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Yuan Devaluation

How Yuan Devaluation Could Improve Margins for These 5 Companies

The advent of Donald Trump to U.S. President has ushered in a new era of protectionism for the world’s largest economy. As the U.S. looks inward, China appears poised to fill the vacuum as the world’s preeminent trade leader. Therefore, it came as no surprise when Chinese President Xi Jinping defended globalization at the World Economic Forum in Davos this past January.

Understanding China’s desire to lead globalization brings to bear its policy of yuan devaluation, a multiyear strategy that has allowed Beijing to achieve greater export competitiveness while catapulting its currency among the world’s elite. For businesses, yuan devaluation has important implications on global trade in an environment increasingly dominated by China. This is especially true for companies that have the bulk of their production base located in the world’s second-largest economy.

For decades, companies have outsourced work to emerging markets, such as China, to lower cost and expand production capacity. For companies that operate in China, a weaker yuan could mean improved operational efficiency, since converting dollars to yuan would increases local currency cash flow that can then be used to pay wages, salaries and other costs.

In the following section, we explore five U.S. multinational companies that have set up shop in China and evaluate them on the basis of their competitiveness.

Major U.S. Companies That Have Outsourced to China

Apple, Inc. (AAPL )

As the world’s most valuable company, Apple owes a large part of its success to its relationship with Chinese manufacturing company Foxconn. Like many before it, AAPL has built strong production capacity on the mainland. However, China is also a major consumer of AAPL products, which means most of the speculation around yuan devaluation has been on how much Beijing’s strategy will end up costing the iPhone maker in the long run.

Turning to production, manufacturing an iPhone in China costs roughly $8. By comparison, the same phone would cost at least $65 to produce in the U.S. Most of the components of Apple products, such as the iPhone and iPad, are also based in China. This suggests that yuan devaluation could be a net positive for AAPL, even though it might take a bite out of profitability from its Chinese end market.

Nike, Inc. (NKE )

Sports apparel maker Nike outsources the production of all its footwear to emerging markets, with China comprising the largest share. This means that a yuan devaluation would likely lower operational costs for the company’s China operations. This is compounded by the fact that NKE is already making strong inroads in so-called ‘lean manufacturing,’ a systematic method for waste elimination that relies on emerging technologies.

However, like AAPL, NKE has seen its share of Chinese revenue increase sharply in recent years. Sales since the 2008 Beijing Olympics have surged more than 100%, which means that a yuan devaluation might hurt NKE’s bottom line as the company hikes prices to retain profit – a double-edged sword that could ultimately lower demand for an already expensive product.

Cisco Systems Inc. (CSCO )

Information technology giant Cisco has steadily increased its share of foreign workers, with nearly half of its global workforce now based outside the United States. China is currently among the biggest beneficiaries of the company’s strategy to shift a larger percentage of its operational costs overseas. Additionally, China isn’t a particularly large end-market for CSCO, which means it stands to benefit from a cheaper yuan. This would allow the company to manage payrolls and expenses much more easily, which could provide it with more incentive to expand its Chinese capacity.

As history demonstrated, CSCO has struggled to retain core staff in China as its sales dip and Beijing tightens its tax regulations. A weaker yuan could provide a magnet for companies like CSCO to remain in the country despite the changing domestic landscape.

Wal-Mart Stores Inc. (WMT )

Wal-Mart has outsourced the large majority of its goods production to China. This makes the U.S. retailer a prime benefactor of a weaker yuan – that is, if its suppliers pass on the benefits of the falling currency.

WMT has already sought price cuts from suppliers that produce goods on the mainland, claiming that it deserves to benefit from the systemic devaluation of the renminbi. WMT managers have contacted tens of thousands of suppliers connected to China seeking cost cuts of between 2% and 6% on general merchandise, including home furnishings, apparel, appliances, electronics and beauty products. With total operating expenses exceeding $100 billion annually, a 2% to 6% reduction in prices could add billions to cost savings.

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IBM Corp. (IBM )

With massive outsourcing operations in India and China, IBM is keenly interested in developing a global workforce to lower costs and boost profitability. Amid demonetization concerns in India, China could be a major source of operational cost savings for the technology company as Beijing continues to support the yuan’s competitiveness. Already today, IBM outsources thousands of high-paying programming jobs to the mainland to lower costs, which can then be passed on to consumers.

However, IBM has also identified China’s rapidly growing mass market as a major potential business driver for the company. As IBM seeks end-markets in the world’s second-largest economy, any gains it realizes on the operational side might be limited by its foray into an unknown market.

Be sure to check out how Rising Interest Rates is affecting the markets.

The Bottom Line

Yuan devaluation is just one of several factors that impact a company’s price and dividend payouts. President Trump has already talked down the dollar by stating it is overvalued relative to the yuan and other currencies. If Trump has his way, yuan devaluation could play a smaller role in corporate profitability.

Keep a track of our Yuan Devaluation superpage for the latest on how this market catalyst is playing out.

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