Cold Winds From China
When China catches a cold, the FTSE 100 sneezes. With the World Bank warning that China faces a three-pronged threat — from local government debt, cooling property, and uncertain exports — a number of portfolio stalwarts are feeling the chill.
Diageo (LSE: DGE) (NYSE: DEO.US), Rio Tinto (LSE: RIO) (NYSE: RIO.US) and Unilever (LSE: ULVR) could struggle if Chinese growth slows further. How big a danger do they face? And can a recovery in the Western economy compensate?
Hard Drink
Diageo got the sniffles earlier this year, with its share price declining 6% on falling sales in China, and also Nigeria. The Chinese slowdown wasn’t purely due to economic factors, there was a political aspect as well, as a government anti-corruption crackdown put a stopper on gifting spirits to officials.
Diageo suffered a whopping 19% drop in sales in Asia-Pacific in the first three months of 2014, with political instability in Thailand also proving a downer. Ironically, this only confirmed Diageo’s strength, as a mighty 27.7% rise in sales in Latin American and the Caribbean helped offset these losses.
Sales in the US and Western Europe both rose 1.2%, so the developed world is doing its bit. Across the quarter, total organic net sales fell just 1.3%. Diageo’s share price has risen in recent weeks, and although I think the glory growth days are over for now, it remains a strong long-term hold.
Rio Loses Brio
Diageo’s sharp drop in Asia-Pacific sales underlines the scale of the threat facing other companies. Rio Tinto is particularly exposed to China, which buys roughly half its iron ore production. The iron ore price is down 30% this year to around $92 a tonne, a 20-month low, although there are now signs it has bottomed out.
Mining industry profitability has fallen to its lowest level for a decade, according to a new report from PwC, although it says that “traces of calm” are returning to the sector. It warned that dividends could even be under threat, unless they can reverse the trend by cutting costs.
I’ve been bearish towards Rio Tinto and other miners such as BHP Billiton lately, because I don’t think the West’s recovery is strong enough to compensate for a loss of Chinese appetite. If you disagree, you’ll think this stock is a bargain at just 9.6 times earnings.
Lux Redux
Global companies will always face challenges in one market or another. Unilever’s first-quarter results were knocked by political difficulties in Russia. China was less of a problem, with a “strong” 5.8% rise in underlying Asian sales growth, against 3.6% for the group as a whole. A major relaunch of Lux and new Cornetto flavours in China helped.
People still buy soap, even in a slowdown. Ice cream is a cheap treat. They still drink water too, and Unilever has just completed the acquisition of a majority stake in China’s Qinyuan global water purification business. Attempts by the European Central Bank to drive down the euro may help future sales.
Diageo and Unilever have the global spread and product diversification to shrug off the China slowdown. Rio’s concentration on iron ore leaves it far more vulnerable to chill winds.
