China's Competitive Threat
The decision to allow the RMB to float has brought a host of macro sensitivities and interpretations as to its significance. If one of these considerations is restoring China’s competitiveness cyclically, there is also a key structural threat to understand which we revisit here. A weak RMB only underlines its relevance.
* Three key existing drivers of competitive risk: First, the risk of China exporting its excess capacity and further disrupting pricing – only heightened by poor export data. Second, China’s dramatic ascent of the value add curve (it has more than doubled its share of the domestic robotics market). Third, Chinese companies are seemingly comfortable to operate at consistently lower industrial returns and margins (e.g. 8% vs 16% HOLT EBITDA
margins for European autos). As we see increasing value add from China, it becomes more difficult for Western companies to play the “quality” card.
* China’s Industrie 4.0: Low margins/pricing have been doubtless part of China’s strategy to establish footprint/national champions in key segments. Should there be doubt as to its commitment to this approach, the recent “Made in China 2025” plan underlined 10 key industries of strategic focus (detailed inside), and implicit fiscal support confounds it. China intends to source 40% of key components domestically by 2020 and 70% by 2025.
* We detail the key end markets for global companies where Chinese companies reside and our judgement as to the strategic competitive risk (pages 9-10). We also examine stocks where their CFROI® track record has already been pressured and where revisions are weak. A poor returns profile now with structural risk in the future is not an appealing mix (page 8). If one industry ticks all of the above boxes, it is autos. We highlight our PEERs supply chain tool that allows investors to track the competitor dynamic of companies and also where JV and equity investments exist.