Why American Companies Are Facing Increasing Challenges Due to China

10 Sep, 2023

Why American Companies Are Facing Increasing Challenges Due to China

One of my significant college regrets is not being able to join a six-week trip offered by the business school to China due to scheduling conflicts. This was back in 2007 when China's potential as the world's next major player was becoming evident. It took several years, but I finally got the chance to visit in 2012 as part of a work assignment with CNBC. I only had the opportunity to explore Beijing, but it left a lasting impression. The sheer size of the city, with blocks dwarfing those in Washington, D.C., was remarkable. There were limited places to grab food or coffee during long walks, which seemed like an obvious opportunity for Starbucks. On a more somber note, the air pollution and the absence of chirping birds, flitting squirrels, and dying trees gave the place a somewhat gloomy atmosphere.

By 2023, I had hoped we would be reflecting on China's remarkable development and discussing the resolution of its numerous challenges. However, the opposite seems to be occurring. China's struggle to recover from the Covid pandemic has exposed its deeper economic issues, and for many U.S. investors and businesses, Chinese exposure, which had driven returns for the past 15 years, is now becoming a liability.

Perhaps the most concerning development in this direction is the recent report that Chinese officials are prohibited from using Apple iPhones (or other foreign devices) and bringing them to work. Apple's shares dropped 4% on this news, and they are down another 3% as Bloomberg reports that China may expand this ban to state-owned enterprises, which are significant employers, and other government-controlled agencies.

Piper Sandler warns that this is part of a broader trend, occurring as U.S. and Chinese officials debate whether our two nations are "decoupling" or "de-risking" or neither. Companies with substantial exposure to China have been underperforming since early 2022. For example, Starbucks shares, which traded as high as $125 in mid-2021, are now at just $95, having dropped 4% this year.

The tech sector, in particular, has the highest sales exposure, with roughly 15% coming from China, compared to about 7.5% for the S&P 500 overall. The semiconductor industry has the highest exposure within tech, with "a whopping 30+% share of their sales from China," according to Piper. Even after a significant surge this year, shares of Micron are still trading more than 30% below their January 2022 highs. In May, China banned the company from using its products in "vital infrastructure projects."

Other industries facing particular vulnerability include autos, where Tesla's significant exposure to China raises the industry average above 20% for sales to China. Tesla shares are still 40% below their late 2021 highs. Autos are also a focus for China in driving its global exports, with BYD becoming the world's largest electric car maker.

Additionally, certain luxury retail brands and various other industries, from pharmaceuticals to energy, may encounter difficulties if their Chinese exposure transforms from a boon to a burden. The billion-dollar question is whether they should increase their existing exposure and invest further to expand their presence in China, or take a more cautious approach.

One major caution against doubling down on China comes from China Beige Book and AEI analyst Derek Scissors. He argues that China has not suddenly started to perform poorly; its economy "has been off course for at least 14 years and continues to slowly grind to an In summary, he stated that "Policy remains stagnant, the debt burden continues to grow, and the impact of demographics is becoming increasingly apparent." He went on to express skepticism about the ability of government stimulus measures to address these challenges. these challenges.

Considering the risk of a Chinese invasion of Taiwan, which China's President Xi Jinping has instructed his military leadership to prepare for by 2027, it's challenging to imagine multinational companies making substantial long-term investments in China right now. It's remarkable how we've witnessed the emergence, ascent, and potential decline of China all unfolding in just the past 16 years or so.