Shanghai Securities News and cnstock.com | Three-year SOE Reform Reaps Rewards

Translated from Shanghai Securities News and cnstock.com

Recently, the Central Economic Work Conference reiterated the imperative to intensify efforts in implementing actions for the deepening and enhancement of state-owned enterprise (SOE) reform, aiming to fortify key functions and elevate core competitiveness. On January 15, 2024, the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) convened a symposium on the economic performance of SOEs, further emphasizing the initiation of quality and efficiency improvements in central SOEs to achieve a strong start in the first quarter.

The three-year meticulous SOE reform has now entered a phase of strategic achievements. Since 2020, SOEs and central SOEs have been following the three-year action plan for SOE reform, consistently enhancing internal strength and shaping external perceptions. On the capital market, the Shanghai Stock Exchange (SSE) has actively implemented the Opinion on Further Improving Quality of Listed Companies released by the State Council. It has put in efforts to support SOEs and central SOEs in steadily enhancing their operational scale, quality, and efficiency, intensifying R&D innovation, leveraging the role of equity incentive, M&A, reconstructing, and other capital operation mechanisms while delivering sustained returns to investors. These efforts have led to a notable improvement in the quality of listed companies.

"Looking at the current juncture, it is anticipated that the soon-to-be-announced 'new round of actions for the deepening and enhancement of SOE reform' will focus on 'quality and efficiency improvements'. This will facilitate the ongoing realization of reform dividends, ultimately reflecting in valuation uplift." A brokerage firm highlighted this in its latest research report.

Steady Growth in Business Scale and Quality

As of January 15, 2024, a total of 775 SOEs and central SOEs are listed on the SSE, with a combined market capitalization of RMB 35.89 trillion. Among them, 278 are central SOEs, contributing to a total market capitalization of RMB 24.17 trillion.

In the first three quarters of 2023, SOEs and central SOEs listed on the SSE achieved total operating revenue of RMB 29.85 trillion, remaining unchanged year on year, and a net profit attributable to the parent company of RMB 2.83 trillion, a 2.61% growth year on year. Specifically, central SOEs listed on the SSE recorded operating revenue of RMB 21.34 trillion and a net profit attributable to the parent company of RMB 2.23 trillion, accounting for over 50% of the total operating revenue and over 60% of the net profit, respectively. More than 440 SOEs and central SOEs experienced year-on-year operating revenue growth, and nearly 450 saw an increase in net profit attributable to the parent company, accounting for over 30% and nearly 40% of SSE-listed companies with growing performance, respectively.

In 2022, SOEs and central SOEs achieved a combined operating revenue of RMB 39.98 trillion and a net profit attributable to the parent company of RMB 3.48 trillion, respectively representing 78% and 82% of the total amount of SSE-listed companies, with a year-on-year growth of nearly 8% and approximately 6%. Notably, the performance of central SOEs demonstrated even more significant growth, with a total operating revenue of RMB 28.55 trillion and a net profit attributable to the parent company of RMB 2.72 trillion, up by 9% and 8% year on year, respectively.

The overall scale has steadily increased. Over the past three years, the number of SSE-listed SOEs and central SOEs has increased from 675 to 775, with their total assets, operating revenue, and profits expanding from RMB 214.39 trillion, RMB 30.77 trillion, and RMB 2.75 trillion at the end of 2019 to RMB 284.13 trillion, RMB 39.98 trillion, and RMB 3.48 trillion at the end of 2022, respectively. Moreover, their compound annual growth rates reached 9.84%, 9.12%, and 8.12%, while cumulative growth rates reached 32.53%, 29.91%, and 26.4%, respectively.

From a median perspective, the median values of operating revenue and net profit attributable to the parent company of SSE-listed SOEs and central SOEs increased from RMB 5.177 billion and RMB 275 million in 2019 to RMB 6.568 billion and RMB 333 million in 2022, with cumulative growth rates of 27% and 21%, respectively. Among them, entity-based SOEs and central SOEs achieved operating revenue of RMB 32.79 trillion and net profit attributable to the parent company of RMB 1.49 trillion in 2022, respectively accounting for 77% and 72% of the operating revenue and net profit of all entity-based enterprises listed on the SSE, with growth rates of 34% and 37%, respectively, compared to 2019.

From an average scale perspective, each SSE-listed central SOE achieved steady growth over the past three years, with average operating revenue and net profit attributable to the parent company increasing from RMB 82.376 billion and RMB 7.848 billion in 2019 to RMB 104.202 billion and RMB 9.937 billion in 2022, representing growth rates of 26.5% and 26.62%, respectively. The average operating revenue and net profit attributable to the parent company of local SOEs increased from RMB 16.708 billion and RMB 1.229 billion in 2019 to RMB 23.277 billion and RMB 1.544 billion in 2022, with growth rates of 39.32% and 25.62%, respectively.

Operational quality and efficiency have witnessed a significant improvement. From the perspective of profitability, in 2022, 632 SOEs and central SOEs listed on the SSE achieved profitability, accounting for approximately 83%. Among them, 583 sustained profitability for three consecutive years, constituting approximately 76%. From the perspective of assets return, as of the end of 2019, the overall return on equity (ROE) of SSE-listed central SOEs and local SOEs was 10.45% and 9.94%, respectively, slightly lower than the overall ROE of SSE-listed companies by 0.16 percentage points and 0.67 percentage points. By the end of 2022, these figures rose to 10.11% and 9.38%, respectively. From the perspective of leverage levels, the median asset-liability ratio of SSE-listed SOEs and central SOEs was 52.43% at the end of 2022, with entity-based enterprises having an asset-liability ratio of 50.05%, a respective decrease of 0.54 percentage points and 0.88 percentage points compared to the end of 2019, maintaining a relatively stable liability level.

Unwavering Commitment to R&D Innovation

In 2022, R&D expenditures of SSE-listed SOEs and central SOEs totaled RMB 574.184 billion, showing a year-on-year growth of 25.56%. Notably, 15 SOEs and central SOEs, including China State Construction Engineering Corporation Limited, Petrochina Company Limited, and SAIC Motor Corporation Limited, surpassed RMB 10 billion in R&D expenditures.

According to statistics, the median R&D expenditures of SSE-listed SOEs and central SOEs have steadily increased from RMB 82 million to RMB 125 million over the past three years. The number of enterprises with a R&D expenditure ratio above 3% has risen from 266 to 287. Among them, 245 enterprises maintained a R&D expenditure ratio above 3% for three consecutive years, and 95 enterprises sustained a ratio exceeding 5%.

In the first three quarters of 2023, SSE-listed SOEs and central SOEs invested over RMB 341.3 billion in R&D, with a year-on-year growth rate of nearly 8 percentage points. Sustained R&D investment has facilitated technological breakthroughs, propelling the transformation and upgrading of the industrial chain. For instance, Shanghai Pharmaceuticals Holding Co., Ltd increased its R&D expenditure ratio from 0.56% in 2016 to 10.47% in 2022, expanding its innovative drug lines from 16 to nearly 50, with two class I new drugs applying for market approval. Similarly, the R&D expenditure of China State Construction Engineering Corporation Limited has consistently exceeded RMB 10 billion over the past three years, resulting in cutting-edge technological achievements in the construction industry, such as the "skyscraper-building machine" and "zero elevation house".

Activated Talent Dynamism through Equity Incentives

Over the past three years, while increasing R&D investment, SSE-listed SOEs and central SOEs have actively optimized corresponding talent incentive mechanisms, significantly raising the enthusiasm for equity incentives.

Data shows that from 2020 to 2022, SSE-listed SOEs and central SOEs rolled out a total of 133 equity incentive plans, a marked increase from the 84 programs in the preceding triennium (2017-2019). Simultaneously, the intensity of these incentive plans has ascended, with the median proportion of equity incentive shares to total share capital reaching 1.44%, a significant leap from the 0.99% observed in the prior three years.

According to statistics, in 2023, a total of 27 equity incentive plans were launched by SSE-listed SOEs and central SOEs, with the median proportion of incentive shares to total share capital reaching 1.65%, signaling a robust escalation in incentive intensity. Notably, restricted share emerged as the preferred incentive method of SOEs and central SOEs. Among the 160 equity incentive programs launched by SOEs and central SOEs since 2020, 128 adopted this approach. In particular, 11 enterprises listed on the STAR Market have chosen Class II restricted shares. Across industries, technology-driven sectors such as computing, biopharmaceuticals, power equipment, and electronics exhibited high participation, alongside traditional sectors like transportation, basic chemicals, and construction decoration.

Noteworthy is the trend of continuous equity incentive plans by some SOEs and central SOEs. For instance, China State Construction Engineering Corporation Limited formulated a decade-long medium-and-long-term incentive plan, consecutively executing four phases of restricted share incentive plans since 2013. The proportion of incentive shares increased from 0.49% to 2.17% and the number of covered incentive objects increased from 686 to 2,765, with a cumulative number of covered incentive objects exceeding 7,000 and the total granted shares amounting to approximately 2.082 billion.

Industrial Integration Facilitated by Capital Operations

Since 2020, SSE-listed SOEs and central SOEs have disclosed 120 significant asset reorganizations, with a total transaction value exceeding RMB 590 billion. Approximately 60% of these enterprises utilized share issuance as a means of consideration payment, with a noticeably higher enthusiasm for M&A among manufacturing-focused SOEs and central SOEs. Since 2023, 22 SSE-listed SOEs and central SOEs have launched plans for significant asset reorganizations.

Specifically, SOEs and central SOEs M&A and Restructuring primarily fall into the following categories: 1. Horizontal resource integration to strengthen core competitiveness. For example, China Shipbuilding Industry Group Power Co., Ltd unified and integrated its diesel power business through restructuring, with a total transaction amount of RMB 22.5 billion. This move not only addressed industry competition but also further solidified the company's leading position in the industry. China Avionics Systems Co., Ltd. absorbed and merged AVIC Electromechanical Systems Co., Ltd. through stock swap, orderly integrating the avionics and electromechanics sectors to establish an overall listing platform for AVIC's airborne business.

2. Vertical integration upstream and downstream to achieve resource interaction. For example, the Zhuzhou Smelter Group Co., Ltd. acquired 100% equity of Hunan Shui Kou Shan Nonferrous Metals Group Co., Ltd. and 20.8% equity of Hunan Zhuzhou Smelter Nonferrous Metals Co., Ltd. through share issuance and cash payment with a transaction scale of RMB 3.9 billion. After the transaction, the company directly owns lead-zinc ore resources, becoming a comprehensive company integrating the exploration, smelting, and sales of non-ferrous metals such as lead and zinc.

3. Asset replacement to drive business transformation and upgrading. For example, Gansu Qilianshan Cement Group Co., Ltd, a subsidiary of China National Building Material Group Co., Ltd., underwent asset reorganization with China Communications Construction Company Limited's affiliated design institute. The original cement business was divested, making way for high-quality highway and municipal design assets and facilitating the transformation and development of the listed company's core business. Similarly, Yunnan Wenshan Electric Power Co., Ltd. divested its assets and liabilities related to its original electricity purchase and sale, power design, and power distribution business, exchanging them with the counterparty for 100% equity in the Peak Shaving and Frequency Modulation Co., Ltd. held by the China Southern Power Grid Co., Ltd. After the restructuring, the company achieved the overall listing of pumped storage and energy storage, significantly improving the operating scale of the listed company.

Simultaneously, spin-off listings have increasingly become a means for SSE-listed central SOEs to streamline their business structure and promote the discovery of subsidiary values. As of now, 32 SSE-listed SOEs and central SOEs have launched spin-off plans, with 12 of them already listed. For example, China Communications Construction Company Limited spun off its design institute assets for reorganization and listing, becoming the first central SOE to achieve market-oriented backdoor listing on the A-share market. Likewise, China Energy Engineering Corporation Limited facilitated the spin-off and listing of its subsidiary, Explosives Corporation Limited, driving the expansion and strengthening of its internal civilian explosive business. Additionally, China United Network Communications Limited advanced the spin-off and listing of its subsidiary, ChinaUnicom Smart Connection Technology Co., Ltd, in the field of connected vehicles on the STAR Market, promoting the growth and strengthening of the company's connected vehicle business.

Enhanced Sense of Gain of Investors through Dividend Returns

SSE-listed SOEs and central SOEs stand as the primary force in cash dividends. In 2022, these enterprises collectively distributed dividends amounting to RMB 1.41 trillion, constituting 82% of the total dividends on the SSE. About 70% of SSE-listed SOEs and central SOEs engaged in cash dividends, with over half of them maintaining a dividend ratio exceeding 30%.

Over the past three years, the cumulative dividends of SSE-listed SOEs and central SOEs in 2020-2022 reached RMB 3.47 trillion, consistently contributing nearly 80% of the total market dividends. The "Six Major Banks" accumulated dividends of RMB 1.17 trillion during the same period, with the Industrial and Commercial Bank of China Limited contributing the highest dividends in the entire market, with a total of RMB 317.2 billion. In terms of stability, over 40% of SOEs and central SOEs maintained a cash dividend ratio exceeding 30% over the past three years. Notably, 46 SOEs and central SOEs, including China Petroleum & Chemical Corporation, China Shenhua Energy Company Limited, and Shandong Iron and Steel Company Ltd, consistently maintained a cash dividend ratio exceeding 50% for three consecutive years, providing sustained returns to investors.

Worth noting is the growing trend of shareholding increase and repurchase as a pivotal means for SSE-listed SOEs and central SOEs to reward investors. According to statistics, throughout the year 2023, a total of 39 SSE-listed SOEs and central SOEs disclosed repurchase plans, with a total planned repurchase amount of up to RMB 23.034 billion. Currently, 6 of them have completed the repurchase. For instance, Baoshan Iron & Steel Co., Ltd. announced in mid-October 2023 a repurchase plan not exceeding RMB 3 billion, marking the company's third repurchase plan since its listing, effectively boosting market confidence.

Additionally, 96 SOEs and central SOEs disclosed shareholding increase plans, with a total planned increase amount of up to RMB 22.207 billion. Currently, 34 of them have completed the increase. Several shareholders of SOEs and central SOEs expressed confidence in the future development prospects of listed companies through shareholding increases. For example, Central Huijin Investment Ltd. invested RMB 477 million to increase its holdings in the shares of the "Big Four Banks", sending a positive signal for market stability. Similarly, Power Construction Corporation of China, the controlling shareholder of PowerChina, planned to increase shareholding by no more than RMB 2.4 billion, making it the company with the highest shareholding increase amount in 2023.