A Peek Behind the Chinese Curtain
Financial transparency is not quite the watchword of Chinese companies, at least in the consumer electronics space, and even more so in the display space. There is considerable pressure on Chinese display companies to grow and increase market share given the construction and infrastructure grants and operating subsidies given to Chinese display producers. Along with these subsidies and the share ownership of local or state-owned organizations, Chinese panel producers also have a cultural desire to show that they have the production and business savvy to compete and/or dominate in the global markets, and sometimes the optimism necessary to maintain an enthusiastic view of what is a highly competitive and cyclical business, becomes more important than the details and that can be reflected in company financials by a lack of explanations for items that might not paint the more perfect picture Chinese display companies would like to project.
The Shenzhen Stock Exchange does question certain aspects of the financials for companies listed on the exchange when there is little detail to explain particularly unusual or aberrant financial data through a letter sent to the company by the exchange asking for the detail that might help investors to better understand the data, and one such letter was sent to OLED producer Visionox (002387.CH) by the exchange in reference to the 2021 annual report. The letters are not accusations, but a request for a better explanation of specific financial entries, and after the company’s response the data is either accepted as explained or suggestions are made on how to better report the data.
In the Visionox letter there were a number of points that the exchange needed clarified, the first of which was the gross margin, which was -2.93% for the 2021 year. In itself a single year with negative gross margins for an OLED producer would not be unusual, but the letter indicted that a negative gross margin had been the case for the last four consecutive years, a bit more troubling for a company that has been operating OLED fabs since 2015 and has a ~5% share of the small panel OLED market.
The company’s response was as follows[1]: “The company's net profit after non-deduction and the gross profit margin of OLED products have been negative for several consecutive years, mainly due to the company's 5.5th generation AMOLED production line projects [that] have been completed successively since 2019, and the 6th generation AMOLED panel production line project, 6th generation AMOLED module production line project in 2021. Before the production line reaches the predetermined usable [state, the company is still in a] ramp-up period of yield rate and utilization rate. In 2021, the company's OLED product gross profit margin [will increase][increased] year-on-year by 6.60 percentage points, gross profit margin was negative mainly because the company continued to import in response to customer needs. New products, and the production of new products needs to go through a certain climbing period to reach a higher level of good quality [which affects yield] rate and utilization rate, so the initial product cost is relatively high.”
Another issue brought up by the exchange was the high proportion of inventory reserves taken by the company, which were 21.43% of book for the year. The company cited long cycles, ‘heavy’ capital and technology costs, and the fact that the company’s main production line (Gen 6) did not open until June 2021 and had a low utilization rate which raised the fixed cost allocated to products produced on that line, causing negative gross margins leading to impairment of inventory. That said, Visionox also gave a comparison of the year-end depreciation reserve levels for other comparable companies ((BOE – 200725.CH), Tianma (002387.CH), and TCL (000050.CH)) to point out that while the rate was high, it was not out of line with comparable companies, although from our perspective it gave little help to their cause (see table below).
[1] We paraphrased and added missing text due to translation errors and inaccuracies
The Shenzhen Stock Exchange does question certain aspects of the financials for companies listed on the exchange when there is little detail to explain particularly unusual or aberrant financial data through a letter sent to the company by the exchange asking for the detail that might help investors to better understand the data, and one such letter was sent to OLED producer Visionox (002387.CH) by the exchange in reference to the 2021 annual report. The letters are not accusations, but a request for a better explanation of specific financial entries, and after the company’s response the data is either accepted as explained or suggestions are made on how to better report the data.
In the Visionox letter there were a number of points that the exchange needed clarified, the first of which was the gross margin, which was -2.93% for the 2021 year. In itself a single year with negative gross margins for an OLED producer would not be unusual, but the letter indicted that a negative gross margin had been the case for the last four consecutive years, a bit more troubling for a company that has been operating OLED fabs since 2015 and has a ~5% share of the small panel OLED market.
The company’s response was as follows[1]: “The company's net profit after non-deduction and the gross profit margin of OLED products have been negative for several consecutive years, mainly due to the company's 5.5th generation AMOLED production line projects [that] have been completed successively since 2019, and the 6th generation AMOLED panel production line project, 6th generation AMOLED module production line project in 2021. Before the production line reaches the predetermined usable [state, the company is still in a] ramp-up period of yield rate and utilization rate. In 2021, the company's OLED product gross profit margin [will increase][increased] year-on-year by 6.60 percentage points, gross profit margin was negative mainly because the company continued to import in response to customer needs. New products, and the production of new products needs to go through a certain climbing period to reach a higher level of good quality [which affects yield] rate and utilization rate, so the initial product cost is relatively high.”
Another issue brought up by the exchange was the high proportion of inventory reserves taken by the company, which were 21.43% of book for the year. The company cited long cycles, ‘heavy’ capital and technology costs, and the fact that the company’s main production line (Gen 6) did not open until June 2021 and had a low utilization rate which raised the fixed cost allocated to products produced on that line, causing negative gross margins leading to impairment of inventory. That said, Visionox also gave a comparison of the year-end depreciation reserve levels for other comparable companies ((BOE – 200725.CH), Tianma (002387.CH), and TCL (000050.CH)) to point out that while the rate was high, it was not out of line with comparable companies, although from our perspective it gave little help to their cause (see table below).
[1] We paraphrased and added missing text due to translation errors and inaccuracies
The letter questioned a number of other entries, particularly the movement of assets allocated to projects under construction, but we also noticed a question about the company’s top five customers which gave some insight into how the company negotiated contracts with its major customers, although the questions from the exchange were related to AR entries. While the company’s largest customer grew 18.8% y/y in 2021 and accounted for 20.08% of total sales, Customer A’s share of receivables in 2021 was 56.6%, far in excess of that of Customer B (12.8% receivable share), who generated only 5.6% less sales during 2021. The company explained this discrepancy as a function of credit policies, which for that customer (A) were for payment within 90 days after the end of the month in which shipped, while Customer B’s credit policy was for payment within 50 days, also noting that Customer A was the leading smartphone brand, which we assume allows Visionox to give them some slack on payments.
While there were other less relevant questions in the letter, the exchange signed off on all of Visionox’s responses, offering only a few points on ways the company could make future reports more transparent. We expect the reason for the letter was due to requests for clarification from investors, either directly to the exchange or through the Q&A forum that allows investors to pose questions directly to company managements. As we have noted in the past, some companies actively answer questions, while others give only pat answers that seem to rankle investors who have likely lost money on the stock or are just trying to understand what amounts to somewhat foggy financials for certain companies. Again we note that most Chinese panel producers are beholden to funding sources and less to the smaller public shareholders, especially during periods when growth or profitability is under pressure, so there seems to be a distinctly optimistic picture of financials presented, whether through emphasis or de-emphasis. This makes examining the detail even more important than might be the case with other foreign companies, though while we single out Chinese companies and display producers more specifically, we do see similar biases coming from companies in other countries, particularly those with a need to prove their worth in the global markets, making it necessary for governing bodies and local exchanges to ask questions when details are not specified.
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