In the past, when CEOs mentioned China in earnings reports in a negative manner, it typically centered on supply chain issues such as delayed shipments, quality concerns, counterfeit or substitute materials, increased pricing or related “procurement” considerations. No longer.
Despite the debate around trade deficits, IP transference and market economy considerations, China has become increasingly important from a top line perspective as well. And stagnation in segments of the Chinese economy have now impacted the top line of western manufacturers as well, creating a material impact on revenue and earnings.
Consider Apple, a Fortune 5 manufacturer, as a case in point. When Apple’s CEO, Tim Cook, writes a letter to shareholders blaming Apple’s overall revenue/earnings slowdown on China as he did in early January, it is worth paying attention. In his 2019 note, Cook observes that Apple “did not foresee the magnitude of the economic deceleration, particularly in Greater China. In fact, most of our revenue shortfall to our guidance, and over 100 percent of our year-over-year worldwide revenue decline, occurred in Greater China.”
Further, Cook suggests that “China’s economy began to slow in the second half of 2018” and “as the climate of mounting uncertainty weighed on financial markets, the effects appeared to reach consumers as well, with traffic to our retail stores and our channel partners in China declining as the quarter progressed.”
Beyond Apple, an increasing number of U.S. manufacturers remain dependent on China as a significant source of revenue – not just supply. Intel and Boeing individually had over $10 billion in revenue linked to the country during 2017. And firms like Texas Instruments ($6+ billion), P&G ($5+ billion), 3M ($3+ billion), Corning ($2.2+ billion) and Cummins ($2.3+ billion) also have their “outbound” supply chains critically linked to the region. Hence, aside from the impact of Chinese tariffs on U.S. firms, it has become increasingly important to pay attention to the top-line of U.S. manufacturers in the region as a proxy for overall company performance as the outlook for overall Chinese growth and business and consumer spending remains increasingly uncertain.
China remains keenly aware of the impact of spending reductions on its domestic economy. And unlike Western economies, the centrally planned state has far more levers at its disposal in attempting to influence the economy. A CNBC article suggests that late in 2018, China’s “People’s Bank” – it’s Fed equivalent – introduced a new source of liquidity, the “targeted medium-term lending facility,” to “encourage commercial banks to give out more loans to smaller firms.”
Moreover, as CNBC observes, the Chinese government would likely help support infrastructure spending as well as tax cuts. China also reduced its bank reserve levels as a percentage of loans five times in 2018. These various moves come on top of a January cut in the equivalent of the Chinese internal bank lending rate of 1% (the equivalent of the Federal Funds rate).
The combination of these activities suggests that China has taken an aggressive – some might argue panicked – stance to fuel continued economic growth. It also suggests that the U.S. has greater leverage over China in trade talks than might initially appear on the surface. But even more than this, China’s economic doldrums should cause concern for U.S. manufacturers that either sell into or have supply chains dependent on materials, parts and components from Chinese suppliers. From an even scarier perspective, some of the risks the Chinese government has taken by interjecting increased liquidity to encourage bank lending, while lowering reserve requirements – should start ringing alarm bells and not just Apple’s.