Zheshang Securities: Industrial profits still need demand to drive inventory passively pushing higher

According to the information from the Intelligent Finance and Economics APP, Zheshang Securities released a research report stating that the profits of large-scale industrial enterprises from January to June have steadily increased, slightly rebounding from the previous period. The main challenge remains the insufficient effective demand, with the feature of trading price for quantity being more prominent. The profit growth rate of industrial enterprises in June increased compared to May, mainly due to the decline in investment income of enterprises last month, and the short-term impact has passed. The supply exceeding demand has led to a passive increase in industrial enterprise inventories. Opportunities in reversing industries within the structure may be worth paying attention to, such as large-scale equipment updates driving the profit growth rate of related upstream raw material processing industries to narrow the decline and rebound, which may further transmit to upstream resource products, thereby bringing about a situation of simultaneous increase in quantity and price. In addition, the dividends of export price competitiveness, consumer upgrades, infrastructure, and real estate projects landing are structural clues.

Zheshang Securities' main points are as follows:

Steady growth in industrial profits, with trading price for quantity still being the main feature

From January to June 2024, industrial enterprise profits increased by 3.5% year-on-year, slightly higher than the previous value of 3.4%. In June, the monthly profit growth of large-scale industrial enterprises increased by 3.6%, accelerating by 2.9 percentage points compared to May, mainly due to the short-term impact of the decline in investment income growth of industrial enterprises in May.

The bank believes that trading price for quantity is the main feature of current industrial enterprise operations. From the perspective of the three elements of quantity, price, and profit margin, price is the main drag, quantity is the main driver, and the revenue profit margin of industrial enterprises is basically flat compared to the same period last year.

From the perspective of revenue profit margin, the operating income profit margin of large-scale industrial enterprises from January to June 2024 was 5.41%, showing a greater rebound from January to May. It is basically flat compared to the same period last year. The gradual rebound of revenue profit margin also conforms to seasonal characteristics. In addition, the industrial capacity utilization rate in the second quarter rose to 74.9%, bringing about a certain scale effect to reduce the unit cost of products. According to the bank's calculations, the industrial revenue profit margin in June was 6.51%. By industry, the manufacturing industry's revenue profit margin in June was about 5.54%, showing a slight rebound from the previous period, but still lower compared to the mining industry, electricity, heat, gas, and water production and supply industry.

From the perspective of prices, the decline in the PPI in June narrowed, and the recovery of industrial product prices slightly reduced the drag on enterprise profits. In June 2024, the year-on-year decrease in the national industrial producer ex-factory prices was 0.8%, a decrease of 0.6 percentage points from the previous month, changing from a 0.2% increase last month to a 0.2% decrease.

The bank believes that the biggest challenge facing current industrial enterprises is still the insufficient effective demand. If large-scale equipment updates and policies for consumer upgrades can be implemented to accelerate the release of market space, and the physical work volume of the three major infrastructure and real estate projects is implemented, it will have a certain positive support effect on the profitability of industrial enterprises. This will help adapt to and leverage the favorable conditions of supply leading and high-quality production capacity leading, further transforming supply into profits, and stabilizing the trend of profit recovery for industrial enterprises. The bank predicts that under the base effect, the profit growth rate in the second half of 2024 will show a trend of peaking first and then declining, with the annual growth rate expected to be around 0.8%.

Equipment manufacturing profits remain high, and attention should be paid to the continued narrowing of the decline in upstream raw material profits The profit of the equipment manufacturing industry has maintained rapid growth, becoming an important engine for the growth of industrial enterprise profits. In the first half of the year, the profit of the equipment manufacturing industry increased by 6.6% year-on-year, driving a 2.2 percentage point increase in profits of large-scale industrial enterprises, contributing over 60% to the growth of profits of large-scale industrial enterprises. The proportion of profits from the equipment manufacturing industry in large-scale industrial enterprises is 35.0%, up 1.0 percentage point year-on-year. High-tech products such as smartphones, integrated circuits, and new energy vehicles have seen rapid growth in production and sales, while the competitiveness of the shipbuilding industry has been supported by increasing orders. The advancement of high-end, intelligent, and green manufacturing in the manufacturing industry, the cultivation of new productive forces, and the continuous implementation of large-scale equipment renewal policies provide positive support for the demand and profits of the equipment manufacturing industry.

The logic of quantity and price recovery supports the narrowing of profit decline in the upstream raw material processing industry. The bank believes that the recovery elasticity of its profits is worth noting, and it may further transmit to the upstream resource industry in the future. With the effective implementation of policies such as large-scale equipment renewal, the steel market is expected to improve, prices are rebounding, and the steel industry saw rapid profit growth in the second quarter, reversing the overall net loss in the steel industry in the first quarter; factors such as continuous product price increases have driven rapid growth in the non-ferrous metal smelting industry.

The export cost-effectiveness dividend supports the improvement of consumer goods exports, as well as the deepening implementation of policies to expand domestic demand and promote consumption, driving stable recovery of domestic consumption. Meanwhile, under the low base effect of the same period last year, the profit growth rate of the consumer goods manufacturing industry remains relatively high, although there has been a marginal decline. From January to June, the profit of the consumer goods manufacturing industry increased by 10.0% year-on-year, with a slower growth rate compared to January to May, with positive performance in industries such as chemical fiber, papermaking, cultural and educational goods, textiles, agricultural and sideline food, printing, alcoholic beverages, tea, and food manufacturing.

Supply exceeding demand leads to passive inventory accumulation, with the upstream raw material processing industry deserving attention.

By the end of June 2024, the inventory of finished products of industrial enterprises above a designated size increased by 4.7% year-on-year, significantly higher than the previous value of 3.6%, indicating a more obvious passive inventory accumulation due to supply exceeding demand. The bank believes that as industrial growth remains stable due to supply-side measures, there is still significant room for recovery in demand from consumption, real estate investment, etc., leading to passive inventory accumulation. The bank continues to emphasize that the current inventory cycle is showing a new form of flattening and jumping. If demand-side policies can be implemented in a timely manner, inventory is expected to decline. Conversely, if demand is insufficient and supply continues to increase, inventory will continue to passively accumulate.

From the perspective of inventory structure, the actual inventory percentile of the upstream raw material processing industry is relatively low, and the thorough destocking makes the supply relatively rigid. With the continuous expansion of demand in midstream manufacturing supported by large-scale equipment renewal, the profit recovery trend of the upstream raw material processing industry may continue.

As of the latest industry inventory data (May), the actual inventory percentiles of the leather, fur, feather and its products, and footwear industry, non-ferrous metal ore mining and dressing industry, pharmaceutical manufacturing industry, and black metal ore mining and dressing industry are below 10%, while the actual inventory percentiles of the chemical raw materials and chemical product manufacturing industry and the special equipment manufacturing industry are below 20%. The instrument manufacturing industry, wood processing and wood, bamboo, rattan, palm, grass, and straw products industry, petroleum, coal and other fuel processing industry, automobile manufacturing, food manufacturing, and non-ferrous metal smelting and rolling processing industry are below 30% According to the forecast of this line, it is expected that within 2024, there will be an overall trend of oscillating inventory replenishment, with a flattening slope of inventory replenishment, making it difficult to achieve stronger-than-expected performance. At the same time, the inventory cycle is accompanied by a new form of jump in the inventory stage: If demand continues to lag behind supply, active inventory replenishment will switch to passive inventory replenishment. If demand follows up in a timely manner and supply-side policies recede, active inventory replenishment may transition to passive destocking. If demand does not follow up in a timely manner and supply recedes, active inventory replenishment may transition to active destocking.

During a period when the profit growth of industrial enterprises is stable and the inventory cycle is flattening, the line continues to suggest that relevant industrial total indicators should be downplayed, and attention should be paid to structural opportunities in industrial enterprises. Large-scale equipment renewal, export cost-effectiveness dividends, consumer goods replacement, infrastructure and real estate three major physical work landing, or structural clues.