The world’s second-largest economy has ground
to a virtual halt as China grapples with the deadly coronavirus. Nearly 60
million people have been quarantined, and stores and production lines are still
largely shut. Even once the virus is contained, side effects will linger for
many companies.
The outbreak has infected more
than 60,000 people and killed more than 1,300, inflicting an unquantifiable
wave of suffering. When it comes to companies, the pain isn’t limited to
those heavily reliant on China for sales or that operate facilities in Wuhan,
the epicenter of the virus.
The city is a center for auto,
electronics-component, and semiconductor production, but it’s also a transport
hub—much like Chicago—making it even more crucial to the global supply chain.
The takeaway: Disruptions could ripple through an array of industries and hurt
sales and earnings, possibly throughout the year.
Tourism-related companies are feeling some of
the most acute pain. China estimates 13 million individual passenger flights
were canceled, and Delta Air Lines (ticker:
DAL) and others have suspended flights to the mainland until March. Cruise
operators are under siege as they approach a key period for bookings. Wynn Resorts (WYNN) is
losing $2.6 million a day as Macau closed casinos.
While markets have priced in a near-term drop
in demand and brief supply-chain disruptions, the wider indirect fallout hasn’t
been factored in, says Anh Lu, manager of the T. Rowe Price New Asia fund.
“Everyone thinks everything is going to bounce if demand comes back, but
previous incidents have shown that not every company will benefit the same
way,” she says.
The next couple of weeks will determine if the
virus is contained. Many fund managers expect a sharp rebound in markets once
the outbreak appears to be contained and factories restart, with Deutsche Bank estimating a 0.2% hit
to full-year global economic growth—some of which will be recovered in 2021.
While China President Xi Jinping has
reportedly called for a loosening of restrictions, production
is still halted and many workers stranded. Parts aren’t available—or companies
are unable to provide the required face masks for workers due to a shortage.
Even in the best-case scenario—operations gradually restart—the virus is going
to deal China the biggest hit to growth since
the 2008 global financial crisis, according to Gavekal Research analysts Andrew
Batson and Ernan Cui.
As production resumes, fund managers will look
for opportunities, though selectively. Companies with pricing power may be able
to split the costs related to the virus—such as paying overtime or expediting
orders to make up for lost time—with customers. But weaker companies could see
margins deteriorate, and those burdened with a lot of leverage could struggle
to make it even through the initial fallout.
In a note to clients, UBS Global Wealth
Management recommended a short-term playbook that favored high-dividend payers
with strong cash flow while avoiding vulnerable companies in Asia. Here are
some of the companies analysts and fund managers are monitoring for signs of
weakness.
Consumer stocks. Companies catering to Chinese consumers have
been a bright spot in many global managers’ portfolio for years. But they are
far from immune. Take liquor companies. Lunar New Year is a big time for
alcohol consumption, and retailers, bars, and restaurants had stocked up in
anticipation. But most large gatherings were canceled—and that lost demand is
unlikely to be recovered. Inventory won’t need to be replenished for a long
time.
“Even when people resume going out,
manufacturers might not get new orders for a while,” says Donny Kranson,
co-manager of the Vontobel International Equity strategy. Shares of spirits
maker Diageo (DEO) are down
3.7% so far this year, while Budweiser Brewing APAC (1876.Hong
Kong), the Asia-Pacific subsidiary of the beer maker, is down 11%.
The outbreak could also change attitudes
toward eating out. Meituan Dianping (3690.Hong
Kong), a darling among emerging market investors, has fallen 12% from a recent
high last month. Only about 20% to 30% of restaurants have been opened for food
delivery, and delivery volumes appear to be down 50% or more at the majority of
those that are open, according to Bernstein analyst David Dai.
Widely held luxury retailers and cosmetics
companies like LVMH Moët
Hennessy Louis Vuitton (MC.France) and Estée Lauder (EL) won’t escape
unscathed. Luxury stores on the most fashionable streets around the world are
empty as Chinese tourism has plummeted. LVMH has estimated a not-too-terrible
hit to sales, while Estée Lauder cut
its profit outlook for its fiscal second half, though it expects a rebound once
travel resumes. Over the long term, the outbreak is unlikely to wean Chinese
shoppers from luxury goods, but for now, fund managers are looking to cheaper
pockets of the market, like industrials.
Industrials. The sector was well-positioned for a global
economic recovery previrus, and economists still expect one, just delayed. In
the near term, though, industrial companies risk weakened demand, as well
as supply-chain interruptions,
yet most have not adequately discounted the blow from the virus in 2020
outlooks, Deane Dray, an analyst at RBC, wrote in a recent note. Two
exceptions: Emerson Electric (EMR),
which estimated a roughly $50 million to $100 million hit to sales, or a 1.5%
hit to second-quarter revenue estimates, if factories had reopened on Feb.
10—and a greater impact if it extended beyond that—and Xylem (XYL), which could
see a three- or four-cent hit to first-quarter earnings per share.
Technology. Companies linked to China’s 5G buildout—which is reliant
on government spending—could also be vulnerable, as the government may need to
focus on other priorities. Plus, Wuhan is known as China’s Optical Valley, home
to much of the optical-component supply chain crucial to the 600,000 to 650,000
5G base stations planned to be operational in China by the end of 2020, says
Matthew Sigel, managing director at Hong Kong–based broker CLSA.
If the Chinese government continues to enforce
travel and commerce restrictions within Wuhan, “we could see Wall Street’s
earnings estimates for some of the handset and 5G supply chain adjust lower
and/or get pushed into 2021,” Sigel says. Qualcomm (QCOM), the
world’s largest maker of mobile phone chips and modems, warned of “significant
uncertainty” around its handset demand and supply chain.
Components like printed circuit boards, optical
fiber, and displays face the biggest risks to production, while LCD, memory,
and Chinese auto technology may be more resilient, Sigel adds.
Goldman Sachs highlights
semiconductor and technology hardware companies as the most exposed group
within the sector, with 47% and 14% of revenue, respectively, coming from
Greater China.
These two areas also are starting with
valuations that had baked in some good news pre-outbreak—signs the semiconductor
industry was about to emerge out of a downturn with better earnings-growth
expectations for Apple (AAPL).
The outbreak has cast a shadow over those assumptions.
Apple has closed all its stores and corporate
offices in mainland China and is at risk of major disruptions, with nearly half
of its manufacturing and supply sites located in China. While iPhone
assembler Foxconn
Technology (2354.Taiwan) was expected to resume production this
past week, reports suggest some of its factories will remain closed, while
others are operating with 10% of the workforce. For every week business
activity doesn’t resume from Feb. 10, Cowen analyst Krish Sankar estimates a
two-cent-a-share hit to earnings from lost iPhone or service sales.
Apple has factored some of the hit into its
outlook, mitigating some of the risk, according to Evercore ISI analyst Amit
Daryanani. Other companies Daryanani highlighted as worth monitoring
include Amphenol (APH), which
has roughly 30% of sales tied to China; HP Inc. (HPQ),
which has about 70% of its manufacturing workers in China; and Dell Technologies (DELL),
which has more than half of its suppliers in China.
Citi China internet analyst Alicia Yap summed
up the wariness of those on the ground: “We would be patient and wait for
better entry points and assess the downside risks versus valuation before
getting too excited.”
Write to Reshma Kapadia at reshma.kapadia@barrons.com
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