Evergrande was one of China’s blind spots

Even the savviest of investors were caught off-guard by the speed of China Evergrande Group’s unraveling. They shouldn’t have been: Trouble has long been brewing at China Inc, where balance sheets are weakening in the face of a rocky economic recovery. This could be Beijing’s worst blind spot yet. At over 1,100 listed companies in China’s industrial and manufacturing sectors, receivables are piling up; cash conversion cycles are getting longer (that is, the time it takes to turn inventory investments into cash); and net short-term debt levels are becoming increasingly volatile, a Bloomberg Opinion analysis shows.
The pandemic has been a challenge, no doubt. Officials deployed hefty stimulus measures to keep the lights on and production lines running for China Inc. Yet for the roughly 40 million small and medium-size enterprises, it’s been even tougher. Their struggles, including poor access to cash and strained working capital, predate Covid-19. What’s worrying is how mainland companies got into this compromised position in the first place.
Chinese suppliers wait a long time to get paid by their customers, which squeezes their working capital. Even in the pre-pandemic good times of 2019, it took almost 92 days on average, compared with 51 in the US. To bridge that funding gap, companies increasingly have turned to supply chain financing — instead of waiting to get paid, firms go to a third party that hands over cash sooner. A big benefit is that companies struggling to borrow can use their assets as collateral, which helps break the vicious cycle of weak creditworthiness.
But the moment repayment becomes an issue, credit tightens. Cracks quickly appear up and down the supply chain.
That’s what eventually caught up with Evergrande. Inventory makes up a big portion of its working capital, and as that deteriorated, bills piled up. (According to the New York Times, the real-estate developer’s funding squeeze hit as early as April.) In addition to the debt the company took out from mainstream financing channels, Evergrande leaned on vendors and other parts of its supply chain — apartment buyers and customers. It even roped in its employees, who were told to invest in the company’s wealth products. In an interview cited by the Times, management said the employee investments were part of “supply chain financing” and would allow Evergrande to make payments to its suppliers.
Companies across China’s industrial landscape have turned to similar arrangements to alleviate their funding troubles.

—Bloomberg