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China has long been seen by investors as a valuable asset for U.S. multinationals. It’s now at risk of becoming a liability.
Yahoo! is exiting China amid tighter data privacy laws.
Las Vegas Sands shares (ticker: LVS) tumbled in September on signs Beijing would increase scrutiny of casino operations.
Qualcomm’s (QCOM) market share in China’s smartphone chip market slid earlier this year as the U.S. restricted sales to Huawei Technologies.
Nike (NKE) went viral on Chinese social media—not in a good way—as it faced backlash over a company statement related to forced labor in the Xinjiang province of China.
Caterpillar (CAT) is grappling with fierce local competition, while
Starbucks’ (SBUX) sales have suffered amid China’s zero-tolerance Covid policy.
Mentions of China on earnings conference calls have doubled in the past three months from the previous three months, according to financial research platform Sentieo. Yet even as they noted higher costs or pockets of weakness, the executives on the calls stressed that China remains a critical market with long-term opportunities.
Call it the China conundrum. As U.S. multinationals gingerly navigate changes in what is the world’s largest market for retail, chemicals, chips, and other industries, analysts and money managers are beginning to worry about the potential costs of that exposure to China—and whether growth will be as strong as expected.
China accounts for an average of 5% of
companies’ sales and more than 60% for some. Over decades, U.S. companies have invested aggressively in China to sell cars, excavators, phones, shoes, and luxury goods to a middle class that is bigger than the entire U.S. population and to capitalize on a low-cost manufacturing hub, making the country an important factor in corporate earnings power. Bank of America strategists found that the correlation between China gross domestic product and S&P 500 earnings per share since 2010 has gone from zilch to 90%. About 80% of margin expansion for the S&P 500 is on the back of globalization over the past 30 years.
|Company / Ticker||Recent Price||YTD Change||China Sales (Percentage of Total)|
|Wynn Resorts / WYNN||$92.02||-18.4%||70%|
|Las Vegas Sands / LVS||40.04||-32.8||63|
|Qualcomm / QCOM||159.80||4.9||60|
|Texas Instruments / TXN||187.02||14.0||55|
|IPG Photonics / IPGP||166.69||-25.5||42|
|Western Digital / WDC||55.26||-0.2||40|
|NXP Semiconductors / NXPI||214.22||34.7||39|
|Qorvo / QRVO||154.28||-7.2||34|
|Broadcom / AVGO||548.77||25.3||33|
|Corning / GLW||37.87||5.2||33|
|Applied Materials /AMAT||150.40||74.3||32|
|Lam Research / LRCX||605.78||28.3||31|
|Amphenol / APH||82.29||25.9||30|
|Xilinx / XLNX||197.89||39.6||29|
|Intel / INTC||50.76||1.9||26|
|KLA / KLAC||404.35||56.2||25|
|Analog Devices / ADI||180.86||22.4||24|
|AMD / AMD||139.87||52.5||24|
|MGM Resorts International / MGM||46.06||46.2||24|
|Nvidia / NVDA||294.59||125.7||23|
Sources: FactSet; BofA Securities
That earnings force is likely to weaken as the Chinese economy slows, President Xi Jinping moves to cement control even at the expense of growth, and the relationship between Beijing and Washington frays. Yet the risk of weaker growth out of China isn’t priced into the valuations of many of these companies, money managers and strategists say.
“Over the last 30 years, it was not uncommon to see double-digit growth out of companies’ China or Asia-Pacific operations,” says Samantha Palm, chairwoman of Parnassus’ fixed-income committee. “That is where the growth algorithm will take a step down. I don’t think that has been baked into the market yet because there are so many other factors right now investors are monitoring.”
U.S. multinationals have long faced challenges in China, but the trade war started under the Trump administration signaled a major pivot in the relationship.
“The last several years have been particularly volatile ones for the purpose of business planning,” says Anna Ashton, vice president of government affairs for the U.S.-China Business Council. “Every year we ask [our members] to rank the top 10 challenges of doing business in China, and for the last four years it has been U.S.-China relations—something that wasn’t even in the top 10 prior to that.”
President Joe Biden and President Xi are expected to meet virtually soon. While the Biden administration has dialed down the rhetoric, it has continued to press China. Tariffs remain in place. A bipartisan bill that includes incentives for companies to make more of critical supplies like semiconductors closer to home has passed the Senate. Analysts expect more targeted restrictions that could limit sales to China for critical technologies.
And it’s not just the geopolitical uncertainty. Rising wages in China have already pushed some companies to seek alternative locations for producing their goods. That search took on renewed urgency during the disruption created by the pandemic.
“We’re at an important tipping point.”
China’s slowing economy could produce the biggest change. After averaging 10% growth between 1978 and 2010, China’s economy is expected to grow just 5.6% next year.
Chinese authorities are also shifting their policy focus, away from growth and jobs and more toward resilience, looking to create a more-equal society, less reliant on debt-fueled property investments—and on foreigners for exports or inputs for critical technologies.
“We’re at an important tipping point,” says Matthew McLennan, co-head of the global value team at First Eagle Investment Management. “For the last two decades, power and progress went hand in hand in China with 6% plus annual economic growth, full employment, and the CCP [Chinese Communist Party] in control. It’s looking increasingly likely that China won’t be able to grow at a pace anything like that—as such, power and progress may start to diverge if power requires more coercion by the party.”
A more interventionist state is rarely welcomed by investors. This past week,
SoftBank Group (9984.Japan) took a $54 billion hit to the value of its assets because of Beijing’s crackdown on the technology sector. “We are right in the middle of a storm,” SoftBank CEO Masayoshi Son told a news conference.
Restrictions to help China meet its climate goal has led to an array of supply-chain disruptions as Beijing rations power, and authorities’ efforts to tackle the longstanding debt issues in its property sector have pushed many developers to the brink.
A slowing property market is likely to sap demand for metals—especially since China buys more than half of global steel output—and pressure the sales of construction and industrial companies. In a recent call with analysts,
Carrier Global (CARR) CEO David Gitlin played down the risk from the property troubles and reiterated the importance of the country to its HVAC sales. “We continue over the long term to lean into China,” he said.
China’s crackdown around data privacy has led others to exit. Yahoo!, now owned by private-equity giant
Apollo Global Management (APO), cited an “increasingly challenging business and legal environment in China” for its decision to pull out. LinkedIn, a unit of
Microsoft (MSFT), made a similar call recently.
“Microsoft, for example, doesn’t guess about, well, anything,” wrote DataTrek co-founder Nicholas Colas. “For them to leave China, a large and systemically important market, speaks volumes to us about what they know is still coming down the road in terms of government policy.”
For now, the market has reacted reflexively to one-off news items, like Starbucks’ sales in China contracting. So far, there hasn’t yet been a lasting penalty to the multiples for companies with China exposure.
The average valuation of a basket of the top 50 U.S. companies ranked by their China sales exposure was trading at one standard deviation over its historical valuation as the group has outperformed other U.S. multinationals and domestically focused companies this year, notes Jill Carey Hall, head of BofA’s U.S. small- and mid-cap strategy, which looked at the potential China risk for U.S. companies. “The risks are not adequately reflected,” she says.
Nor are they equally shared. “The old economy was dominated by global players—and growth for them is slowing as the economy slows,” says William Blair manager Vivian Lin Thurston. “But in broader areas of consumption, like healthcare and high-end manufacturing, there is still so much room for growth that everyone can benefit.”
Take life-sciences tools and services, which gets roughly 10% of its sales from China, as Beijing has invested heavily in healthcare, food and water safety testing, and environmental monitoring. Companies like
Agilent Technologies (A),
Mettler-Toledo International (MTD), and
Waters (WAT) have some of the biggest exposure to China, with 17% to 20% of sales from the country, notes BofA. But these companies may be more insulated because of their dominance in a sector where scientists are reluctant to switch and where it could be many years before domestic rivals gain leadership, notes BofA.
A challenge for other multinationals is competition from local rivals, which may be amplified by nationalism or by a nudge from Beijing, which is increasingly concerned about reliance on foreign companies.
One vulnerable sector is autos, in which China represents roughly 30% of both global sales and production. Auto suppliers like
Lear (LEA), and
Visteon (VC) could be the most at risk to pressures in China, according to a note from BofA analysts. Among the auto makers, they identified
Tesla (TSLA) as the most vulnerable. Tesla is already losing share in the Chinese electric-vehicle market and could suffer if Beijing pushes consumers to buy more local goods or increases scrutiny of luxury-oriented purchases, the analysts say.
Apple (AAPL), too, could be vulnerable to a “Buy China” push, with BofA estimating that every 10% drop in iPhone sales in China—or four to five million fewer phone sales—could hit revenue by $4 billion. Even without some sort of consumer backlash, there are challenges ahead as China’s restrictions on gaming, for example, lay the groundwork for tighter regulation that could ding the $4 billion in gaming revenue Apple generates through its China app store.
“China still offers growth for many businesses, but it may come at a lower margin,” says Spenser Lerner, head of multi-asset solutions at Harbor Capital, who has been reducing exposure to many U.S. multinationals.
Still, few analysts see a mass exodus by U.S. companies. The likelihood of a decoupling that cuts swaths of U.S. business from China is slim, largely because of the money tied up in the relationship.
If the U.S. semiconductor industry lost access to Chinese customers, it would cost as much as $124 billion in lost output, put 100,000 plus jobs at risk, and jeopardize $12 billion in R&D spending and $13 billion in capital spending, according to a report from the Chamber of Commerce earlier this year that tried to estimate the cost of a decoupling. The aircraft and commercial aviation industry could lose as much as $51 billion a year if it lost access to China’s market.
The relationship is nonetheless expected to remain tense, raising the risk of nationalistic reactions and boycotts, especially if the winter Olympics being held in China this February ratchets up tensions around human-rights abuses in Xinjiang or the status of Taiwan. Investors need to add China pressures into their analysis of multinationals’ valuations.
BofA screened global exchange-traded funds to find those with limited China exposure. Two broad-based U.S. funds popped up on their list with zero exposure to China:
WisdomTree U.S. Midcap
Pacer U.S. Small Cap Cash Cows 100
(CALF). And the
SPDR Portfolio S&P 500 High Dividend
ETF (SPYD) had less than 1% revenue exposure to China.
Corrections & Amplifications
Matthew McLennan is co-head of the global value team at First Eagle Investment Management. An earlier version of this article misspelled his last name.
Write to Reshma Kapadia at [email protected]