Are some global companies too reliant on China?
Consumer companies like Apple, BMW, and Starbucks saw profits rise last quarter because of surging sales in China, while industrial companies like Caterpillar and ABB struggled. Slowing Chinese growth could threaten the latter, but not the former as much.
Ng Han Guan/AP/File
It has been a banner quarter for some international brands: Apple’s record profits nearly doubled from a year ago. Adidas’s profits were up 38 percent. BMW saw earnings rise 19 percent; Starbucks, 18 percent.
These companies share more than standout quarterly earnings. Their success comes, in large part, from a surge in sales in China. That’s good news, as long as Chinese consumers keep buying, but with that nation’s economy slowing, these companies face a troubling question from skeptical investors: Are they too reliant on China for growth?
The answer is nuanced. It depends on investors' time horizon, of course. The short-term picture gloomier than the long-term outlook. It also depends on the sector. Industrial companies with heavy exposure to China are not faring well. Consumer companies, by contrast, especially those with recognizable global brands, are going gangbusters. Some analysts see this dichotomy as evidence that China is beginning to make its long-awaited transition to a consumer economy.
“It’s risky to extrapolate from a few examples,” warns Nicholas Lardy, senior fellow at the Peterson Institute for International Economics in Washington. “It’s a $7 trillion economy and only $2 trillion is consumer-based. However, urban income, in real terms after tax and after inflation is growing at a rate of 9.8 percent vs. 8.1 percent [for] GDP” or gross domestic product, which measures a nation's overall output. Since three-quarters of consumption takes place in China’s urban areas, that's a telling statistic.
If the consumer economy is growing nearly 2 percentage points faster than the economy as a whole, then that could explain why Apple and other consumer brands are doing so well.
China, with its billion possible consumers, has long been a holy grail for Western investors and companies. The rush to get a foothold in the country has served some companies extraordinarily well. Apple, for example, enjoyed $7.9 billion of sales in China alone in the first quarter of 2012, tripled the revenues of a year ago, and representing 20 percent of total revenues.
Adidas, whose first-quarter earnings climbed 38 percent from a year ago, owes much of that growth to sales in China, which were up 26 percent (nearly four times its sales increase in Europe). The German sportswear company also raised its earnings target for the year, sending its stock price up nearly 9 percent on the announcement.
The picture was similar for Bavarian Motor Works (BMW), which saw a 19 percent increase in profits for the first quarter to $2.8 billion because of higher prices in the US market and increased China sales. China is now the biggest market for the maker of BMWs, Minis, and Rolls-Royces.
Such reliance on growth from a single country might prove troublesome if its economy is slowing. That's the case with China. For example: China's industrial production rose 9.3 percent in April, down from nearly 12 percent in March, and the lowest rate since the financial crisis. Construction and factory equipment for 20.2 percent for the first four months of the year, down from 25.4 percent the year earlier. Real estate investment also fell and imports last month were flat. Some global industrial companies took a big hit in the first quarter because of their bets in China.
Heavy equipment manufacturer Caterpillar beat analysts' estimates with sales of $15.9 billion and profits of $1.6 billion, but its shares fell because its sales in China fell $250 million to $300 million, forcing the company to find other markets willing to buy the equipment it had made in China for China. Weak demand in China caused Swiss engineering company ABB to report weaker-than-expected earnings. United Technologies experienced a 9 percent decline in sales for its Otis elevator division in China, because of a slowdown in construction there.
In the short term, there's no question China is slowing. Foreign investment has dropped for five months in a row, according to China’s Ministry of Commerce. The economy is growing at its slowest pace in three years. But at 8.1 percent, that's still double the world average. Many analysts forecast a so-called "soft landing," a brief period of slower growth, followed by a pickup in activity.
“An emerging market usually experiences a few years of very rapid growth, then it slows, and then it reaccelerates again," says Stephen Volkmann, machinery analyst for Jefferies & Co. in New York. "There is a lot of capacity being added over there and nobody seems to be willing to take their foot off the accelerator.”
Companies will wind up with overcapacity in China in the not-too-distant future, but that capacity should right itself, with demand catching back up to capacity, within one to two years, he says. “My colleagues in China say the government is actively trying to better balance the consumer and asset sectors.”