PETALING JAYA: While investments in Asia have grown rapidly, the scale is not in tandem with improving profitability as Asian companies drag global economic profit down, according to McKinsey Global Institute.
In a report on Corporate Asia: A Capital Paradox, it said Asia accounted for half of the global deterioration in economic profit (minus the cost of capital) from US$726bil to an economic loss of US$34bil between 2005-2007 and 2015-2017.
Almost 43% of the world’s largest 5,000 companies are in Asia.
The report said the flood of capital in Asia and the decline in economic profit in Asia and beyond is inextricably linked.
Reduced economic profit reflects lower returns on invested capital (ROIC) globally.
The vast majority of a decline in ROIC, at an overwhelming 87%, could be attributed to an increase in capital intensity, with the remainder to a decrease in margins, it said.
Worldwide, more capital is now needed to generate the same amount of revenue, which then generated lower profits, it added.
McKinsey senior partner and McKinsey Global Institute director Jonathan Woetzel said Asia is clearly a region that is in transition.
“Many of its companies are riding on economic development to grow scale rapidly but they are simply not returning their cost of capital.
“Nevertheless, there is a huge potential and Asian companies could take the largest share of both the world’s revenues and of its profit, ” he said in a statement.
The report noted that pockets of economic-profit-generating excellence could be found in different sectors across Asia, such as Japan’s capital goods sector, which created the most value in Asia.
Additionally, financial services are highly profitable in China and Australia.
Technology-driven sectors, especially IT, create a great deal of value in China, Japan and South Korea, and are improving as a source of value creation in India.
Furthermore, South-East Asia’s energy and materials sector generates substantial value despite the sector’s overall underperformance globally.
The report said the major sources for the global decline in economic profit stemmed from the cyclical energy and materials sector, European financial institutions and China.
The energy and materials sector accounted for about US$500bil of lost economic profit in the past 10 years, reflecting the decline in oil and commodity prices.
European financial institutions accounted for US$158bil of lost economic profit, while China contributed economic profit losses of US$137bil, reflecting a tendency to allocate capital into value-destroying sectors.
Almost US$10 trillion of capital has been invested in China over the past 10 years, of which 80% was channeled to sectors that earned below their cost of capital.
McKinsey senior partner Chris Bradley said corporate Asia’s rising scale but sinking profits is not sustainable in the long term.
“The challenge ahead for Asia is to unleash the latent potential of its top performers and elevate the performance of companies that are destroying value, ” he said.
Going forward, the report said Asia needed to turn around troubled companies and capture the latent potential of top-performing companies.
Over the past 10 years, only 54% of the bottom 200 Asian generators of economic profit have lifted themselves out of the bottom quintile of all companies, as compared to 61% of firms in North America.
This is compared to only 49% of the top 200 Asian companies which have maintained their position in the top quintile, versus 61% of firms in North America, it said.
The report said should Asia match the performance of North America in top companies maintaining their position and bottom companies improving theirs, the region could unlock US$440bil of economic profit.
Asia accounted for over US$1 of every US$2 in new investment in the past decade, of which US$1 of every US$3 was invested in China.
It said that in the past 10 years alone, Asian companies have increased their share of the G5000 (the world’s 5,000 largest firms) by six percentage points to stand at 43% today.
In comparison, Europe has 25% of the G5000, while North America (Canada and the US) has 24%.