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China's Economy
FAN YU is an expert in finance and economics and has contributed analyses on China's economy since 2015. Fan Yu
Understanding China Risk
Companies need to get smarter about unique risks in China
The earnings of companies within the S&P 500 Index are currently 90 percent correlated with China’s gross domestic product growth, according to Bank of America analysts. In 2010, that correlation was zero.
That’s an astounding statistic.
It’snotunfathomableonceyoudiveinto what it means. The S&P 500 consists of the 500 largest U.S.-based publicly traded companies.Companiesofthissize—think multinationals such as Intel and Starbucks—must have generated sales from Chinesecustomers.Onecan’tbecomeone of the 500 largest companies without operating in the world’s No. 2 economy.
It does raise a question, however: Are companies equipped to manage the risks of operating in China, and are they adequately disclosing such risks to investors?
Ten years ago, the Chinese market was immaterial to corporate revenues. Today, it’s a major driver.
China is a market with unique risks. They pose real challenges for companies and shareholders.
Shares of casino operator Wynn Resorts tumbled by 25 percent from Sept. 10 to Sept. 21, after the Chinese Communist Party (CCP) announced restrictions on casino operations in the gambling hub of Macau. Nike saw its stock drop by 12 percent between March 16 and March 25, as it was censored on Chinese social media after releasing a statement of “concern” about forced labor harvesting cotton in China’s Xinjiang region. And Nike has historically been a proponent of Beijing’s policies.
Those are examples causing quantifiable detriment to investors.
There are also issues that don’t directly correlate to stock price movements. China’s draconian lockdowns during the CCP virus pandemic have harmed restaurant operators such as Yum China Holdings and Starbucks, as well as hospitality firms such as Marriott In-
ternational. That effect is still ongoing.
On Marriott’s third-quarter earnings call on Nov. 3, upon being asked about the risks of operating in China by a Wall Street analyst, Marriott Chief Executive Anthony Capuano said, “Well, how much time do we have?”
Japan’s SoftBank Group, whose subsidiary, Vision Fund, owns several technology startups in China, including ride-hailing company Didi Chuxing, recommended in September to be “more cautious” about investing in China. Beijing’s crackdown on technology firms has forced SoftBank to write down its holdings by more than $50 billion.
There’s no singular type of China risk. Obviously, the CCP’s regulatory whims are a risk. China’s lack of judicial independence is another. Not to mention the CCP’s politics and its views on U.S. businesses in China. The country’s own domestic companies are also becoming increasingly fierce competitors to foreign incumbents. Lastly, China’s economy poses a macro risk—its slowdown hurts mining companies exporting natural resources and farmers exporting agriculture.
In the Nov. 15 issue of Barron’s, the financial newspaper compiled a list of “China sensitive” S&P 500 companies based on the percentage of their annual sales are derived from China.
The top 10 companies on that list, in order, are casino operators Wynn Resorts (with 70 percent of its sales coming from China) and Las Vegas Sands, chipmakers Qualcomm and Texas Instruments, fiber optics firm IPG Photonics, computer hardware maker Western Digital, chipmaker NXP Semiconductors, radio and wireless technology maker Qorvo, semiconductor firm Broadcom, and glassmaker Corning (with 33 percent of its sales deriving from China).
I’m not here to argue that all companies need to exit China. Perhaps some should. Others, with the right framework, could see their profits outweigh the risks. But all of them need to ask if they have the resources, know-how, and expertise to properly assess, identify, and mitigate the risks of operating in China. And they need to be independent enough to give objective assessments.
Even if they’re equipped with the resources, are companies properly disclosing such issues to investors? China is a hot topic of discussion on corporate earnings calls. It’s no longer good enough for corporate CEOs, CFOs, and COOs to say, “We are monitoring the situation in China.”
A paragraph on the risk of doing business in China in a company’s SEC filing is too vague. Companies need to tell investors how they’re monitoring and what contingencies and hedges are in place to dealwithpolitical,regulatory,oreconomic changesspecifictoChina.Managingbusiness in China should span functional departments and executive management.
Risk isn’t a one-way street. With risks, there are also opportunities. But companies and shareholders need to get smarter and be better informed.
