performance grow remarkably in 2018, and laid a solid foundation for high-quality, high-efficiency and low-cost production by researching and developing a variety of powerful high value-added products and continuously improving the intelligent level of production line to achieve the transformation and upgrading from “large-scale manufacturing” to “strong intellectual manufacturing”. In addition, during the reporting period, Sany Heavy Industry Co., Ltd. launched a number of highly competitive and innovative products, and continued to step up the research and development of intelligent, unmanned, energy-saving and environmentally-friendly products to drive the business performance to grow continuously at a high speed. For another example, Shaanxi Coal Industry Company Limited continued to increase investment in science and technology in 2018, and made the world’s leading technological achievements such as intelligent unmanned mining and pillar-free mining. At present, the company has successfully completed the production task of four intelligent working faces, achieving the full coverage of intelligent mining for the thin coal seam, medium-and-thick coal seam, and thick coal seam.
At the same time, strategic emerging industries are gradually rising, and new industries, new models, and new business types are clustering and developing into a new engine for economic growth. For example, Jiangsu Hengrui Medicine Co., Ltd. has been focusing on R&D and innovation for long, investing 10% to 15% of its sales amount in R&D annually. Currently, 4 innovative drugs have been successfully delivered to the market, and the company has been the largest research and production base for anti-tumor drugs in mainland China, with stable growth of performance always maintained. Another example is China Jushi Co., Ltd., which has stuck to independent innovation and is committed to providing a “Jushi solutions” for the development of composite materials in the world. At present, the company has seen its high-end glass fiber products account for more than 80% of the total, and invested nearly RMB10 billion in building a intelligent manufacturing base for new materials so as to further improve the structure of products. For another example, Shenzhen Goodix Technology Co., Ltd. has made its R&D expenses account for more than 10% of its operating revenue in the past three years, with the percentage even reaching 22.5% in 2018. During the reporting period, the company took the lead in achieving the under-screen fingerprint unlocking technology, driving a new round of performance growths for itself.
(6) The SSE-listed companies improve their contribution to the society with the record high of cash dividends.
In terms of dividends, the SSE-listed companies continued to maintain the blue-chip characteristics of significant returns and high dividends over the years. The data shows that 1,108 companies proposed dividend plans in their annual reports, with the total cash dividends proposed amounting to RMB910 billion, a record high on the basis of the RMB810 billion in the previous year; the average dividend ratio was about 41%, an increase of about 4 percentage points compared with 2017. Among the companies distributing the cash dividends, more than 800 proposed a dividend ratio of more than 30%, with the ratios of 220-plus companies exceeding 50%. From the perspective of the distribution of the companies, a group of the companies continuously and stably distributing dividends in high proportions has been formed, and about 480 companies have posted a dividend ratio of more than 30% for three consecutive years. The enterprises such as China Shenhua Energy Company Limited, Fangda Special Steel Technology Co., Ltd. and Inner Mongolia Yili Industrial Group Co., Ltd. have become models of SSE-listed companies characterized by long-term large-scale distribution of dividends.
Vigorously fulfilling their social responsibilities, the SSE-listed companies have energetically advanced the efforts in targeted poverty alleviation, pollution prevention and control and other tasks. In terms of tax contribution, the SSE-listed companies have made continuous and stable contributions to the state tax revenue. The cash flow statement shows that the various taxes and fees paid by the SSE-listed companies totaled RMB2.63 trillion, which was roughly equivalent to the total net profit realized by the companies. In terms of improving employment, the number of the employees hired by the SSE-listed companies has steadily increased, and the companies created more than 14.5 million jobs and paid a total of RMB2.8 trillion in employee compensation, an increase of 11% year-on-year. In the aspect of targeted poverty alleviation, more than 620 SSE-listed companies disclosed information about targeted poverty alleviation. For example, focusing on poverty alleviation based on development of industries, consumption, employment and education, Sinopec invested RMB228 million in helping 32,200 registered poverty-stricken households to get rid of poverty. With respect to pollution prevention and control, more than 570 SSE-listed companies established the mechanism of environmental information disclosure to actively disclose the information about environmental protection.
(7) New results are achieved in optimizing the allocation of resources through M&A and restructuring.
As an important way for the capital market to optimize allocation of resources, M&A and restructuring plays an important role in helping the listed companies accelerate transformation and upgrading, resist risk challenges and achieve high-quality development. In 2018, the M&A and restructuring market on the SSE remained stable on the whole. A total of 1,226 M&A transactions were conducted throughout the year, with a total transaction amount of RMB1.2 trillion, up by 42% and 31% respectively from the previous year. In terms of major asset restructuring, a total of 131 companies initiated the restructuring, basically at the same level as the previous year; a total of 117 programs were disclosed, an increase of 18% year-on-year, with the degree of activity improved; the transaction amount involved stood at nearly RMB400 billion, close to the previous year's level, showing some good momentum and accumulating the upbeat driving forces.
In 2018, the industrial M&A transactions targeting at the integration based on “the same industry, the up-and downstream” accounted for more than 70% of the total transactions. The industrial logic became the mainstream concept and consensus of the market, and the role of the M&A in supporting and serving the real economy was brought into further play. Specifically, both the number and the transaction amount of the programs with the underlying assets in the strategic emerging industries such as biomedicine, high-end equipment manufacturing and electronic information technology accounted for more than 70% of the totals. For example, by injecting the businesses of the underwater information detection and acquisition and the confrontation system and equipment, and forming the synergy with the original underwater information transmission business, China Marine Information Electronics Company Limited developed into an enterprise with the most complete industry chain of underwater information system and equipment in China; With the acquisition of Lanxin Technology, Henan Thinker Automatic Equipment Co., Ltd. achieved technical integration in high-speed train operation monitoring and information management system.
II. There are still some structural constraints on the development of the SSE-listed companies.
In 2018, focusing on the main businesses, the SSE-listed companies showed encouraging performance with stable operation. At the same time, there are still certain structural constraints on production and operation, market valuation, information disclosure, etc., which require attention and settlement in the follow-up reforms.
(1) The main businesses of a small number of companies have been sluggish for a long time.
A small number of companies are plagued by risks and problems such as the dilemma in operation, the loss of the “hematopoietic function”, and inadequate governance. According to the statistics, in 2018, the net profits of 97 companies fell by more than 50%; 143 companies suffered losses, accounting for about 10% of the total number of the listed companies. The companies with losses take up a small proportion in the total SSE-listed companies, and quite a few of them experienced significant impairment of goodwill or other types of asset impairment, with the risk factor of earlier trading based on high valuation of assets being gradually removed. It is worth noting that some companies face delisting risks due to poor management. Statistics show that in 2018, 30 companies met the delisting criteria and were imposed the risk warning for delisting; one company would be suspended from trading; 2 companies would have the listing terminated. Among these companies with the delisting risk, some had insufficient incentives to improve their main businesses. Their businesses shifted from the real economy to the virtual economy, and they are reduced to the "shell companies" criticized in the market. Such companies should be put under strict regulation continuously and be cracked down upon in a timely manner. There are also companies that found their main businesses in the doldrums with the impact of the industry cycle but were vigorously seeking breakthroughs in improving their operations. It is necessary to step up the positive guidance and targeted support for such companies and help them improve the capacity for operation.
(2) Some private enterprises face difficulties in production and operation.
As an indispensable force for China's economic development, the private economy has seized the opportunities of strategic development and achieved encouraging business performance in the process of economic transformation. However, some private enterprises have encountered difficulties and problems. In 2018, the SSE-listed private companies showed sharp contrasts in their operation results, which led to their overall poor performance. According to the statistics, the SSE-listed private companies recorded a total operating income of RMB5.63 trillion, a year-on-year increase of 13%; the net profit amounted to RMB305.1 billion, down by 10% year-on-year. The profit-making private enterprises realizes a total net profit of RMB389 billion, a year-on-year increase of 15%, far higher than the overall level in the SSE market, demonstrating that most private companies have strong operational vitality and resilience. On the other hand, there are a total of 86 private companies with performance losses, including 10-plus companies posting a net loss of more than RMB3 billion, most of which are companies with risk warning. Among these loss-making companies, some fail to adapt to the requirements of industry transformation and upgrading in time, some have irregular short-term behaviors in governance, and some see high pledge risks of their controlling shareholders, which impacts the overall quality of development for the listed companies.
(3) Speculation in market concepts still exists within a certain range.
Some market participants are still keen on concept speculation. Some companies' market valuations deviate significantly from their fundamentals. This adversely affects the normal valuation structure of the market and is not conducive to building a sound market ecology and order. Statistics show that some shell companies and quasi-shell companies in the SSE market have fewer than 100 employees, with an operating income of less than RMB30 million and long-term negative net profit after excluding extraordinary profit and loss. But their valuations are not lower than those of the enterprises in similar industries on the market. In addition, the companies even add fuel to fire with hot topics and concepts from time to time. In contrast, there are also a number of companies focusing on the main business with the number of employees, operating income and operating profit remaining stable, but their market valuations are even lower than those of the companies speculating on the concepts. Such circumstances affect the normal valuation of the market to some extent, and are not conducive to promoting the survival of the fittest in the allocation of resources or encouraging long-term investment and value investing. In this regard, it is necessary to strictly regulate the speculations in concepts in a continuous manner, guide the market in paying attention to and focusing on the companies concentrating on their main businesses, and push the listed companies to improve the quality of operations.
(4) The information disclosure quality of some companies is yet to be improved.
Containing the key messages such as industry development, market competition pattern, core resources of the company, business model and financial statements, the annual report serves as an important channel for the investors to assess the investment value of a listed company. However, in practice, it is found that the information disclosure of some companies is too brief and general and lacks effectiveness in decision-making. For example, some companies only briefly describe the macro environment and industry development. The contents lack details and facts and fail to further explain the impact on the company's own operations. Some of they even present problems of little relevance to the company's existing businesses. Some companies only list\ financial data, and fail\ to make in-depth explanations about major financial data changes on the basis of business model, market environment and the clients’ situations, etc. The empty contents make it impossible for the investors to track the causes for the changes; for another example, some companies fail to disclose the information about the business model, advantages and disadvantages in competition, etc. in a clear and pertinent manner, and do not update the relevant expressions when changes take place in the businesses. In this regard, it is necessary to further strengthen the regulation and improve the quality of information disclosure.
III. Reflections and Suggestions
Since the beginning of this year, with the overall external economic environment tightening and the uncertainties continuing to increase, the SSE-listed companies have taken an active approach in response, deepened their efforts in the main business, demonstrated the role of backbone force in the national economic development, achieved sustained growth in the overall downtrend, and vigorously offered returns to the investors. In the face of the economic downturn pressure in the future and the complex internal and external situations, the SSE should further boost the reform of the capital market and support the development of the real economy through the efforts in improving the quality of listed companies, bolstering the superior and eliminating the inferior, preventing risks and other aspects.
First of all, we should focus on improving the quality of listed companies so as to support the real economy. We should continue to push the listed companies to focus on their main businesses and improve the quality of their operations. To this end, it is necessary to strengthen supervision of information disclosure to give full play to the role of information disclosure in resource allocation. The information disclosure should be adequate enough to reveal the core value and risk factors of the listed companies, so that the intrinsic value of the company can be reflected by the price. Through the choices of the investors, we should incline the market resources toward the high-quality companies with outstanding performance in main business through various channels such as financing and investment. Moreover, we should also foster the market mechanism of the survival of the fittest with the aim of improving the quality of listed companies.
Secondly, we should support the high-quality companies in using the capital market to grow bigger and stronger. We should improve the financing policies for mergers and acquisitions and other activities. On the one hand, we should encourage quality companies to use mergers and acquisitions to achieve industrial integration and transformation and upgrading, and consolidate the main business; on the other hand, we should guide the investment of the long-term funds into the enterprises with core technologies, the leading position in the industry and good development prospects and reputation, so as to optimize allocation of resources. At the same time, we should effectively serve and support the information disclosure, improve the training services, streamline and enhance work processes, reduce the cost of information disclosure for listed companies, and increase the market's attention to quality companies, so as to form a virtuous circle between the capital market and the companies.
Thirdly, we should step up the elimination of inferior enterprises and the purification of the market. In dealing with the inferior companies, we should focus on protecting the legitimate rights and interests of the investors, earnestly perform the regulatory duties, make special efforts in cracking down on the violations such as financial fraud, illegal occupation of major shareholders, market manipulation and insider trading, increase the costs of the violations in the capital market, and urge the relevant parties to fulfill their responsibilities, so as to maintain the market order and the integrity foundation. At the same time, we should also further implement and improve the delisting system, smooth the exit channels of the capital market, accelerate the elimination of inferior enterprises such as the companies with major violations, the “zombie” enterprises and the shell companies, and enhance the ecological purification of the market.
Fourthly, we should prevent systemic risks and ensure that the capital market operates smoothly and orderly. We should deeply understand and respect the laws and connotations of the market, focus on strengthening the supervision of major risk areas and key risky companies, effectively predict the risks, make special efforts in preventing, defusing and dealing with the risks in the key areas such as stock pledge, bond default, privately offered funds and OTC funding, strictly guard against risk spillovers of individual cases, defend the bottom line of no occurrence of systemic risks, and safeguard the market stability.