3 Reasons Investors Worry Too Much About China

This week, we saw China’s gross domestic product grow less than 7 percent in a quarter for the first time since 2009. Meanwhile, the country’s stock market has been a proverbial bounce house, moving up and down faster than President Xi Jinping can devalue the currency or pump extra funds into the economy.

All this has had a screeching effect on the U.S., with the Standard & Poor’s 500 index down 3.5 percent since the beginning of August, and reports of gloom are filling the headlines.

But while analysts and investors want to blame China’s woes for the U.S. market’s latest hiccup, there are reasons to believe that Beijing’s slowdown not only has little impact on U.S. companies, but can actually prove bountiful for certain industries and investments.

Part of the reason for the upheaval is due to China’s decision to transition from a manufacturing-focused economy to one geared around the consumer. If the country can pull off the evolution – which there are signs that it might – then it could prove valuable to many U.S. companies as well.

1. U.S. companies aren’t worried.

  

© Tyrone Siu/Reuters   

Contrary to many reports, the U.S. doesn’t have a large stake in the growth of China. Research firm FactSet pegs that about only 10 percent of sales for S&P 500 companies come from the Asia-Pacific region. China and Japan make up a large proportion of those sales.

Of course, some companies have a strong exposure. For example, Yum! Brands (ticker: YUM), the parent company of KFC, Pizza Hut and Taco Bell, generates nearly 60 percent of revenues from China. Yum says it will spin off its China division into a separate organization, in part because of struggles circumventing the country’s changing economic landscape while under the control of the parent company.

But Yum is the outlier. For the most part, it’s likely “more companies in the S&P 500 have currency exposure than China exposure,” says John Butters, senior earnings analyst at FactSet. It’s the strong U.S. dollar, near five-year highs, that companies more often blame for dragging down sales.

Early in this quarter’s earnings season, FactSet measured the number of times S&P 500 companies mentioned China in a negative instance. While only about 5 percent of the companies had reported when FactSet took the measure, a mere 13 percent of companies had stated China’s economy was an issue. On the contrary, 78 percent say the strength of the U.S. dollar led to weaker sales.

2. Opportunities are out there.

A woman holding an umbrella walks past signage for Wal-Mart Stores Inc. in Beijing, China, on Monday, Sept. 8, 2014. China is scheduled to release figures on consumer and producer prices on Sept. 11. Photographer: Brent Lewin/Bloomberg

© Brent Lewin/Bloomberg 

Ever since President George W. Bush’s administration, the U.S. has urged China to move to a more consumer-focused economy. When President Xi took the helm, it appeared as if he agreed and would take steps to encourage this transition.

“The growth opportunities is in services and the advanced technology sector,” says Robert A. Kapp, a Washington state-based independent China consultant and former president of the U.S-China Business Council. As more opportunities open in the services sector, and jobs grow, it’s “congruent where U.S. companies has the most to offer.”

Areas such as high-tech and medical services, in particular, could become in far greater demand as the growing middle class in the region demands better tools and care. These are areas where the U.S. has strength and where companies could profit. It depends, however, on how open China will be with allowing U.S. companies to conduct business within its borders, and “under what conditions,” Kapp says.

IBM Corp. (IBM) is shining some light onto those stipulations. The Wall Street Journal reported that IBM is allowing Chinese government officials to look at the company’s source code. This is the blueprint in which IBM’s software runs, and it irks U.S. government officials and technology companies over fear of espionage and intellectual property theft.

There’s no doubt that China will make sure the stakes to play in the country are high. Still, others will likely follow IBM’s lead for a piece of the growing service pie.

3. China bonds show signs of strength.

  

© Aly Song/Reuters   

One tactic Beijing is using to stem an all-out crisis is encouraging lending. By reducing interest rates and easing certain requirements to provide loans, China’s leaders hope to keep money flowing.

“One of the sectors benefiting from this would be real estate development, with strong policy support in terms of easing onshore bond issuance requirements and lowering mortgage rules,” says Christopher Yip, S&P’s director of corporate bond ratings.

These efforts have also pushed down yields on Chinese bonds. Bond yields move inversely to price, which means bonds are now expensive. Another factor leading to the increased interest in bonds is it’s a safer haven than the stock market right now. Investors are using bonds to increase exposure to China while waiting to see where stocks eventually go. This has pressed down yields in the country by over 50 basis points this year, creating a 3.1 percent yield on a 10-year government bond.

Meanwhile, the S&P China Bond Index, which measures performance of Chinese corporate bonds, has risen 6 percent in 2015. “The bond market’s expansion also demonstrates the ample liquidity onshore,” Yip says. All this allows more money available for investments locally.

Since bonds are long-term investments, it may also signal the belief by many investors that China’s efforts to transition from a manufacturing economy to a consumer-focused one will eventually take hold.

If U.S. companies can get a seat at that table, then today’s China struggles could turn into tomorrow’s gains. Instead of a gloom-and-doom approach to China, maybe it’s more of a wait-and-see.

Written by Ryan Derousseau of U.S. News & World Report

(Source: U.S. News & World Report)

Yum! Brands Not the Only Fast Food Giant Facing Pain from China

© TheStreet
© TheStreet

NEW YORK (TheStreet) — One byproduct of a slowing Chinese economy appears to be that its huge population is cutting back on its consumption of fast food and casual dining fare.

At least that was the sense gleaned from one of the largest operators in the country Yum! Brands earlier in the week. The fast food giant, which has a combined 6,867 KFC and Pizza Hut locations open in China, reported dreadful third quarter results in China and served up dour commentary on consumer demand that rocked the industry.

“In recent weeks, we’ve seen companies cut back on parties, dinners and entertaining — so, while our weekend business is doing okay, this has impacted our weekday dinner results significantly,” explained Yum! Brands CEO Greg Creed on the company’s third quarter earnings call Wednesday. Same-store sales at KFC China increased a paltry 3%, while those for Pizza Hut’s China division fell 1%.

At KFC’s China division, Creed acknowledged that the recovery from a high-profile food supplier issue in 2014 is occurring more slowly than expected, in large part due to surprising economic weakness. The situation at Pizza Hut was even more alarming.

According to Creed, in late August and continuing into September, the company witnessed a “very substantial deceleration in same-store sales” in China versus what had been forecast. Creed and other execs blamed volatile financial markets and the yuan deflation for the slowdown, both of which occurred as the company was introducing an important premium-priced steak product.

Yum! Brands’ bombshell on China, which led to an 18% plunge in its stock on Wednesday, comes as many companies are banking on continued strong growth in China’s fast food industry. In a new report released this month, research firm IBISWorld estimated that the country’s fast food sector will generate $121.7 billion in sales in 2015, up 9.7% from 2014. Over the five years through 2015, IBISWorld estimated the industry’s revenue has been growing at an annualized rate of 11.6%.

And that favorable outlook has been echoed elsewhere. “Constantly revamped menus featuring localized dishes, together with the family-concept dining environment, is expected to underpin the stable growth,” said Euromonitor International back in July.

TheStreet takes a look at four other fast food players with significant operations in China that may be poised to disappoint investors with their results in the months ahead. The list is ranked from largest operators in the country to the smallest ones.

1. McDonald’s

Number of locations in China (estimated): 2,000

China as a percentage of global store count: 5.7%

Despite efforts to improve its value perception and the introduction of delivery services, McDonald’s has not performed well in China this year. Comparable sales in China for the second quarter fell 3% — the top five cities, which represent about 50% of China’s sales for the company, delivered flat comparable sales for the quarter.

“Lower tier cities are not recovering as quickly as top tier cities, driven primarily by weaker macroeconomic conditions in those outlying areas,” said McDonald’s CEO Steve Easterbrook on the company’s second quarter earnings call in July, adding “we are on track to return to a normalized level of performance in China for the second half of the year.”

But “normalized” performance in China may be something not in the cards for McDonald’s until 2016, based on the dreary commentary shared by Yum! Brands.

2. Burger King

Number of locations in China (estimated): 350

China as a percentage of global store count: 2.7%

China has been a key driver of Burger King’s Asia Pacific segment, which delivered a 2.3% same-restaurant sales increase in the second quarter. In fact, strength in China helped to offset sluggish results in Australia, a component of the company’s Asia Pacific segment. Burger King is a division of Restaurant Brands International.

“In particular, we saw sales growth and unit profitability growth accelerate in China,” boasted Burger King CEO Daniel Schwartz on the chain’s second quarter earnings call in July.

Similar to Yum! Brands, however, slowing demand for fast food in China seemingly out of nowhere could surprise Restaurant Brands’ investors.

3. Papa John’s

Number of locations in China (est.): 232

China as a percentage of global store count: 5%

Papa John’s has struggled to turn a profit in China since it opened its first restaurant there in Shenzen in 2005. The ongoing difficulties, in part due to the high cost of owning about half of its restaurants in the country, led to the closure of 11 locations in 2014.

So far in 2015, the situation hasn’t improved much. “Our China business showed a modest improvement versus the prior year, I think we’re making some progress — it’s still early,” said Papa John’s CFO Lance Tucker on the company’s first quarter earnings call. No additional details on China’s performance were shared on the second quarter call.

Any turnaround for Papa John’s in the country may be pushed out to 2016 in light of the issues highlighted by Yum! Brands.

4. Domino’s Pizza

Number of locations in China (estimated): 60

China as a percentage of global store count: 0.5%

The Chinese becoming more comfortable eating cheese, as well as a growing dairy herd, are two factors why China has been seen as a ripe expansion opportunity for Domino’s. “We are starting to have success there, but it has taken some time,” said Domino’s Pizza CEO Patrick Doyle in an interview withTheStreet in April.

With the Chinese economy slowing, though, opening new restaurants may be put on the back burner. At the 60 restaurants already open in China, generating healthy sales and profits may take longer than execs and investors anticipate.

Written by Brian Sozzi of TheStreet

(Source: TheStreet)