Chinese groups feel pain of cash squeeze As the Chinese corporate earnings season went on through late August, analysts at CICC, the mainland investment bank, noticed a startling new trend - net profit numbers were coming in much lower than the rest of their numbers would suggest. After quizzing managements of a number of companies, a common theme emerged - local governments were suddenly raising their tax demands. IN Retail "Managements explained that it is because some local subsidiary had been requested by the local government to pay full enterprise tax rate this year, rather than the preferential high- and new-tech-enterprise tax rate they had been granted," the analysts noted in an email to clients. The story is illustrative of the cash squeeze that is afflicting broad sections of the Chinese economy this year as growth slows, credit remains tight and a hoped-for stimulus from the central government is emerging only slowly and in some areas, not at all. On top of the tax demands from local governments, exports have slowed and, if the experience of toy manufacturers in Hong Kong is anything to go by, overseas buyers have been delaying payment on invoices from 60 days to 90. At the same time, both labour and electricity costs have continued their steady rise, with the latter up 15 per cent on average across China since 2010, according to analysts at Macquarie. All of this has been hitting the profit margins of Chinese companies and for those that have seen a particularly sharp drop-off in sales, or a jump in other input costs, the effect on cash flows has been sharp. The Financial Times analysed patterns in operational cash flows over the past six quarters for more than 1,700 companies in the database of S&P Capital IQ, which collates financial releases from listed businesses round the world and makes comparisons as close as possible. The results showed that the pain is being much more broadly felt than in just the property, construction, steel and heavy machinery sectors most closely linked to government investment. Investors and analysts have long been aware of the impact of China's slowdown on the big investment-hungry industries that benefited so much from the Rmb4trn stimulus of 2009. It is not that surprising to see companies such as China Communications Construction Company, Tongling Nonferrous Metals Group or Hebei Iron and Steel Company high on the list of groups that have seen cash flow from operations turn negative. But it is more surprising that GD Midea, a maker of air conditioners and other household appliances, Rainbow Department Stores Company, or Parkson Retail Group are up there. Pharmaceuticals, electronics and textiles, where there may be overcapacity or increasing competition from countries where production is now cheaper, all were sectors with a relatively high number of companies that are seeing a turn to negative cash flows that do not appear to be part of a seasonal pattern. But the sector that threw up most results was the consumer and retail sector. Household appliances, packaged food and meats, department stores and clothing companies are all suffering from China's slowdown. Louis Kuijs, chief China economist at RBS in Hong Kong, says he has begun to notice similar patterns in profit margins. "The decline in profit margins we have seen since last year is more across the board than we'd expected," he says. There is something more than a real estate and investment slowdown going on [inside China]. Part of the problem is that some companies have got their growth strategies wrong - the costly build up of inventories at sportswear maker Li Ning has been well documented for example. But other areas, such as department stores, are just too fragmented to face up to the competition from big new shopping malls and the rapid growth in e-commerce. The four leading department store chains in China control just 7.5 per cent of the market, according to analysts at Nomura in Hong Kong. This compares with a 60 per cent market share for the top four operators in Japan, Hong Kong, South Korea and the US. There is no question that the slowdown inside China as well as through exports is going to continue to be felt for the near future. Fred Neumann, economist at HSBC, notes a sharp slump this summer in the bank's measure of new orders minus inventories, which he says is a leading indicator for manufacturing broadly. However, he and other analysts such as Jonathan Garner, Asia equity strategist at Morgan Stanley, are positive about the power of Chinese consumers to turn their country round. Mr Garner reckons that China already has about 120m households with disposable income of $10,000 - more than the US, which it over took around the start of last year. Their spending power could help reduce inventories quickly and get the orders flowing again. Company executives, their investors and their banks will all be hoping this gets the cash flowing into China's companies once more.