#5: What are companies saying about China?
Taking stock of the Chinese economy from the perspective of the largest companies
Summary:
A review of earnings calls have revealed the difficulties businesses faced when operating in China this year
There were issues both on the sales and supply chain side
The economy bottomed over the month of June, but the improvement has been timid
Most companies remain very bullish on the future of the Chinese economy
Chinese president Xi Jinping has just won an unprecedented appointment to a third term as head of the party and military at his ruling Communist party’s 20th national congress.
While most analysts will be scouring over his speech in order to gleam insights about the future direction of policy making, I thought it would be a good idea instead, to take stock of how the economy has evolved over the course of 2022 rather than provide another ‘hot take’.
One of the best ways to do this is to go through the earnings calls of businesses who operate in China to get a sense of how the economy has evolved.
There were a few key themes consistent among the earnings calls which I thought were worth highlighting.
Theme 1: The economy turned decisively lower due to covid lockdowns in April:
Caterpillar ($CAT) – Q2 Earnings call
Sales to users in Construction Industries decreased 4%, primarily due to weakness in China and continued supply chain constraints. Asia Pacific sales to users were down in the quarter. However, excluding China, the Asia Pacific region, sales to users increased.
Rio Tinto ($RIO) – Q2 Earnings call
Iron ore prices dropped 24% from the record highs we enjoyed in 2021 first half. In a context of continued softness in the Chinese property market and COVID restrictions, steel demand remained relatively robust.
3M ($MMM) – Q2 Earnings call:
As you know, the macro environment remains uncertain with mixed trends and signals across geographies and end markets. For example, improving build rate trends in automotive; continued strong demand in semiconductor, data center and factory automation; increasing health care elective procedure volumes; and a strong bounce back in China, following April and May COVID-related lockdowns. However, there are also continued challenges and areas of concern that we are monitoring, including the stubborn and evolving impacts of COVID; global supply chain and logistics challenges; persistent and broad-based inflation, which is pressuring consumers' purchasing power and shifting spending patterns; softening trends in consumer electronics; and geopolitical uncertainties, particularly in Europe. We are working through these challenges and are taking actions such that we expect to offset the majority of these headwinds. However, as I mentioned earlier, the strength of the U.S.
So China (specifically), as Monish highlighted in his prepared remarks, we saw better-than-expected recovery in June to the lockdowns that we were seeing, then the soft start to April, May that we talked a bit about in China. So as we go forward, and for the quarter, you're right. It's down high single digits year-on-year. GDP still looks positive in Q2.
Siemens ($SIE) – H1 Earnings call:
As expected, the lockdowns in China in April and May limited output and impacted overall productivity. However, the team did a tremendous job to rapidly catch up during June. We see this to continue in the fourth quarter. I'm particularly proud of our Digital Industries automation business, once again, clearly gaining market share with revenue up by 15% despite challenges in the supply chain.
Volkswagen ($VOW) – H1 Earnings call:
Sales in the second quarter were heavily impacted by the semi and wiring harness shortage as well as COVID-related measures in China. The situation stabilized in May, and we saw a clear upward trend in June with more than 800,000 deliveries worldwide.
Porsche is well underway with 149,000 units sold in H1 2022, showing impressive return on sales of almost 20% in H1 in its automotive business. Deliveries in Europe increased, while other markets, especially China, were still impacted by the semi and wiring harness shortages.
McDonald’s ($MCD) – Q2 Earnings call:
Recovery in China remains challenged with negative double-digit comp sales in the second quarter due to ongoing COVID resurgences and related lockdowns across key cities. This resulted in temporary restaurant closures throughout the country for most of the quarter. While operating conditions are challenging, restaurants remained focused on the consumer, offering core menu favorites and targeted digital coupons.
Starbucks ($SBUX) – Q2 Earnings call:
I'm particularly pleased that we delivered our results in the face of stiff ongoing consumer economic and inflationary headwinds; COVID lockdowns across China that kept Shanghai, our largest China market, largely closed for 2 months, and that continues episodically today; and continuing shifts in customer traffic and behaviors, including materially reduced office occupancy in our largest urban markets.
In Q3 (Q2 2022), China faced its most severe COVID disruption since the onset of the pandemic. Mobility restrictions and lockdowns were implemented faster and eased more slowly under China's zero COVID policy. Shanghai, our largest market with more than 940 stores, was completely locked down for approximately 2/3 of the quarter. In Beijing, 150 stores or roughly 1/3 of our stores in the market were closed for almost 6 weeks with the balance of our Beijing stores operating without indoor dining.
We entered Q3 (Q2 2022) with over 1,300 stores, close to 1/4 of our total portfolio, temporarily closed. We exited the quarter with roughly 2,000 stores across nearly 50 cities operating with mandated reductions in seating capacity or other COVID restrictions. Similar patterns remain today with COVID restrictions being eased in some cities and new restrictions imposed in others. We continue to expect our recovery in China to be nonlinear.
Yum China ($YUMC) – Q2 Earnings call:
We operate with our Shanghai headquarters under lockdown for over 2 months and still managed to execute with extraordinary agility, quickly forming cross-functional and across brand crisis management team, while we develop flexible tool kits to tackle each problem as they arose. Through it all, we have stood firm and built the business stronger in so many ways.
In the Q1 earnings call, I shared that with 10% to 15% of the store opened in April, shanghai achieved 40% to 50% of pre-lockdown sales. In May, with less than half of our stores open, we reached pre-lockdown sales level. This was a remarkable achievement.
The COVID situation has significantly impacted our second quarter results. In April and May, same-store sales declined by more than 20% year-over-year. On average, more than 2,500 stores were temporarily closed or provide only limited services.
Nike ($NKE) – Q2 Earnings call:
Next, I'll provide some color around our results in Greater China. In Q1, revenue declined 13% on a currency-neutral basis, and EBIT declined 23% on a reported basis. NIKE Direct declined 2% on a currency-neutral basis with a 5% decline in NIKE Digital. While COVID-related disruption had meaningful impact on store operations and retail traffic, business performance and inventory management are ahead of plan as we continue to proactively recalibrate supply and demand.
LVMH ($LVMH) – Q2 Earnings call:
Numbers in China were, more or less, flat for LV in Q3 (Q2 2022). Obviously, we had a difficult start of the year for reasons I don't have to mention. But Q3 ended up, more or less, on a flat note, both for the client base and for the country as obviously this is exactly the same thing.
As far as Cognac is concerned, the situation is more contrasted, particularly in China. You remember that we had a complicated Chinese New Year period. We ended up overloading a little bit the trade. I mean, the level of sellout was not exactly what we -- what I thought it would be. And we've been pushing ahead a little bit of stock excess with our main clients, which we decided to absorb in Q3. So the numbers in China are not -- for Cognac, the volumes are not particularly good, with a view of removing the excess inventories in the system ahead of Chinese New Year, which will probably take place.
Kering ($KER) – Q2 Earnings call:
Mainland China posted a significant decline in the quarter, impacted by strict lockdowns and mobility restrictions translating into traffic drops in many locations, not to mention complex logistical issues. The situation has been gradually easing since June but remains unsettled.
Farfetch ($FTCH) – Q2 Earnings call:
By region, for the Marketplace, GMV from China was down year-on-year due to COVID-19 restrictions. However, we have seen strong engagement from customers including during our 6.18 event in the China market and year-on-year growth on Tmall, which means we remain optimistic about the China market and our overall proposition moving forward. We expect this market to return to growth over the next 12 months.
Theme 2: Supply chain stresses were elevated:
Caterpillar ($CAT) – Q2 Earnings call
On withholding guidance:
In light of the current environment, including supply chain constraints, we continue to refrain from providing annual profit per share guidance. However, I will share some thoughts on our third quarter and full year. Pricing was better than expected, while sales of equipment to end users lagged our expectations due to supply chain challenges and additional weakness in China.
Siemens ($SIE) – H1 Earnings call:
Although order backlog is at even further elevated levels, the outlook for the fourth quarter is again largely depending on global component availability, logistic constraints and a still fragile situation in China due to its unchanged Zero-COVID policy.
Volkswagen ($VOW) – H1 Earnings call:
Supply chain's improving. We had 3 major issues in the supply chain. One, of course, the terrible war in the Ukraine with the effects on supply of wiring harness. Second, a more underlying structural undersupply of semi, which started basically already last year, which we see still at least until like summer. And then the third one, obviously, COVID measures in China.
LVMH ($LVMH) – Q2 Earnings call:
In Cognac & Spirits, Hennessy, while still affected by restrictions in China and logistical disruptions in the U.S., continued its upward trajectory with double-digit reported growth, given it maintains a firm price policy.
On digital in China, no, it's simply the fact that the Chinese market is not functioning or working the normal way. We still have disruptions, both in terms of people being in lockdowns, some stores are being closed. We -- the supply chain in China doesn't work particularly well. So my point is just that we shouldn't be drawing conclusions as to what's going on in China.
Samsung ($005930) – Q2 Earnings call:
In DRAM, for server, there were some disruptions in set builds due to supply issues for certain components, with continued expansion of the proportion of high core CPUs kept fundamental end demand on a solid trend and memory demand on an upswing. Inventories increased at major PC OEM companies due to low sellout amid intensifying macro issues such as inflation and demand weakened accordingly. Mobile experienced weak demand trend as well as consumer sentiment worsened due to lockdowns in China and price instability caused by the prolonged Russian-Ukraine war. We achieved the high sales of server products in the industry for any quarter by optimizing our portfolio and actively responding to solid demand centering on servers. However, we missed guidance for total bit growth due to weak demand for consumer products such as PCs and mobile devices.
Now the supply chain situation actually worsened as we passed through this year with the Russia-Ukraine war and also some lockdowns in parts of China. And so watching that, we have been increasing our inventory levels this year. And this was actually one of the key factors of why we were able to continue stable supply of products throughout the first half.
Theme 3: The economy bottomed in June
3M ($MMM) – 14 September 2022 Morgan Stanley Conference:
Then I come to China, your question on China. When we came into the second quarter, Josh, we had said that China COVID shutdown would cost us approximately $300 million of revenue.
The team did a marvelous job once China opened up to reduce that to $140 million, which we had disclosed during earnings. And we had said we assume -- we see that backlog recovering over the next 2 quarters. And we are seeing that pretty much play out. But I think we'll have to wait and watch what these COVID shutdowns mean, how deep they are and how wide they are. And that will, I think, definitely, again, have an impact on supply chains.
Siemens ($SIE) – H1 Earnings call:
Andrew, I think that's really hard to tell because there is temporary effects that are compensated then quickly. And there is a kind of sustainable impact for more than a quarter then maybe. What is important, however, is that we are winning new orders, occupy the marketplace and then have an opportunity to deliver and convert into revenues and finally into profit and cash.
Yum China ($YUMC) – Q2 Earnings call:
The situation gradually improved in June. We were able to capitalize on that improvement with same-store sales decline narrowed to high single digits year-over-year and the number of temporary store closure also reduced. We achieved operating profit of $81 million and restaurant margin of 12% in the second quarter. We were able to generate meaningful profit in the quarter, which exceeded our expectations, not only by capturing sales when the COVID situation improved in June, but also, by taking swift and decisive actions.
LVMH ($LVMH) – Q2 Earnings call:
Well, the demand recovery in China, frankly, when you look at the numbers, we cannot really talk about recovery. Things are better than they were in Q2, for sure. But they are not back to normal. We still have, as I said, lockdowns here and there. The supply chain is heavily disrupted. The level of traffic in stores across the country is nowhere near what it was in 2019. So we are not operating in normal conditions.
So are we satisfied or not? Obviously, we're not. I mean, we would want this market to be as strong as it could be and we expect it to recover soon. I will obviously not comment on political decision for obvious reasons, the main one being that I don't know them. But I mean, we are not operating. My message is that despite the fact that the business is flattish in Mainland China in Q3, we are not operating in a normal way. And therefore, we cannot be satisfied with that, but there is not much we can do about it.
Kering ($KER) – Q2 Earnings call:
We are not yet back at full speed, of course, in China as we can imagine, but there was an improvement, and we continue to see somehow of improvement in July. Let's see, of course, what will happen in the coming weeks. And as you can imagine, it's very difficult. So overall, we were around -- for the quarter, around minus 30 to minus 35 in average for our luxury houses in China in Q2.
Farfetch ($FTCH) – Q2 Earnings call:
The situation in China continues to be impacted by COVID-19 restrictions, especially for our cross-border businesses, as we're having a long lead time to deliver to customers. There's still quarantine process procedure for our parcels crossing the barter and in certain gateways, disinfection procedures for parcels, which we're confident that probably there will be more comfort around cross-border logistics and packages, et cetera, given clearly the World Health Organization has said that there's no risk of contagion from parcels.
And that was relaxed in the West very, very quickly, in China is taking a little longer. But I think that once we are able to service our customers, there is very strong engagement on the platform. The demand is there. The conversion rate obviously is affected by these longer lead times, but I think this is transitory, and there's huge potential and pent-up demand in fact in that market that we will be able to seize.
Theme 4: Companies remain overwhelmingly bullish about the future
Caterpillar ($CAT) – Q2 Earnings call:
In China, we have seen the market weakened, as I mentioned. We had a couple of very strong years in 2020 and particularly in 2021. It's too early for us to really predict what's going to happen there. To your specific question, again, we'll continue to support our customers there. And again, what we see now, of course, is a weaker market for that 10 tonne above excavator market than we had previously.
Residential demand today remains healthy for us. Certainly, it could moderate somewhat due to interest rates and inflation. However, nonresidential demand is stable outside of China.
For the second half of the year, we expect revenues to be higher compared to the first half. To reiterate Jim's comment, we remain encouraged by the strong demand in our end markets for our equipment and services.
Rio Tinto ($RIO) – Q2 Earnings call:
For Rio, China accounts for over half of our revenues. We remain convinced that the longer-term trends that we highlighted last October remain intact, underpinned by ongoing urbanization and additional demand created by the energy transition. This reinforces our belief that Rio Tinto is a mining company that is uniquely positioned for the future. While it is a time of continuing economic uncertainty, it is also one of opportunity. We have the portfolio to play a vital role in supplying materials for the energy transition, the ambition to decarbonize our business and the conviction that we are making the right investments in our culture and our partnership to unlock our full potential.
3M ($MMM) – Q2 Earnings call:
As we go forward, part of the answer is going to be how quickly does it recover? What is the impact going forward of COVID as any potential additional lockdown? So it's really looking at where we go there. I mean China continues to be an important market for 3M. It's -- the macro backdrop shows a good positive backdrop, but it's really going to be how all things progress relative to COVID and the recovery from COVID than what else comes our way as we go through the quarter and through the rest of the year.
Ingersoll Rand ($IR) – Q2 Earnings call:
And a further look into our leading indicators like demand generation lease shows stable growth in Mainland Europe. Despite nearly 2 months of lockdowns in Shanghai, China, the Asia Pacific team delivered orders in the mid-teens. This was driven by low double-digit growth in China and mid-20s growth across the rest of Asia Pacific.
Volkswagen ($VOW) – H1 Earnings call:
I told you we built up basically inventory in anticipation of the higher production in second half of the year, which we're really confident we can achieve. We see better situation in semi. We don't expect a further lockdown in China from today's perspective.
And COVID China, you're very well aware of, there are huge improvements there. And from today's perspective, we don't think that we see a major lockdown, but this is obviously something we can't control.
McDonald’s ($MCD) – Q2 Earnings call:
We look at that around the world. One of the things that makes me feel confident is in almost every major market where we operate -- there's just 2 exceptions, China and Spain, but in every other market where we operate, we are leading amongst any of our peers from value for money standpoint.
And hopefully, the economic environment can get back there to something relatively normal because we're still big believers in the opportunity in China and have a lot of confidence in our business there.
Starbucks ($SBUX) – 13 September 2022 Analyst/ Investor day:
Let me take a page out of Rachel's book and say let me put an exclamation point on that. We've been in China now for 21 years. We lost money in China, I think, for the first 9 years. It took us a while to get it right. And in the last decade, I think we've proven that the power of the Starbucks brand and the experience and literally creating an industry that did not exist and a category that did not exist. If I had to put a headline on the China opportunity, we are playing the long game.
I don't know if you picked up a word that Belinda used in her presentation. She said the growth in China over the next year or 2 will not be linear. There are obviously external issues but our belief going back to a decade ago when I made the declaration that China 1 day would be as large as the U.S.
Well, we're 3,000 stores away from the same size in the U.S. Now I believe that China is going to be 2x of the U.S. as the size of the opportunity is twice of America. And certainly, if you look at the scale of the opportunity, the population, the power of the brand, the investments we've made, continuing to invest ahead of the growth curve, we are going to build a major business in China and we will become one of the most respected and recognized brands, not western brands but brands in China.
And so from an investment thesis, what other consumer brand in your portfolio has the opportunity, the runway and the proven success that we have in China? And so we're going to continue to be bullish on China despite some of the external issues. And we believe the relationships we've built with the customer, relationship we've built with our partners, relationship we built with the government puts us in a very unique position.
Nike ($NKE) – Q2 Earnings call:
As mentioned last quarter, we are taking a cautious near-term approach in Greater China, given the ongoing risks of COVID-related disruption. However, our brand and business momentum gives us increasing confidence that NIKE's unique value proposition will fuel long-term growth in Greater China.
LVMH ($LVMH) – Q2 Earnings call:
We still think that in China, the end demand is strong once the drawbacks or the difficulties connected with the pandemic situations are overcome. So we expect the business to resume. Middleton festival was comparable to last year, which is frankly a good achievement in the context because particularly, the on-trade business is deeply affected. So overall, I mean, the Cognac business is not flying but is doing well in a context that is quite -- that has been quite difficult since the beginning of the year.
Farfetch ($FTCH) – Q2 Earnings call:
Doug, in terms of China, I think, first of all, we remain very bullish about China in the medium and in the long term. We think this is an incredible market. It will be the largest luxury goods market in the world by 2025. We have an incredible position there as the only Western player that has for many years invested in that market, creating incredible capabilities there. And I think that we will be able to seize the strong demand for luxury products, especially online where penetration is still very low in that market.
So we remain very bullish in the medium to long term in terms of China, and we'll continue to invest in that market. I think what makes me confident is that we see strong engagement from the Chinese customer. We continue to see high traffic, elevated levels of traffic. We continue to see -- we saw a very strong June 18 event. Tmall is seeing positive growth in spite of the macro headwinds. And I think right now, we're seeing in terms of our app which is the larger part of our business there. We're seeing double-digit declines. I don't think this will last for long. I think this will turn into positive growth next year and potentially a strong positive growth.
I think this theme is perhaps the most interesting given the recent indications we’ve received both from the Party Congress and from state media that the CCP remains committed to zero covid.
I recommend investors continue to monitor earnings calls as we commence Q3 earnings season for further indications as to how the economy has evolved, and more importantly, how future investment plans within China may change due to uncertainty.
Summary:
A review of earnings calls have revealed the difficulties businesses faced when operating in China this year
There were issues both on the sales and supply chain side
The economy bottomed over the month of June, but the improvement has been timid
Most companies remain very bullish on the future of the Chinese economy
Thanks,
VKMacro
#5: What are companies saying about China?
Reassuring to see good companies remain bullish on China. Despite what all the social media and Youtube gurus say, its the businesses on the ground that have the most information about what is going on. I'm watching Farfetch closely as they look pretty cheap. Thanks for this.