China Worries Keep Me Up at Night
Arthur is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Fraudulent account practices, irresponsible overbuilding and an unreliable government sector are valid reasons to avoid investing in China. The Motley Fool recently ran an in-depth article by Jeremy Bowman -- 3 Reasons I’m Avoiding China -- which illustrates the near tipping point of the bubble.
Economic bubbles normally go through predictable steps, originating from rapid expansion, which is eventually and inevitably followed by inflation, and the subsequent collapse of the overheated system. In a recent visit to China, World Bank president Robert Zoellick warned that inflation is a vital pressing concern for the nation. China’s monetary policy is now struck with the complicated task of controlling rapid inflation, while appeasing trading partners who claim that the Yuan is undervalued. To stress the importance of controlling runaway prices, the People’s Bank of China was forced to increase interest rates three times through 2011.
Arguments centered on China’s bubble are readily available through the blogosphere and various news portals; a quick Google search for “China’s bubble” produces 8 million search results. Most investors realize that investing into the Chinese markets, whether it be though real estate or equities, poses immense risks. However, the threat of a Chinese slowdown will have massive consequences on the operations of American firms as well. Most U.S. corporations rely on continued growth from China to maintain their share prices; if this growth subsides, companies will no longer be able to meet their long-term targets.
Examples of Diverse Industries
Yum Brands! (NYSE: YUM) has pushed for a massive expansion program within the Chinese market, opening approximately 4,200 restaurants in more than 700 cities. Growth in the region has surpassed that which is realized within the U.S. In its latest reported quarter, Chinese revenue increased 35% to $1.6 billion while American revenue decreased by 10% to $873 million. Chinese sales now nearly double those generated at home. Although the restaurant concepts operated by Yum can be viewed as countercyclical, Yum provides a perfect example of the reliance placed on growth within China.
Metal miners such as Alcoa (NYSE: AA) have a large dependency on high levels of Chinese consumption. Alcoa’s output is primarily China driven as the nation accounts for approximately 45% of sales and is predicted to be the fastest growing country in terms of aluminum demand. When Alcoa released its annual results, performance was lackluster due to falling aluminum prices. However, the optimistic forecast, driven by expected 12% growth in China, propelled the company shares forward.
Apple (NASDAQ: AAPL), the largest company in the world, has a strong need for the growing demand in the world’s most populous country. With over 1.3 billion people, China is the world’s largest PC market, a consumer segment that Apple is vying for, and obviously has a strong demand for the iPhone, as became apparent during the iPhone sale riots. Apple’s revenue in China grew by 1,522% between 2009 and 2011 while American sales “only” increased by 87% in the same period. China is the only country other than the U.S that accounts for over 10% of Apple’s revenue.
Perhaps the best Chinese growth story pertains to Wynn Resorts (NASDAQ: WYNN). Wynn operates 4,750 suites in Las Vegas and only 1,008 suites in Macau. Yet, quarterly revenue generated in Las Vegas is a paltry $347 million compared to the $951 million realized from in Macau. Vegas properties are more focused on hotels and slots while those in Macau are centered on table games in casinos; the yearly 29% growth for the Wynn has been exclusively driven from China.
Concerns over the European debt crises and a slowdown in China have recently been cited as concerns for luxury jewelry retailer Tiffany (NYSE: TIF). Tiffany generated approximately half of its revenue from outside the United States, with, naturally, China being the leading driver of the 40% spike in sales. As a result of these concerns, Tifanny has seen its stock drop by 15% within the last three months.
Conclusion
Globalization has been a mixed blessing for corporations. On the one hand, firms are able to penetrate new markets with relative ease; on the other, a hiccup in a major region can have catastrophic consequences on their operations. A Chinese slowdown will not only affect direct investments in the country but also will burden a wide range of American firms as well, either directly or indirectly. Although a select few companies were briefly discussed above, they cover a broad range of industries and sectors and are merely meant to serve as an example of the China fear.
In order for China’s woes to become major international concerns, it does not have to go down the same route as Greece whose GDP growth rate sits at -4.5%. China must simply fail to record the same level of robust growth it has been able to achieve in the past. When China’s growth rate ebbed to 8.9%, in contrast to Germany’s 0.3%, a brief wave of uncertainty spread throughout as this was China’s second lowest growth rate observed within the last 20 months. For companies to feel the pinch of a Chinese pullback, China does not have to fall into a recession, but merely must show slower growth.
However, the factors are aligned for China to go into a recession.... Scary.
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