In a previous article I outlined a few stocks that will probably be slammed if Chinese economic data continue to worsen. Since then, my outlook on China hasn't improved at all because we've only seen more confirmation of the nation's slowing growth and overshot expectations.
Yesterday (June 11th), we saw new yuan loans come in at a whopping 793 billion for the month of May. Normally I'd consider this impressive, but the good taste was ruined by the money supply figures, which reminded me of how manipulative the yuan can be. The least likable statistic was M2 for the yuan, which has grown 13.2% in the last year.
Last week, we saw more misses. May retail sales increased 13.8% since last year, and industrial production increased a measly 9.6%. These numbers sound great until you factor in speedy growth of the money supply. Going back a bit further, we have the Chinese PMI figures for May. Manufacturing PMI was a very disappointing 50.4 while non-manufacturing was a more tolerable 55.2
As you may figure, China's economy is hugely dependent on manufacturing. If that sector gets crushed, the broader economy is at risk and the following companies can be adversely affected:
1.) Freeport-McMoRan (FCX)
FCX is a materials producer that operates in North and South America, and like the other companies in its industry Freeport is hugely dependent on China's consumption. About 2/3rds of its revenue comes from selling its copper product (and most of the remainder is from gold). Since China is the world's largest buyer of copper, Freeport investors should be unnerved by dismal trends in its macro data.
What's even more scary is that recently reported growth in Chinese copper demand (a 12% increase in May relative to April) is more a speculative move rather than legitimate demand for the metal. China has been seen hoarding natural resources before, and this is confirmation that it intends to continue.
According to ANZ research, this phantom statistic ultimately results in an estimated 400,000-500,000 tons of copper sitting in warehouses. What is preventing China from doing the same thing with other basic materials?
Not only does this remove the viability of Chinese copper demand as a barometer of economic activity, but introduces a variety of unhappy oversupply scenarios for companies like Freeport-McMoRan that rely very heavily on copper prices for revenue. The almost 4% yield is nice, but when a company's fundamental business is at heavy risk you may want to think twice.
2.) BHP Billiton (BHP)
This Australian giant has more diversified production relative to Freeport-McMoRan. For example, it produces a substantial amount of petroleum and coal (together bringing about 1/4th of the company's total revenue). There are other interesting materials BHP sells, like diamonds, which brought the company about $654 million in the second half of 2011.
Regardless, BHP Billiton's biggest export is iron ore, which is mined primarily in Australia and by itself brings in about 1/3rd of total revenue. China is the biggest buyer of the iron ore, which is why BHP Billiton stock has struggled so much after the nation began to exhibit disappointing growth.
An Australian newspaper named The Sydney Morning Herald published a descriptive account of the iron situation at Chinese ports, which fits into the bigger picture we built with copper. It's increasingly apparent that China's demand for all the industrial metals was artificially inflated. When the starry image of a super-fast expansion of China's infrastructure and industrial production is taken away, all that remains is a huge supply glut and the potential for a bigger slide in commodity prices. This is what materials companies have nightmares about.
3.) YUM! Brands (YUM)
Now we're going to step away from industrial materials and into the world of pizza and fried chicken. Indeed, YUM! is heavily exposed to Asia and relies on it for a huge chunk of its growth. Its estimated PEG ratio of 1.4 simply wouldn't be justified if it weren't for China.
YUM's China division is reporting some really great data, and has encouraged the company to open an eye-popping first-quarter record of 168 new restaurant units. First quarter same-store sales from 2011 were 13% higher than in 2010, while Q1 2012 was another 14% increase from 2011. Total growth in China is now an impressive 28% annually, ignoring exchange rate effects.
The only problem I have with its supposed "threatening exposure" to China is with the feasibility in using economic data to determine the consumption of fried chicken and pizza. While a weak economy helps nobody, I think we might be overly pessimistic when it comes to YUM! Brands. Food demand isn't supposed to be very procyclical, but I see YUM mentioned in a huge number of doomsday scenarios involving China.
Still, YUM stays on this list because its inverse-correlation with China has been apparent. The stock has fallen about 12% in the last month along with most others, and I expect that poor Chinese data will drive many investors out of YUM if things get worse. This might create a buying opportunity later on, because I think YUM will be fine.
4.) Starbucks (SBUX)
Now that it has invaded every square foot of Manhattan (and I suppose the rest of the United States), Starbucks is looking for growth abroad. Just like YUM, Starbucks is seeing stellar growth in China. Its most recent quarterly report outlined this at the very top - Starbucks has seen >20% sales growth in China for seven consecutive quarters. This adds up to about $175 million of revenue every quarter, just from China.
This is only about 5.5% of the company's revenue, but the rate of expansion and the company's continuing expansion of stores implies that China will play a huge role in the company's future. Starbucks is quite determined to succeed in China, as evidenced by its goal to open a net 400 new stores in the Asia region - "about 2/3rds of which are planned for China."
As was the case with YUM, I can see investors wrongfully fleeing Starbucks due to its big China strategy. What I can't see is a noticeably adverse effect on coffee demand due to a slowdown in heavy industry, construction and manufacturing.
Still, Starbucks fits this list because of investor and media association with China. It has certainly got a bigger safety net compared with the likes of Freeport and BHP Billiton though. Keep SBUX in mind if the market gets too pessimistic.
5.) General Motors (GM)
One of the great American companies of the 20th century has essentially become half Chinese. If you remember the headlines from earlier this year, GM's sales figures in China were great. So great, in fact, that GM now sells more cars in China than the USA. If you check its corporate news feed, there seems to be a never-ending stream of new sales records in China. I'm sure GM marketing strategists continue to devise plans to take more of the world's largest car market.
This year will be equally promising for GM in China. We expect the market for both passenger and commercial vehicles to continue to expand, particularly in China's Tier 3 and Tier 4 cities. With our leading sales position and the strong performance of our brands, GM is well positioned to capitalize on the growth opportunities.
-Kevin Wale, President & Managing Director of GM China Group
GM derives about 16% of its revenue from GMIO, or "General Motors International Operations" which includes its China division. According to the last 10-Q form, a whopping 80% of the sales volume from its GMIO branch (which operates in some Eastern European countries including Russia, as well as Africa and the Middle East) comes from just Chinese customers. The recent growth there has been nothing but stellar. This is why General Motors would become a very unpopular investment if China stalls. The following statement sums up GM's big intentions to expand business:
We view the Chinese market, the fastest growing global market by volume of vehicles sold, as important to our global growth strategy and are employing a multi-brand strategy, led by our Buick and Chevrolet brands.
-General Motors Q1 2012 10-Q Form
With amazing 8.6% growth in Chinese vehicle sales in the last year, it's obvious why GM is so interested, and now heavily invested there. The market is huge, and offers huge opportunity for expansion.
One awful release could crush GM shareholders overnight. The purchase of big-ticket items, especially cars, tends to get delayed or cancelled during bad times. Knowing this, investors may attempt to preemptively escape disappointing sales results by GM if they think China is headed in that direction.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
