Industrial corporate and SOE profit growth stayed strong in June.    To assess Chinese banks' asset quality risks, we track closely the profit growthof China's industrial enterprises (22% of system credit) and SOEs (31% ofcredit). NBS reported that profits of industrial enterprises grew by 22% yoy in1H17 (5M17: 22.7%); all SOEs recorded profit growth of 24.3% in 1H17.    Specifically, industrial SOEs, perceived as the most troubled sectors (11% ofsystem credit), maintained rapid profit growth (Figure 2&3). The improvingcorporate profitability should relieve asset quality risks for banks and also besupportive to NIM. We stay positive on big banks, on their higher exposure toindustrial SOEs (please refer to our report: Time to accumulate big banks).    Industrial enterprises: ample sales growth underpinned profit momentum.    The continued profit growth of industrial enterprises in 1H17 was mainlyunderpinned by solid revenue growth at 12.6% yoy (vs. 12.6% in 5M17, Figure4). Among 41 major sectors of industrial enterprise, 38 saw profit growth yoy.    Industry-wise, we have observed that profit growth momentum has graduallytransmitted from raw materials to downstream sectors – NBS officials indictedautomobile, steel and electronic equipment manufacturing industries’ profitgrowth outperformed other sectors in June. It is worth highlighting that Junemonthly data shows financing cost for industrial enterprises went up 9.7% yoyin June, versus 5.1% yoy in May (Figure 5). This suggests banks' asset yieldmay have trended higher.    SOE: intact profitability from industrial SOE contribution.    SOE enterprises’ revenue in 1H17 came at Rmb24.6trn, up 14.9% yoy (vs.    15.1% in 5M17, Figure 6); profits came at Rmb1.41trn, up 24% yoy (Figure 7).    The rapid profit growth of SOE enterprise was mainly due to slower operatingexpense growth (sales/ administrative/ interest expense up 9.8%/ 5.8%/ 8%)(Figure 9). Industrial SOE’s 12-month rolling profit came at 35% yoy in June(vs. 32% in May), and are the key contributors of strong SOE probability, whilenon-SOEs’ profit only grew by 3% yoy in June (vs. -3% yoy in May, Figure 8)Looking into breakdown by sector, about 30% of China’s SOEs are in industrialsectors, MoF highlighted the reasons for strong SOE profit in 1H17 weremainly from: (1) profit turnaround in steel companies, and (2) rapid profitgrowth in coal, petrochemical and transportation sectors.    Overcapacity industry: financial structure continue to improve.    With tighter capacity control, we have continued to see probabilityimprovement in overcapacity sectors. Based on NBS data of mining, steel andnon-ferrous metals sectors, the 12-month rolling profit growth of theseovercapacity sectors improved to 132% yoy in June 2017 (vs. 76% yoy in 2016,Figure 20). Besides, NBS also highlighted the continual supply-side reform hashelped industrial enterprises improve financial structure – (1) expense perRmb100 revenue improved by Rmb0.18 yoy to Rmb7.17, (2) accountreceivable days decreased by 1.1 days yoy, and (3) the liability to asset ratio ofindustrial enterprises improved by 0.8ppt yoy to 55.9% (Figure 21).

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