www.pwchk.com All cash out? Working Capital Management China Market Study Deep dive on the automotive sector February 2018
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Foreword In this 2017 Annual Working Capital Survey for China and Hong Kong, we analyse 5 years worth of company data, listed on Hong Kong Stock Exchange, Shanghai Stock Exchange and Shenzhen Stock Exchange. In this study, we divided the listed companies into 16 sectors and analysed the industry trends. We especially focus on the automotive sector as representation of underlying trends. Given the relative slowdown of the Chinese economy, we see a clear impact on working capital performance levels across most sectors. Only 2 out of 16 sectors have shown any improvement (over the last 5 years) and the variability in working capital performance across the different sectors has been amplified significantly this year. With any slowdown in demand, all three elements accounts receivables, inventories and accounts payables are affected. Accounts receivables tend to increase as terms are extended or invoices are simply not paid on time; inventories are stuck in sales channels often pushed onto distributors who can t pay and accounts payables are stretched and increased as suppliers are not deemed a priority. By not paying suppliers, working capital optics look good! However this is a dangerous strategy to adopt, as it ultimately causes the breakdown of liquidity across the supply chain. Traditionally, working capital has not been an issue as borrowing money was inexpensive. However, now the lack of liquidity in the supply chain causes companies higher borrowings at higher interest rates, often from the shadow banking market. This directly erodes margin and makes the financing of corporate expansion more costly. With increasing interest rates, there will be more pressure to liberate cash from within working capital, especially in sectors such as manufacturing and retail, which are typically cash hungry sectors. Working Capital is always the cheapest source of funds. Better working capital management can be achieved by tighter processes and tools, stronger management behaviour and cultural attitude, with a top down focus. Working capital is now on every Board agenda. In addition, companies are looking to new trade financing products that will improve working capital. One such trade financing product is Supply Chain Finance. This is now gaining ground in the China market. These programs, established for suppliers by buyers, enable third parties to settle suppliers approved invoices in full, when the supplier requires, for a small charge. Also known as reverse factoring, this helps total supply chain liquidity and we think its adoption in China, although slow to date, will catch up with Europe and North America levels. In short, tighter working capital management processes can ensure revenues and profits grow without value destruction. In times of lower growth, and liquidity crises, organisations with a stronger cash culture will be able to focus on their core businesses without distraction, and emerge stronger and leaner, being the first movers to expand and leverage their market position. All cash out? 2017 Working Capital Management China Market Study 1
Globally and regionally in China, things have worsened ROCE has declined by 4% globally Significantly lower level of investment in CAPEX Spike in leverage 4% compound growth in net debt levels as a percentage of revenues (3-month interbank interest rate increased from 3.3% (Jan-17) to 5.4% (Dec-17)) Inventory & receivables performance has deteriorated NWC performance has only been maintained by a stretch in payables Only Aerospace and Hospitality sector in China managed to improve working capital since 2012 Companies in China had been delaying payments to suppliers to disguise the true working capital level Automotive is among the sectors with lowest NWC days, only because of its second highest DPO RMB 39.7 billion could be released from the balance sheets of Chinese listed companies by improving the net working capital of all sampled listed companies by 5% 2 PwC
Only when the tide goes out do you discover who s been swimming naked Warren Buffett Globally, ROCE has been decreasing and leverage increasing capital, companies cannot swim against the tide Economies are facing slow-down recently The latent problem of cash need starts to appear when cash becomes more expensive with rising interest rate Economies were not seriously affected due to the relatively low interest rate, but this is changing Companies are stuck at their current NWC position, and are looking for cheap sources of capital to fund their business On average for the 16 sectors detailed in our study, the NWC days performance has deteriorated by 33% from 2012 to 2016 All cash out? 2017 Working Capital Management China Market Study 3
What is happening - China 4 PwC
China & Hong Kong industry analysis Macroeconomic trends - China Liquidity crisis in China is evident, and cost of capital is increasing Economic shortage has been replaced by large scale overcapacity Fixed investments and exports two growth pillars have faltered Change in SOE administration and less government intervention have enabled more market economics There is a debt problem (in both corporate and local government) China is going through a re-adjustment The time of high GDP growth rate is over, and China has entered into a period of the New Normal, which requires rebalancing of its economic competitiveness Chinese companies urgently need cash for outbound investments All cash out? 2017 Working Capital Management China Market Study 5
Median net working capital days - China 0 30 60 90 120 1 Pharmaceuticals and life sciences Engineering & construction Healthcare Aerospace, defence & security Metals Industrial manufacturing Technology Communications Forest, paper and packaging Retail and consumer Entertainment and media Chemicals Transportation & logistics Automotive Hospitality and leisure Energy, utilities and mining 128 104 95 94 91 86 84 83 83 77 74 74 63 62 54 43 Pharmaceuticals & life sciences, Engineering & construction and Healthcare are the sectors having the highest net working capital days ( 95days) The results are similar to last year s study. Pharmaceuticals & life sciences, Engineering & construction and Healthcare were among the top 4 sectors with the highest NWC days in 2015. Relative size of the sectors in China 25.0 20.0 Industrial manufacturing 2016 Total revenue ('tn) 15.0 10.0 Energy, utilities & mining Transportation & logistics Retail & consumer Chemicals Technology Metals Engineering & construction 5.0 0.0 6 PwC Automotive Hospitality & leisure Entertainment & media Communications Forest, paper & packaging Healthcare Aerospace, defence & security Pharmaceuticals & life sciences 30 70 90 110 130 NWC days
Most sectors show a significant spread in performance between top and bottom performers Net Working Capital Days (NWC days) Pharmaceuticals & life sciences and Engineering & construction are the sectors having the longest median NWC days Top Performers Median Bottom Performers 0 100 66 36 104 42 95 33 94 36 91 29 86 36 84 37 83 43 83 27 77 14 74 37 74 23 63 9 62-1 54 2 43 1 200 2 128 223 221 191 178 187 180 159 152 162 1 178 144 147 128 254 120 300 Pharmaceuticals & life sciences Engineering & construction Healthcare Aerospace, defence & security Metals Industrial manufacturing Technology Communications Forest, paper & packaging Retail & consumer Entertainment & media Chemicals Transportation & logistics Automotive Hospitality & leisure Energy, utilities & mining All cash out? 2017 Working Capital Management China Market Study 7
Analysis on working capital elements by sector - China Days Sales Outstanding (DSO) Aerospace, defence & security is the sector with the longest median DSO Top Performers Median Bottom Performers 0 100 1 200 46 120 195 46 95 171 46 91 162 89 1 38 87 145 39 83 152 55 83 115 46 80 115 36 77 138 43 74 118 47 73 114 37 69 128 29 61 98 25 52 90 19 49 88 8 29 69 Aerospace, defence & security Communications Engineering & construction Technology Automotive Industrial manufacturing Pharmaceuticals & life sciences Healthcare Metals Chemicals Forest, paper & packaging Energy, utilities & mining Entertainment & media Transportation & logistics Retail & consumer Hospitality & leisure 8 PwC
Days Inventory Outstanding (DIO) Pharmaceuticals & life sciences is the sector with the longest median DIO Top Performers Median Bottom Performers 0 100 1 64 110 165 7 84 40 75 143 44 74 148 39 71 136 41 70 107 28 68 137 40 68 104 36 65 117 24 64 139 30 63 116 30 62 121 21 61 124 14 41 125 16 38 92 9 30 120 200 218 2 Pharmaceuticals & life sciences Aerospace, defence & security Healthcare Metals Retail & consumer Chemicals Industrial manufacturing Automotive Forest, paper & packaging Engineering & construction Technology Communications Transportation & logistics Entertainment & media Energy, utilities & mining Hospitality & leisure Days Payables Outstanding (DPO) Transportation & logistics is the sector with the shortest median DPO Top Performers Median Bottom Performers 200 197 1 100 0 87 47 26 88 22 121 23 95 54 29 102 61 35 99 67 39 102 69 40 129 72 37 112 74 41 146 76 35 136 77 40 148 77 34 143 80 167 82 39 152 93 106 32 Transportation & logistics Entertainment & media Hospitality & leisure Retail & consumer Forest, paper & packaging Healthcare Pharmaceuticals & life sciences Metals Chemicals Industrial manufacturing Technology Energy, utilities & mining Communications Engineering & construction Automotive Aerospace, defence & security All cash out? 2017 Working Capital Management China Market Study 9
In China, only 2 out of 16 sectors managed to improve working capital since 2012 Working capital increment 2012 2016 in percentage points 52% Improvers Non-improvers -11% -1% 22% 24% 24% 29% 30% 33% 33% 40% 40% 43% % 55% 58% Aerospace, defence & security Hospitality & leisure Communications Chemicals Retail and consumer Engineering & construction Entertainment and media Industrial manufacturing Technology Forest, paper and packaging Transportation & logistics Pharmaceuticals & life sciences Healthcare Automotive Energy, utilities and mining Metals Overall, only 12.5% of sectors have shown an improvement in working capital since 2012. The only companies that have achieved a marked improvement since 2012 are companies within the Aerospace, defence & security and Hospitality & leisure sectors. RMB 39.7 billion of cash could be released if the net working capital of all sampled listed companies inchina were improved by 5% 10 PwC
Analysis on working capital performance of companies within the same sector - China Improvers 41% 43% 44% 44% 45% 45% 45% 45% 46% 48% 48% 48% 51% 55% 55% 62% 47% Pharmaceuticals & life sciences Metals Healthcare Transportation & logistics Chemicals Forest, paper & packaging Entertainment & media Retail & consumer Automotive Technology Energy, utilities & mining Industrial manufacturing Engineering & construction Hospitality & leisure Communications Aerospace, defence & security Total Non-improvers 59% 57% 56% 56% 55% 55% 55% 55% 54% 52% 52% 52% 49% 45% 45% 38% 53% 4 out of 16 sectors have seen more companies improving their working capital performance than deteriorating. The Pharmaceutical & life sciences and Metals sectors are the notable exceptions, as 57% or more of companies did not manage to improve their working capital performance. If the net working capital of all sampled listed companies in China continue to grow at the existing rate, the aggregate net working capital level will reach RMB 824.2 billion in 2019 All cash out? 2017 Working Capital Management China Market Study 11
Focus on automotive sector 12 PwC
Focus on automotive - A winding road ahead? The challenges facing the automotive sector today are huge: self-driving cars, interconnectivity, expansion through acquisition and collaboration, mobility services and car sharing. In order to fund these initiatives, automotive companies must have a strong balance sheet and controlled operating costs across the whole automotive chain, especially as China is experiencing an automotive slow down which leaves both OEMs and non-oems open to risk. However, weakness and risk are not the same across the automotive industry in China. In order to meet the capital demand for the challenges faced by the OEMs, they are jeopardising the supply chain by delaying payment to non OEMs. The leading OEMs in China have a range of working capital tied up in 2016 from -25 to 10 days, because they essentially hang on to their money (DPO in the range of 113 to 189 days). But the non OEM producers numbers tell a very different story. NWC days OEM (Chart 1) OEM DSO trend (Chart 2) 40 41 34 1 129 131 130 30 20 10 0 (3) 10 11 10 120 90 103 87 111 84 81 87 94 (10) (20) (30) (10) (9) (13) (16) (25) (26) (24) (24) (25) 60 30 34 43 45 47 54 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 Upper quartile Median Lower quartile The above NWC analysis is based on 74 sampled leading automotive companies listed in China/HK All cash out? 2017 Working Capital Management China Market Study 13
OEM DIO trend (Chart 3) OEM DPO trend (Chart 4) 70 2 60 62 54 58 64 62 200 171 183 206 168 189 40 30 46 37 43 43 48 35 34 34 44 33 1 100 115 85 135 125 125 119 107 113 97 98 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 Upper quartile Median Lower quartile Leading non OEMs performance in net working capital days varies from 47 to 167 days with a median of 98 days, in 2016. This is a total juxtaposition from OEM manufacturers performance and the trend has continued over the last 5 years (See Chart 1 and 5). The main driver of this result is the level of the receivables, i.e., the amount of money owed to the non OEMs by the OEMs. The leading non OEM DSO are high: it takes 142 days to get paid. The OEMs have transferred their problem of capital need upstream. In order to preserve cash, the leading non OEM companies inventories have fallen, but still standing at 106 days in 2016. To survive, the non OEMs could only further shift the burden upstream. The leading non OEM payables are at 128 days, whilst the international standard is 51 days for payables. This creates an unhealthy supply chain, which is out of gear, for the whole automotive industry in China. Hence the industry needs a rethink, with solutions that demonstrate partnership where Supply Chain Finance (SCF) might be the solution. NWC days Non-OEM (Chart 5) 200 1 100 0 170 176 125 2012 87 117 2013 72 153 112 109 2014 64 170 167 Upper quartile Median Lower quartile The above NWC analysis is based on 74 sampled leading automotive companies listed in China/HK 2015 48 47 2016 98 14 PwC
Average non-oem DSO performance 2012-2016 (Chart 6) 200 180 160 140 144 142 120 132 126 130 100 2012 2013 2014 2015 2016 Average non-oem DIO performance 2012-2016 (Chart 7) 130 125 120 119 115 114 114 114 110 105 106 100 2012 2013 2014 2015 2016 Average non-oem DPO performance 2012-2016 (Chart 8) 170 160 1 140 130 133 128 120 120 110 112 110 100 2012 2013 2014 2015 2016 Powertrain Electrical components Body and interior Non-OEM The above NWC analysis is based on 74 sampled leading automotive companies listed in China/HK All cash out? 2017 Working Capital Management China Market Study 15
Effective and holistic Supply Chain Finance (SCF) can optimise working capital cycles for both buyers and suppliers while delivering more valuable liquidity. Also known as reverse factoring, SCF allows buyers to pay at an invoice s contracted maturity date, hence they retain their money longer; suppliers, in turn, can choose when they receive payments, beginning the day after the invoice is approved. SCF can help establish healthier, more trustworthy and longer-lasting relationships along the supply chain. On the other hand, it optimises working capital cycles for both the buyer and supplier by providing them with short-term credit for working capital, as well as better visibility and transparency in their collection and payment processes. SCF also enables both sides to access capital at a lower cost. The buyer is able to negotiate extended terms without delaying the actual payment to the seller, thereby retaining cash for other uses without impacting the supplier s cash flow. Conversely, the supplier has the option of receiving payment prior to the actual due date once the invoice has been approved by the buyer. 4 1 Supplier Lender settles invoice as soon as supplier requests payment Supplier delivers goods and sends invoice requesting payment according to standard terms, eg, 90 days 3 Supplier is able to trade the invoice in the system Supply chain finance as a holistic approach to unfreeze tied up working capital Buyer approves and submits invoice Lender Buyer 2 5 Buyer pays lender according to standard terms, eg, 90 days after receiving invoice The cost of capital is normally aligned with the buyer s credit risk. The amount due, on the other hand, is only paid by the buyer at the original due date. This optimises the cash conversion cycle of both companies and provides the supplier with enormous flexibility. It also improves readily available liquidity which, in turn, makes it possible for the supplier to offer more competitive prices and discounts. All of this is done through an external, independent platform, with lenders consisting of both banks and non-bank institutions. SCF eliminates unnecessary cash being tied up across the supply chain, and drives optimal usage of funds for both buyers and suppliers. 16 PwC
Basis of calculations and limitations Basis of calculations This study provides an overview of the working capital performance of companies listed in China/Hong Kong market. The Financial Services, Real Estate and Insurance sectors are excluded. Metric Definition Basis of calculation NWC days (net working capital days) DSO (days sales outstanding) DIO (days inventory outstanding) DPO (days payables outstanding) Indication of the total days to complete the full cash conversion cycle. DSO is a measure of the average number of days that a company takes to collect cash after the sale of goods or after services have been delivered. DIO gives an idea of how long it takes for a company to convert its inventory into sales. Generally, the lower (shorter) the DIO, the better. DPO is an indicator of how long a company takes to pay its trade creditors. DSO + DIO DPO Accounts receivable/sales x365 Inventories/cost of goods sold x365 Accounts payable/cost of goods sold x365 Methodology Industry data is based on the publicly available data (Capital IQ) of companies listed in China and Hong Kong. The industry categorisation is based on Capital IQ sector segmentation. Division in regions is based on the listed country available on Capital IQ. Limitations The research is based on publicly available information and all figures are financial year end figures. Due to the disproportionate efforts to improve working capital performance towards year end, the real underlying working capital requirement within reporting periods might be higher. Also, off balance sheet financing or the effect of asset securitisation have not been taken into account. All cash out? 2017 Working Capital Management China Market Study 17
Our contact Michael Gildea Partner, PwC Hong Kong +852 2289 1816 michael.p.gildea@hk.pwc.com www.pwchk.com This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. 2018 PricewaterhouseCoopers Limited. All rights reserved. PwC refers to the Hong Kong member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. HK-20171213-2-C1