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Michael McDonald Feb 09, 2017
The current political environment is bringing a heightened focus on the costs and benefits of international trade. While Mexico is in the spotlight right now, China is by far a bigger market, and, for many U.S. firms, that means increased exposure to the Chinese yuan.
Despite China being the second largest economy in the world (behind the U.S. and just ahead of Japan), many U.S. firms have limited exposure to the Chinese market. Put simply, China is not a big importer of U.S. goods. The firms that do have a large exposure to China tend to be the firms with direct operations in that country. This is because China is largely an importer of raw materials and unfinished goods for manufacturing, while the majority of U.S. companies produce finished goods and services, and then sell them to domestic or developed foreign markets.
Among the companies with large levels of Chinese yuan exposure are Wynn Resorts, YUM China (formerly part of YUM Brands), Las Vegas Sands Corp, Mead Johnson and AO Smith.
These five firms have the highest levels of revenues derived from China and semi-autonomous Chinese markets (e.g. Macau) – firms with high levels of exposure to Taiwan are not on this list, since Taiwan is not part of what most investors consider China.
Find out how rising interest rates are affecting the markets.
One primary concern for firms operating in China is the prospect of yuan devaluation. All companies operating internationally have to be concerned to some extend about foreign exchange risk. However, unlike many of the more developed countries, China does not have a free floating exchange rate. As a result, currency changes in China can be sharp and unpredictable.
There is considerable speculation right now about the possibility of another drop in the value of China’s currency, the yuan. When the yuan falls or depreciates versus the U.S. dollar, it means that 100 yuan will not buy as many U.S. dollars. One yuan today is worth about 15 U.S. cents. That number used to be closer to 17 cents, as the graphic shows below.
China’s economy is slowing, which is why the yuan has fallen in value over the last several years versus the U.S. dollar. China’s economic growth is continuing to slow and the outlook for the future is murky at best, which would result in a depreciating currency were it not for the fact that the Chinese state tightly controls the value of its currency.
China can only keep the yuan from falling by spending its own currency reserves – essentially its savings – to buy yuan on the market and prop up the currency. China is running out of currency reserves, however, and it may be forced to devalue the yuan soon, though.
Keep track of our Yuan Devaluation superpage for the latest on how this market catalyst is playing out.
The yuan devaluation can have either positive or negative effects for companies in the U.S. U.S. firms that sell products in China are generally hurt by yuan devaluation, while those that import products from China and sell them to U.S. consumers are hurt.
Take YUM China (YUMC) – previously part of YUM Brands (YUM ), which owns Pizza Hut and KFC among other restaurants. YUM China is a U.S. company but it operates Kentucky Fried Chicken restaurants in China. When the yuan falls, KFC still sells food in China and earns a profit there. But when it goes to convert that yuan profit back to dollars, the yuan earned convert to fewer U.S. dollars. As a result, their USD profit shrinks.
Tupperware is a frequent victim of this effect in the Indonesian rupiah because Indonesia is its largest market. Bloomberg described this effect in 2015 in the following article.
The five U.S. companies with the largest exposure to China based on the percentage of their revenues derived from the country are below.
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The last time there was a major yuan devaluation was in August of 2015 when the Chinese devalued the yuan by 2% overnight. The chart below shows the S&P 500 in blue versus the stock price of the five firms above.
It’s important to remember that yuan devaluation is just one factor that can affect a company’s bottom line. Economic growth, new products, new locations and marketing can all play a role as well. As a result, yuan devaluation might have only a modest impact on any of the companies discussed above. In addition, President Trump is talking about the U.S. dollar being too strong.
While the U.S. has a floating market exchange rate that prevents the U.S. government from directly devaluing the dollar, there are indirect actions that could be taken. If the U.S. dollar drops in value against the yuan, then all of the companies mentioned might actually see a benefit.
The broader point is that investors need to keep these risks in mind going forward.
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Check out the securities going ex-dividend this week.
In the end, the market continued its ebb and flow as traders viewed...