Brace, brace: China is upset

Only a few days ago, in a short piece named ‘Alaskan bears’, we had a suspicion that the Blinken trip to Alaska to meet its Chinese counterpart would matter for markets.

Bingo. H&M and Nike have discovered what it costs to be called anti-Chinese by a Chinese government that controls all media/social networks and will make a brutal and tactical use of skin-sensitive national pride. These unhappy Western companies have been crucified for their postures against using Xinjiang grown cotton (implications of Uighurs’ forced labour) some of them even dated several quarters ago (thus well before the Alaskan meeting). 

Nike and H&M were not alone in joining the Better Cotton Initiative (think of Uniqlo, GUInditex, H&M, Bestseller, Nike, Muji, Reformation, Ralph Lauren, Lacoste, C&A, Tommy Hilfiger, GAPAdidas, DecathlonPuma, Kappa, New balance, Ikea; the full list has suddenly disappeared and thus may no longer include Chinese Anta…) and thus were not alone in committing to source only ethical cotton. Here is Nike’s version (abstracts):

Nike does not source products from the XUAR and we have confirmed with our contract suppliers that they are not using textiles or spun yarn from the region.

The Nike Code of Conduct and Code Leadership Standards have requirements prohibiting any type of prison, forced, bonded or indentured labor, including detailed provisions for freedom of movement and prohibitions on discrimination based on ethnic background or religion. 

Nike takes very seriously any reports about forced labor and we have been engaging with multi-stakeholder working groups to assess collective solutions that will help preserve the integrity of our global supply chains”.

While the above is extremely commendable in absolute terms, it is currently backfiring with Chinese consumers now taking offence and Chinese commercial platforms dropping their products. The blow may be huge pretty quickly which will force Nike’s shareholders to make an impossible choice between ESG commitments and profits. Expect some back-pedalling on the ESG wording. In short, no Western corporates can boast ESG credentials and chase a Chinese consumer. Taking sides between shareholders and clients will cost a bundle. 

In the above BCI list, stocks covered by AlphaValue weigh about €220bn in combined market cap. This is for a start as Luxury groups will find it just impossible to navigate such waters made now very treacherous by a government bent on explaining to the West where politics start. That would add another €530bn in market cap. The Western car manufacturers may be tripped at any moment too if the PCC wants to send a similar powerful message to Berlin. That would add another €435bn at risk. 2020 business in China was too good to last. Time to brace as these stocks trade at superior multiples.

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Anthony Blinken (US Secretary of State) and his Chinese counterpart, Yang Jiechi, had a serious public clash on the eve of the first round of Sino-US discussions of the Biden era, held in Alaska.

On the US agenda, beyond trade, IP and the South China Sea, there are the pressing issues of the Uighurs, Hong Kong freedoms and the threats to Taiwan. European equities may regard the rising steam as an accessory to COVID-19/near-term earnings development; it is not.

European CEOs and boards will have to take sides. The ESG requirements mean that many a European management will find it impossible to pretend to navigate inbetween, satisfying Chinese new masters and the rule of law at the same time. Remember that the Uighurs are officially victims of a genocide. That cannot be ignored by corporates. 

Examples of high wire tacking tactics abound: think of HSBC which has essentially chosen to sail with the Chinese wind and hope not to feel too much pressure from its British shareholders; think of European Luxury (a third of the CAC40) which lost Hong Kong but surfed on Chinese inland duty free and has thus swapped an open market situation for a dirigiste one. Think of the garment industry whose EDLP pretences mean relying on the hard to prune supply of Xinjiang cotton/Uighurs’ forced labour. Think of Ericsson fighting for a corner of the Chinese market when Huawei is kicked out from the western world.

There is not a single European business under the AlphaValue coverage that will be free of a Chinese connection, mostly as an essential supplier but quite frequently as an essential partner and often as a big client. The issue being that, as we repeatedly mentioned, European corporates have been extremely parsimonious about the detail of such connections/operations. The Chinese legal entities that house local operations of European groups are extremely intricate, to be polite, not to mention the increasing presence of a CCP representative.

There will be a price to be paid for ignoring how much China, its political agenda, its own set of regulations and its military push have been percolating into the European valuation exercise. This is part of a risk premium that has so far been eroding, courtesy of central banks. The wake-up call may be all the more brutal. 

No figures

Using scarce figures, there are about 60 corporates tracked by AlphaValue with declared exposure to China such that it accounts for 15% of their revenues or that their Renminbi income accounts for 10% or more. That will be about 20% of the market cap. The median 2021 P/E is 27x vs. 20x for the whole coverage universe …”.

What goes up quickly is fragile. European luxury surfed in China on a combination of a benevolent PCC, the push of e-retail and the support of social platforms. All three catalysts disappeared overnight. 35x PE may no longer be warranted. Jie Zhang, AlphaValue analyst on luxury and non-food retail, will comment on her readings of Chinese social networks ire in relation to the Uighur equation, on 26-03 at 3pm CET.

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