Seeking Alpha
Special situations, micro-cap, biotech, healthcare
Profile| Send Message| ()  

On Friday (June 1st), we are going to get a very important economic release - China's PMI Manufacturing index. China has the largest manufacturing workforce in the world (with about 112 million workers) and acts as an accurate barometer of industrial growth outside of the U.S. (Europe is far too problematic these days). In addition, we know that China represents a disproportionately large (and growing) chunk of the world's demand for construction materials.

In recent months we've been hearing a lot about the Chinese slowdown, and I would like to illustrate the point graphically:

(Click to enlarge)

This is Chinese industrial production by percent change. Since the beginning of 2010, you can see that China's industrial growth has been decelerating, and it seems to be getting worse this year. I think this is probably the most important factor that is scaring major commodity-producing companies today, and it may continue until either China begins to accelerate industrial growth again, or another factor puts overwhelming upward pressure on commodity prices.

Since everyone is anxious to see just how much China is going to be slowing down, I expect that important leading indicators like manufacturing PMI will have a major impact on certain stocks. Here are a few to be careful about:

1.) Caterpillar (CAT)

Caterpillar manufactures industrial machinery (which links it to both construction and natural resource extraction). China's demand for capital goods has been impressive in recent years, but large expenditures (like Caterpillar machinery) will be extremely sensitive to interest rates and economic activity. To prove that Caterpillar really does depend on China for future growth, here is an excerpt from the 2011 annual report:

"... one of eight strategic imperatives for Caterpillar to achieve between 2011 and 2015 is to, quite simply, 'Win in China.'"

In 2011, Caterpillar's revenues in the Asia/Pacific region totaled about $15 billion, representing around 25% of total revenue. Even if the majority of revenue is still coming from North America, investors are looking for more rapid development. So ultimately, I expect CAT to react noticeably to any surprises in China.

2.) Lafarge S.A. (OTC:LFGEF)

This humongous French cement producer has about 19% of its revenue coming from the Asia region, which means heavy exposure to China. Asia is the company's fastest growing region by sales, next to Latin America. I presume that shares of Lafarge will most certainly react to critical data like the PMI manufacturing index.

To emphasize the effects that China's situation is having on Lafarge, I present an excerpt from the Q1 2012 report:

"In China, sales volumes benefited from 3MT capacities added in 2011, but overall market growth was subdued with the governmental monetary tightening that started in the second half of 2011. Our domestic cement sales volumes increased 2%, while average prices were down, with increased competition on some locations."

Monetary tightening by China's central bank has induced lower prices, which Lafarge has counteracted with higher sales volume. Nonetheless, as competition grows, I predict that Lafarge may have difficulty gaining ground in China without stronger growth on the demand side for cement.

3.) Rio Tinto plc (RIO)

Rio Tinto is a British mining giant that derives a huge 30.7% of its revenue from China (according to its 2011 annual report). Rio's primary product is iron ore, which accounted for 17% of the company's income despite huge drops in the metal's price.

Rio Tinto also produces large quantities of aluminum, copper and coal which China is an avid consumer of.

As I was reading the annual report, I came across an interesting statement.

"we are seeing in China at present underlines our expectation of a soft landing in our key Chinese market, with growth in excess of 8% in 2012."

Apparently Rio Tinto is not all that pessimistic about the market for industrial materials in China, and expects very solid growth for 2012. Regardless of the company's forecast and its accuracy, I think RIO investors will be reacting to the PMI number, since it should give insight into the Chinese hard vs. soft landing debate.

4.) Dover Corp. (DOV)

Dover is a manufacturer of specialized industrial machinery, and has a significant stake in Asia's prospects, particularly China. About 17% of the company's revenue is derived from Asia, primarily China. In its Q1 2012 report, the company highlights its China strategy which can be summed up in one quote:

"Our focus on emerging and developing economies, especially China, remains firmly in place, and again this year we achieved significant progress in this area."

Clearly China's spending in the manufacturing sector (measured by PMI) will have a sizable impact on Dover's financial data. I presume a good number of DOV shareholders will be watching for Friday's results.

While I've been focusing on the negatives associated with the PMI number we will see on Friday, we can also see the opposite. Signs that China has already completed its healthy slowdown will allow for great buying opportunities in the aforementioned shares, since they derive so much of their revenue from Asia.

In addition, I want to note that the energy sector is also at risk. Major oil and gas producers like Exxon (XOM) and Chevron (CVX) will likely follow commodity producers into the green/red as we see China's growth unwind (or continue), even if a small chunk of their revenues are derived from Asia. China's demand for energy is an enormous factor in the price of oil. Keep the oil speculators in mind.

Source: 4 Stocks That Could Get Slammed By Chinese Data