Preparing Chinese Holdings For Potential U.S. Action

By John Lin and Stuart Rae

Tensions between the US and China are flaring up again, but tariffs probably aren’t on the table this time. With pressure mounting on Chinese stocks listed in the US, including those widely held in emerging-market portfolios, investors need to consider how to prepare for the mounting risks.

Four months after the phase-one trade deal raised hopes of a US-China de-escalation, the pandemic has fueled fresh sparring between the superpowers. The US is pressing the World Health Organization to investigate China’s handling of the global outbreak. More measures are preventing US technological exports to China. Supply chains through China are being shaken up by unresolved political issues and corporate reconfigurations amid the global shutdowns.

These developments aren’t surprising. While both sides took a step back from the trade war, the US-China relationship may well be thorny for years to come. Investors should focus on the potential implications for their investment portfolios.

US Targets Chinese Companies

In late April, Chinese stocks began to make headlines in the US. The US Securities and Exchange Commission published a statement warning that Chinese companies could not be relied upon to provide transparent reports. Investors who are harmed by disclosure failures would have “substantially less access to recourse, in comparison to US domestic companies,” the SEC said.

Less than a month later, the US federal government retirement fund stopped plans to invest in Chinese companies. And on May 20, the Senate passed a bill that would bar foreign companies from US exchanges if they cannot prove that they aren’t controlled by a foreign government and if they do not allow greater US oversight of company financials. While this would only apply if the company isn’t compliant for three years, it could clearly lead to large Chinese companies being delisted from American exchanges. The China Securities Regulatory Commission said on May 24 that Chinese and US regulators have made “continuous efforts” to “enhance audit oversight cooperation” and that the Senate act would hurt both US and Chinese interests if enacted.

Some equity investors with Chinese holdings are concerned. Chinese stocks have become a growing component of international investment portfolios in recent years. MSCI has increased the weights of Chinese onshore stocks in its global and emerging-market indices. MSCI indices have 226 Chinese American depositary receipt (ADR) companies listed with a combined market cap of $966 billion. Shares of major companies that have become global household names, including Alibaba Group and NetEase, suddenly looked vulnerable to forces beyond their control.

Are Chinese Companies Less Transparent?

So are Chinese stocks really less transparent? The recent accounting scandal at Luckin Coffee (NASDAQ:LK), China’s largest coffee shop chain, has certainly put the spotlight on corporate China’s financial transparency. That’s why active investors must always properly research Chinese candidates to make sure that the most attractive businesses comply with rigorous accounting practices. In fact, we believe that China’s listing requirements are more stringent than widely perceived and some companies seek US listings to avoid tighter scrutiny at home.

Conflicting regulatory frameworks are also a source of discord. For example, three Chinese banks were held in contempt by a US court for failing to disclose information and violating North Korean sanctions in June 2019. Under US anti-terror law, these companies were obliged to disclose client information related to suspicious accounts. However, doing so would breach Chinese rules. Although there is currently no mechanism for resolving this type of technical regulatory conflict, recent reports suggest that US and Chinese officials are discussing potential solutions.

What about the withdrawal of federal pension investments from Chinese equities? We don’t think this is a material issue for Chinese stocks or investors because there is no significant investment in these stocks from federal pension investments. That said, the message aims to deter US investors from putting money in Chinese stocks.

How to Prepare for Potential Delisting

Delisting Chinese ADRs from US exchanges is a possibility. Even though it could dissuade companies in other countries from issuing shares in the US, the US political momentum to take action against Chinese companies is growing. So investors shouldn’t rule out the possibility of measures that could disrupt the normal trading of Chinese ADRs.

Investors can prepare for such a scenario without forfeiting exposure to Chinese shares. Today, more Chinese companies with ADRs are seeking dual listings in Hong Kong, and the Hang Seng Index is taking steps to make it easier for them to do so. The Chinese government is also encouraging companies to consider dual listings.

As Chinese ADRs establish their secondary listings in Hong Kong, one way investors can prepare is to swap US-listed Chinese holdings to Hong Kong shares. While this does incur switching costs, we think it can help avoid disruptions in Chinese equity exposure if Chinese shares in the US become illiquid.

Looking Beyond Political Tension

While the coronavirus crisis will likely fuel US-China friction in the months to come, we think equity investors shouldn’t let these tensions overshadow investment opportunities in China, where the economy is recovering and earnings have remained relatively resilient.

Of course, any company-in China and elsewhere-should be scrutinized for financial transparency. And investors cannot let their guard down about the potential political risks. For investors who want to capture the potential of China’s economic recovery and vibrant corporate sector, holdings of domestic Chinese A-shares can provide access to attractively valued stocks that are less exposed to unpredictable regulatory risk and international tensions.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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A Potential Game-Changer? The Details Behind The EU’s Proposed Recovery Plan

On the latest edition of Market Week in Review, Quantitative Investment Strategist Dr. Kara Ng and Julie Zhang, director, North America sales enablement, provided an update on the latest policy responses to the coronavirus pandemic. They also discussed the outlook for the U.S. labor market as well as renewed tensions between China and the U.S.

European Union unveils plans for massive recovery package

Reiterating that the road to a global economic recovery depends on three factors – the spread of the coronavirus, the amount of economic damage caused by government containment measures and the effectiveness of the global policy response – Ng noted that the economic devastation inflicted by measures to slow the spread of the virus has been unprecedented. Importantly, though, the magnitude of the worldwide policy response has also been unprecedented in scope, she said. The latest example of this occurred May 27, when Japan announced an additional $1.1 trillion stimulus package, Ng noted. “When added on to the country’s relief measures from March, Japan’s total stimulus package now amounts to roughly 40% of its annual GDP (gross domestic product),” she stated.

The European Union also made headlines the same day, Ng said, with its proposal of a €750 billion recovery plan. “Two-thirds of this package would consist of grants, and one-third would consist of loans,” she stated, adding that the size of the package amounts to 6% of eurozone annual GDP. Ng characterized the package as a potential game-changer, if approved, noting that it would represent risk-sharing across the eurozone via the issuance of what would be known as Eurobonds.

Eurobonds, she explained, would be government bonds issued by the European Union, rather than by individual eurozone countries. Eurobonds were first proposed in 2011, amid the European debt crisis, but never came to fruition, Ng said.

“There is some opposition to this recovery plan, especially from some of the more frugal member-states of the EU, so discussions around the plan will be an important watchpoint moving forward as Europe attempts to stabilize its economy,” she stated.

Pace of U.S. unemployment claims slows

Turning to the U.S., Ng said there is tentative evidence that the U.S. labor market has bottomed out. New jobless claims, while still at extraordinarily high levels, have been falling for the past eight weeks, she noted. In addition, the number of continuing jobless claims -representative of individuals who are already receiving unemployment benefits – dropped for the first time since widespread containment measures were imposed in mid-March. “This is a sign that some workers are returning to their jobs as lockdown restrictions ease,” Ng stated.

The May jobs report, which will be released June 5, will provide further clarity on the state of the U.S. jobs market, she said. “April’s report showed that only 10% of laid-off workers expected their job loss to be permanent. Keeping an eye on whether this number changes in the May report will be important,” Ng remarked.

She explained that in a frictionless world, a pause in economic activity due to containment measures would result in only temporary, rather than permanent, job losses. Unfortunately, the real world doesn’t work that way, Ng said, due to the secondary effects of these measures. “For instance, consumer confidence may fall, which could result in less demand for goods and services. This, in turn, could cause businesses to make permanent reductions to their labor force-and a souring job market could then further derail consumer confidence and spending,” she explained.

In other words, Ng said, the negative confidence spiral brought on by economic disruption could turn a temporary shock into a sustained one – with major implications for the economy, corporate profits, markets and investor portfolios.

Hong Kong national security law sparks renewed tensions between China, U.S.

Shifting to China, Ng noted that after the successful signing of a Phase 1 trade deal between the U.S. and China in January, tensions between the world’s two largest economies are on the rise again. This time, one of the key issues centers around China’s plan to impose a national security law on Hong Kong. The proposal, recently approved by the Chinese government, served as a trigger for the U.S. government’s May 27 declaration that it no longer considers Hong Kong autonomous from China.

“This declaration means that the special trade exemptions the U.S. has carved out for the city of Hong Kong may go away. In addition, the U.S. could also introduce punitive measures against China,” Ng explained. The renewed tensions between China and the U.S. could potentially escalate into another trade war, she said, which would be disruptive for global supply chains, investment spending and business confidence.

“With things already on shaky ground due to the coronavirus pandemic, a re-escalation in trade tensions could be a fatal blow to the global economy,” she concluded.


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Renault chairman dismisses fears over potential Maubeuge closure By Reuters

© Reuters. Chairman of Renault SA Jean-Dominique Senard attends a news conference at French carmaker Renault headquarters in Boulogne-Billancourt

PARIS (Reuters) – Renault (PA:) has no plans to close its Maubeuge plant in northern France, Chairman Jean-Dominique Senard said on Sunday, two days after the carmaker announced 15,000 job cuts globally as part of a major restructuring.

The recovery plan, which would eliminate 4,600 jobs in France, aims to consolidate the Maubeuge site’s vehicle production with that of the nearby Douai plant.

“I have no intention of closing the Maubeuge factory,” Senard said on LCI television on Sunday after thousands of employees and family members demonstrated outside the plant the previous day.

Under the proposals unveiled on Friday, a parts reconditioning center in Choisy-le-Roi, south of Paris, is the only facility earmarked for outright closure.

The carmaker’s Caudan parts foundry in Brittany, western France, could also be sold as part of the restructuring, Senard said on Sunday. The plant is one of six that Renault has placed under strategic review.

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Low Growth Potential Of The Russian Market (BATS:RSX)


The VanEck Vectors Russia ETF (BATS:RSX) is a fund that offers exposure to equities from Russia, which include publicly traded companies that are incorporated in Russia or that are incorporated outside of Russia, but have at least 50% of their revenues/related assets in Russia.

Source: VanEck


The Russian Federal State Statistics Service has published macroeconomic data for April – the first month when the Russian economy experienced the full impact of the COVID-19 epidemic.

In April, the Russian retail turnover fell by 23.4% YoY:

This is of course an unprecedented result. But, firstly, we need to understand that because of quarantine measures, people in many cities simply were physically unable to make purchases. And secondly, a month earlier there was a jump in retail growth. Therefore, in April, we observed a rollback. In a word, nothing unexpected really happened. Now let’s look at the industrial production of the country.

In the last month, the Russian industry declined by 6.6% YoY:

It is worth noting that a decrease of around 20% was expected. Therefore, the actual result can be regarded as positive. But let’s look at the structure of this indicator:

As we can see, the growth rate of the mining industry, the basis of the Russian economy, was again negative. Within the bounds of the renewed agreement with OPEC+, Russia has undertaken to limit oil production from May to 9.5 million barrels. This means that in May the growth rate of the mining industry will be reduced by at least 10% YoY. Thus, despite the end of quarantine, the growth rate of the Russian industry will not recover in the coming months

According to the latest Markit research, the business activity in the Russian manufacturing industry fell to a multi-year low:

… New export orders contracted at a record rate, with a number of firms stating that clients had cancelled or postponed orders since emergency public health measures were put in place …

… Manufacturers registered a decrease in the degree of optimism towards the outlook for output over the coming 12 months …

… The decrease in employment was a stark turnaround from the broadly unchanged levels seen in March …

Bottom line

When it comes to the Russian stock market, you always have to remind yourself that this market is the cheapest in the world judging by the P/E multiple. Agree, it is difficult to expect that what is already the cheapest will become even cheaper.


But let’s look at the situation a little deeper. Russia is one example of an economic phenomenon called the “Dutch disease“. For decades, Russia has focused on the development of the mining industry to the detriment of other sectors. Now, for a variety of reasons, cash flow from oil sales has fallen and the ruble has become significantly cheaper. Of course, this will help other export-oriented companies increase their sales. But their share is relatively small. And therefore, the overall situation will not improve significantly.

I don’t recommend to sell. But at the same time, I do not expect the RSX price to rise significantly in the coming months.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Dana Still Worth A Look On Better Decrementals And Recovery Potential (NYSE:DAN)

Up another 25% from my last write-up on the company, I still believe Dana (DAN) has more upside from here. Not only is Dana leveraged to recoveries in autos, trucks, and other commercial vehicles, but the company’s surprisingly strong decremental margins so far lends a lot of credibility to management’s past comments about the resilience of its margin and cash flow structure. Further down the road, Dana has a portfolio of electrification technologies that should enable it to preserve its business as manufacturers and customers shift to electric powertrains.

Low single-digit revenue growth and low-to-mid single-digit FCF margins can support a fair value in the high teens, though the near-term margin-driven EV/revenue fair value is more in the mid-teens. Either way, I think these shares offer appealing potential here even with the risk of a protracted downturn in the company’s major markets.

Better Decrementals The Main Highlight Of Q1

Looking back at first quarter results, Dana managed to outperform reasonably well on the top line (around 5%), but significantly on the EBITDA line (about 25% better than expected). Of course, this outperformance has to be viewed in the context of lowered expectations going into the quarter, but I believe the margin outperformance is a significant takeaway and one that reduces some of the risks at this still-early point in the downturn.

Revenue declined about 14% in organic terms, with the auto business doing considerably better than the commercial vehicle business. Light vehicle driveline revenue declined about 9%, outperforming underlying production by about 1,400bp, while the Power Technologies business declined 6%, outperforming by about 1,700bp on platform/program launches.

On the commercial side, Off-Highway declined about 22%, while Commercial Vehicle declined about 20%. Good data on underlying production volumes are hard to find, but looking at the results from companies like Commercial Vehicle (CVGI), Cummins (CMI), and Tenneco (TEN) suggest to me that Dana’s results were basically in line.

Gross margin declined about three points, and EBITDA declined 20%, with margin down about 130bp, but the decremental margins in the low 20%s were meaningfully better than expected. Margins declined in all segments, but three of the four units maintained double-digit margins (Commercial being the exception). This quarter’s results underling a lot of what management has been saying about its flexible cost structure, and management sounds as though they will be prudent about what costs they add back as the end-markets recover.

Time Will Tell How The Recovery Shapes Up

I’m still expecting a pretty healthy recovery in passenger volumes in 2021, helped by what I expect will be government-led stimulus programs in multiple markets. On top of that, Dana stands to benefit from ongoing outperformance of trucks relative to cars and additional upcoming platform launches. Backlog conversion was a positive driver in the first quarter, and I don’t think that is completely tapped out yet.

I’d also note that Dana’s commercial markets (particularly heavy and medium-duty trucks) were already going into cyclical decline before COVID-19. Clearly, this cycle has already been different, with factories forced to close and many customers slashing capex to bare minimums, but I don’t yet see any reason to believe that the total “area under the curve” will be substantially different in this downturn versus past truck downturns.

The rest of the commercial business is a tougher call; I think construction equipment demand could be pressured for a few years without an infrastructure stimulus bill, and I’m likewise not as bullish on agriculture or mining equipment.

The biggest risk I see to Dana, and parts supplier valuations, is an extended or double-dip decline. If there were another wave of COVID-19 infections sufficient to lead to another round of shutdowns, whether later in 2020 or in 2021, the recoveries across Dana’s markets would definitely be delayed, and the company would be looking at another year of weak margin leverage. On the other hand, I don’t see that changing the overall magnitude of the eventual recovery; the relationships between vehicle/fleet ages and volumes tend to be pretty consistent, and older vehicles would still need to be replaced.

The Outlook

Dana management believes that the company is FCF breakeven at around $6B billion in revenue or a 30% decline from the prior year. Based on past results and the margin/cash flow resilience seen this quarter, I believe that’s credible guidance, and I don’t see revenue breaking that threshold.

I’m still looking for long-term revenue growth in the low single-digits (or low-to-mid single-digits on an adjusted basis). Although Dana doesn’t have the same leverage to electrification as BorgWarner (BWA) or Valeo (OTCPK:VLEEY), it’s better-positioned than companies like Allison (ALSN) and Cummins, and I believe Dana will be much more of a participant in electrification than a victim. I’m not expecting significant long-term margin leverage versus past cycles, and it remains to be seen whether parts/components companies can attain the same level of margins with electrical components as they have with internal combustion components. In any case, I’m expecting FCFs margins to bounce off a low in 2020 and average out in the low-to-mid single-digits.

The Bottom Line

Between discounted cash flow and margin-driven EV/revenue, I believe the fair value for Dana is in the mid-to-high teens. Dana has more debt than you’d like to see, but I believe Dana will still be FCF positive, and I’m not concerned about the company’s liquidity or solvency situation. While some of the easy money has been made with Dana up significantly off the March panic lows, I still see meaningful upside from here and this remains one of my preferred names in the parts sector.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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