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Is the Worst Over for Chinas Corporate Earnings?

China’s corporate reporting season for the third quarter kicks off on Monday amid profit warnings and earnings downgrades, but analysts think the worst may be over for Chinese firms, with the last quarter of the year expected to bring back some cheer.

A local investor watches the share-prices index display at a stock brokerage in Shanghai.
Liu Jin | AFP | Getty Images

“I think it (earnings) should stabilize. There should be relatively fewer downgrades unless there’s a big deterioration in exports in the fourth quarter or a hit in local consumption,” said Alan Lam, China equity strategist with Bank Julius Baer in Hong Kong.

While hopes are being pinned on the last three months of the year for a revival in corporate earnings, the third quarter has already been declared a wash-out by many analysts.

In September, Goldman Sachs’ China equity strategist Helen Zhu cut her profit estimates for 2012. According to her profits at companies that make up the MSCI China Index will increase by 1.8 percent for the full year instead of the previously forecast 6 percent, affected largely by third-quarter numbers.

Chinese companies such as truck maker Jinan Truck, shampoo maker BaWang and steel products manufacturer China Oriental have issued profit warnings over the last month, saying they would either report lower profits or outright losses for the third quarter.

But analysts don’t expect more downside from here, with the economy seen to have bottomed out in the third quarter. Corporate profits should track the rebound in gross domestic product growth, they said.

China’s economy is expected to grow at 7.4 percent in the third quarter, according to a Reuters poll, its slowest pace of growth this year before picking up to expand at 7.6 percent in the last three months.

This pick-up in growth momentum should help Chinese corporates, said Aaron Boesky, CEO of China focused Marco Polo Fund Management. “I believe that Chinese companies will have seen the bottom in the third quarter,” Boeskey said. “We will see a slight improvement in the fourth quarter, which may improve yet again in the first and accelerate in the second quarter of 2013.”

Goldman Sachs expects corporate earnings growth to pick up 8.6 percent next year.

Vulnerable Sectors

Despite a brighter outlook for earnings from the fourth quarter onwards, Julius Baer’s Lam cautions that small to medium sized enterprises (SMEs), especially in the materials and industrials sector, remain vulnerable.

“There may be more earnings downgrades for SMEs. Demand needs to pick up. That’s the key to recovery,” he said.

According to Hugh Young, managing director of Aberdeen Asset Management, export-oriented companies also face a tough future. He expects earnings to be “very patchy” at best for the rest of the year.

“We are not seeing any sign of a pickup in business,” Young said. “It’s tough especially for people who trade with the West.”

Banks may also be a weak spot because of their exposure to corporates, according to Nicholas Ferres, Eastspring Investments’ head of global asset allocation.

“The deterioration in the corporate sector and the policy errors (such as state-directed lending) over the past few years may show up in non-performing loans in the future,” he said. “Earnings have been slowing quite sharply in China for some time.”

Non-performing loans rose by 18.2 billion yuan ($2.86 billion) in the three months ended June 30 to 456.4 billion yuan, the China Banking Regulatory Commission said last month. Bad loans surged at all types of banking institutions, including the largest state-owned lenders, rural banks and foreign banks.

By CNBC’s Jean Chua.