After more than a decade of rapid development, China's machinery industry has entered a "red ocean." In 2013, profitability across the entire construction machinery industry continued to decline, and industry leaders such as XCMG Machinery, operating in this investment-driven sector, are feeling a strong chill.

　　Following a sharp profit slump in 2012, XCMG Machinery's net profit fell again by 38% in 2013.

　　Net Profit Continues to Slide

　　On April 8, XCMG Machinery (000425.SZ) released its 2013 financial results, showing operating revenue of 26.995 billion yuan last year, down 16.12% year on year; net profit, on the basis of a sharp decline in 2012, fell again by a large margin, down 38.12% year on year to 1.509 billion yuan.

　　Over the past year, XCMG Machinery not only strengthened its full product line but also sought breakthroughs in overseas market expansion and global layout. According to the financial report, XCMG Machinery is accelerating the development of region-specific products and various certifications through forward deployment in overseas markets and the layout of overseas service and spare parts outlets, and its comprehensive base in Brazil also achieved trial production last year.

　　XCMG Machinery made frequent moves last year: it advanced internal capacity adjustment and released existing capacity as a whole. Construction of the four-wheel-one-track base was accelerated, and planning and construction of a high-end hydraulic valve base began; the new site of the research institute was put into use. The European procurement center began operations, integrating the global supply chain system; and the company completed the issuance of 2.5 billion yuan in convertible bonds.

　　But these efforts still could not withstand the erosion of the industry's broader environment.

　　XCMG Machinery stated in its announcement that its product customers mainly come from infrastructure, construction and energy industries, whose performance is highly correlated with macroeconomic conditions, causing product demand to be significantly affected by economic cycles.

　　According to the financial report, while inventory rose slightly, XCMG Machinery's product sales volume last year fell 14.63% from 2012, and production also declined 12.66% year on year. Due to increased interest expenses from higher corporate bonds and bank borrowings, XCMG Machinery's financial expenses surged 118% year on year.

　　At present, China's machinery industry, in which the company operates, has entered a "red ocean" after more than a decade of rapid development. As an investment-driven industry, affected by slowing fixed-asset investment growth, insufficient downstream demand and industry overcapacity, profitability across the industry continued to decline last year.

　　Industry Pains

　　According to statistics from the China Machinery Industry Federation, the machinery industry achieved total profits of 1.41 trillion yuan last year, up 15.6% year on year, more than 10 percentage points faster than the previous year and 1.8 percentage points higher than the growth rate of main business revenue over the same period. However, the proportion of loss-making enterprises reached 10.9%, up 0.47 percentage points from the previous year, and the losses of loss-making enterprises increased by 15.2%.

　　In fact, although orders at some enterprises grew somewhat, prices remained sluggish. Statistics from the China Machinery Industry Federation show that the cumulative order value of key contact enterprises in the machinery industry from January to December last year increased 10.2% year on year, with year-on-year growth picking up slightly month by month, but under the pressure of oversupply, product prices remained persistently weak. By the end of last year, the monthly price index had been below 100% for 25 consecutive months.

　　Cai Weici, executive vice president of the China Machinery Industry Federation, once said that under the pressure of rising costs, it is becoming more difficult for enterprises to improve the profitability of their main activities: during last year, the year-on-year growth rate of main business costs continued to rise and remained consistently higher than the growth rate of main business revenue. Affected by this, the profit margin of main activities was only 6.57%, down 0.41 percentage points from 2012.

　　Regarding this year's industry situation, Cai Weici believes that the basically stabilizing trend of the macroeconomic environment and a stable policy environment will be favorable to the development of the machinery industry.

　　According to the 2014 Government Work Report, fiscal spending in 2014 will focus on areas such as affordable housing projects, agriculture, major water conservancy, western railways, energy conservation and environmental protection, and social programs. All of these provide real demand for the construction machinery industry and lay the foundation for the industry to stabilize and recover.

　　When forecasting its 2014 performance, XCMG Machinery also raised its sales revenue target to 29 billion yuan, an increase of about 7.6% year on year.

　　However, this is not enough for XCMG Machinery to let down its guard: although the construction machinery industry overall will still maintain a relatively stable demand environment in the future, in the short term, the market trend of the construction machinery industry depends on multiple factors and may diverge from the overall situation for a certain period.

　　At present, a large amount of capacity formed by investment in the machinery industry is being released, and the industry faces pressure from both total overcapacity and structural overcapacity. The slowdown in fixed-asset investment growth in recent years has suppressed market demand, and coupled with uncertainty in the global economic recovery and the existence of trade barriers, the construction machinery industry still faces considerable demand pressure in the short term, and the competitive environment remains fierce.

　　External concerns are that if a future economic downturn leads to a sharp decline in the country's fixed-asset investment, it will adversely affect XCMG Machinery's product demand and profitability. In addition, if the company cannot continue to maintain its core competitiveness across various product categories, it will face the risk of declining market share.