China Inc. earnings growth to slow

SHANGHAI (Reuters) - China Inc.'s explosive profit growth is set to slow to about 25-30 percent in the second half, still impressive by global standards, but a likely let-down for a share market valued at stratospheric levels.

Profits at China's listed firms doubled in the first quarter after soaring in 2006, boosted by a red-hot economy and better corporate management, but also inflated by one-off factors and even by the rise of the stock market itself.

As of Sunday, 1,152 listed firms had posted combined net profit of 75 billion yuan ($9.7 billion) for January-March, up 99 percent from a year ago, the official Shanghai Securities News calculated.

Profit for 2006 at China's 1,453 listed firms rose 46 percent to 360 billion yuan, the China Securities Journal said on Monday, the end of the first-quarter and 2006 earnings reporting seasons.

The higher-than-expected growth has fuelled a spectacular bull run in China's stock market, where the benchmark Shanghai index .SSEC is up 41 percent so far this year, building on a 130 percent jump last year.

Analysts and fund managers warn the market may be vulnerable when profit growth loses steam later this year.

"Many stocks have risen far ahead of their 2007 earnings even if the first-quarter growth rate is retained," said Yan Zhenghua, chief strategist at China Asset Management.

"And investors are ignoring some extraordinary factors that helped push up first-quarter earnings, such as a low profit base last year."

Listed companies in Shanghai and Shenzhen are on average now above 40 times 2006 earnings, against 14 times for the Hong Kong Stock Exchange. They are valued above 30 times forecast 2007 earnings, analysts estimate.

SPECIAL FACTORS

Chief among the special factors is abnormally weak corporate profits in the 2006 first quarter, partly due to higher energy and raw material costs.

Industry leader Baoshan Iron and Steel (600019.SS) posted a profit leap of 156 percent to 3.68 billion yuan in the 2007 first quarter. Last year's first quarter saw the firm's lowest quarterly profit in three years due to surging iron ore prices.

The entire steel sector, accounting for 17 percent of the capitalization of the Shanghai and Shenzhen bourses, benefited from the year-earlier comparison.

Another special factor was a spate of asset injections by state parents into their listed arms, which boosted profits.

First-quarter profit at Shanghai Automotive (600104.SS) was nearly five times the year-earlier level. But that was not due to better profit margins -- parent SAIC sold it stakes in tie-ups with General Motors (GM.N) and Volkswagen (VOWG.DE).

Asset injections are continuing this year but many of the biggest industrial firms have completed such schemes, meaning this factor may be less powerful in coming months.

One-off accounting changes also came to the aid of some top companies in the first quarter.

Ping An Insurance (601318.SS) (2318.HK) had first-quarter net of 3.85 billion yuan -- nearly two-thirds of 2006's total -- after new rules let it book sales costs over several years, instead of immediately.

Some of China Inc.'s first-quarter profit growth was due to the stock market boom itself.

CITIC Securities' (600030.SS) profit was 10 times its level a year earlier. This was due to an explosion of underwriting and stock trading since mid-2006 -- market turnover is nearly 10 times year-ago levels.

While China's securities industry is expected to remain strong, few think underwriting and trading can continue multiplying exponentially.

STOCK SALES

Most ominously, some firms boosted profits largely by selling stocks as prices of their holdings rose. Since the holdings are finite and prices cannot soar indefinitely, growth from this source is not sustainable.

Dongfeng Automobile's (600006.SS) first-quarter profit jumped 24 percent to 131 million yuan -- but 115 million yuan came from investment gains, of which 40 percent was from sales of stock holdings. Operating profit was almost flat.

Profits at Chinese banks, which account for 20 percent of market capitalization, have relied less on special factors. But bank shares are already among the most highly valued, so there may be little room for them to take up the slack as industrial profit growth slows.

With new mutual funds raising tens of billions of yuan monthly, and individual investors opening stock accounts at a record pace, few expect any longer-term downtrend in the market.

But the current euphoria could cause unpleasant moments later this year as the market adjusts to a more sustainable pace of profit growth.

"The facts are that the economy is strong and corporate earnings robust. But this cannot hide the fact that the stock market is in a bubble," said Orient Securities analyst Zhou Fengwu.

($1=7.72 Yuan)