China Weakness Slamming US Companies
Tony is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In the light of the numerous Chinese stock scandals, investors interested in gaining exposure to the Asian giant have largely turned to U.S. multinationals that conduct a large amount of business there. But that method of China investing still does not work well when the Chinese economy weakens. And it has been doing just that...output growth in May was the weakest since 2009.
This has fed through even to companies one would think are relatively immune to an economic slowdown...fast food companies such as Yum Brands (NYSE: YUM) and McDonald's (NYSE: MCD). But in China, American food fare is considered a “luxury” and spending on luxury items has slowed dramatically in the country.
Yum Brands has underperformed the general market by double-digits over the past few months and it turns out for good reason as its latest earnings report disappointed. Profits fell as cost pressures (wages and food) continue to mount and sales – 10 percent same store sales growth – did not grow as fast as some expected. Sales growth was near 20 percent last year.
Yum's rival McDonald's reports its second quarter earnings today, but warned last month that its sales in China were weak. The weakness stems from increasing pressure from number one Yum which is offering cheaper menus and the same slowdown in 'luxury' purchases. McDonald's said May same store sales in Asia declined by 1.7 percent, the biggest decline since 2004. Incoming CEO Don Thompson said the Asia division is “seeing challenging economic conditions, with slow growth in China.”
But even more so that fast food, there is another sector here in the U.S. that is being hit hard by the slowdown in China...the casino companies. Three major U.S. casino firms have extensive operations in Macao including Las Vegas Sands (NYSE: LVS), MGM Resorts International (NYSE: MGM) and Wynn Resorts Ltd. (NASDAQ: WYNN).
The slowdown in luxury spending in China is really hitting home in Macau. Total gaming revenue in June rose only 12 percent, following a paltry 7 percent gain in May. This is a far cry from the prior blistering pace which saw a sevenfold increase in gaming revenue from 2004 and 2011, when casinos made $34 billion in revenues. The $34 billion is the equivalent of seven Las Vegas Strips! This slowing of growth in Macau has led to a drop of about a third for the stocks of all three casino companies over the past few months.
The weakness in Macau cannot be explained solely by a slowdown in luxury spending. Other factors are beginning to weigh on the sector. One is that China this year has tightened restrictions on issuing visas for travel from the mainland. There were 16 million visitors from the mainland in 2011. In addition, some Chinese credit card firms are limiting the amount of money that can be spent overseas. Please recall that Macau, like Hong Kong, is not considered part of the mainland but a “special administrative region.”
Finally, there is increasing competition from elsewhere in Asia for gamblers in Asia including Singapore and the Philippines. This may be the biggest factor in slowing down revenue growth in Macau long term.
So for investors looking to play China through these two sectors, which is the better bet? Probably, fast food. At Yum, for example, same store sales growth is being fueled by an actual increase in traffic. Customers are actually spending a bit less per visit, but more people are visiting the restaurants. This traffic increase bodes well for Yum's future growth in China.
tdalmoe has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services recommend McDonald's and Yum! Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.