Earnings Growth: The Quest for Overseas Profits
Finding growth by tapping into the wants and wishes of a new generation of Asian consumers has proven profitable for many U.S. companies – but the economic slowdown could eat into future returns.
As earnings growth has slowed within the United States, many companies have begun to look overseas in search of revenue – and profits. Some traditional sources of sales growth are no longer viable, notably in Europe, as the ongoing sovereign debt crisis and austerity budgets across the region limit opportunities. Not surprisingly, therefore, most companies are counting on Asia to deliver what they need, as rising incomes in countries like Asia create a new kind of middle-class consumer. For some companies, marketing efforts aimed at transforming these consumers into fans of a particular product or brand seem to be paying off (although the detailed level of disclosure varies widely from one company to the next, since U.S. companies aren’t required to break out the source of their revenues by geographic location).
We identified 46 companies in the S&P 500 that generate at least 10% of their revenues in the Asia-Pacific region in general, or in China specifically, and that reported that geographic revenue data for the second quarter. (The terms China and Asia Pacific are used interchangeably; when a company specified China as the source of the revenue, we noted it as such.) As is shown in the illustration below, companies in the Information Technology sector dominate this list, with seven of the eight companies that get half or more of their revenues from China falling into this group.
Technology companies have been investing in Asia for years, but this has mainly been in production, with much of the revenue coming from selling to other parts of the value chain. The focus on Asia and China as a region full of potential consumers of their products is a more recent phenomenon.
The chart below shows that the rate of revenue growth for the second quarter of 2012 over the same period in 2011 is significantly higher in China for both technology companies and those in other sectors than it is in other parts of the world. The scale of that difference is striking: Chinese revenue growth for the technology companies studied was higher than that of companies in other sectors. However, the contribution to total growth was greater for companies outside of the Information Technology sector; outside of China, their revenue growth was a modest 1.8%, while within China, they saw an explosive 10.8% increase in revenue.
Diversifying globally and emphasizing the Asian and Chinese markets has obviously proved to be a lucrative strategy for many of the S&P 500 companies. But this growing reliance on the region has a downside, as economists begin warning that what has until recently been a hectic rate of growth is beginning to slow. Already, fears of a slowdown are showing up in guidance issued by many of these companies in recent weeks. Only one of the companies in this analysis, Netapp (NTAP.O), issued positive guidance for the third quarter, while another 18 warned investors that their outlook had turned more negative. That ratio of 18 negative preannouncements to one positive sends a far more worrying picture of what lies ahead than does the 4.4 N/P ratio for the index as a whole.
Molex Incorporated (MOLX.O) experienced a year-over-year decline in revenues from China in the second quarter, even as the company’s total revenues grew. “I think the economic growth rate in China has clearly slowed down,” CEO Martin Slark told investors during the company’s conference call. “I think that’s a function of the fact that some of the incentives that were there a year ago to drive consumer demand are no longer there.”
Among the consumer-focused companies with a presence in China is Fossil, Inc (FOSL.O). The watchmaker now reports that 34% of revenues come from the region, so it clearly has benefitted from the rise of a new Chinese consumer class. “The Swiss watch market has been very, very successful in Asia, especially in China and even China travelers buying Swiss watches around the world,” said Kosta Kartsotis, the company’s CEO. That has sent prices soaring and caused them to be scarce – and thus in greater demand. Estee Lauder Companies, Inc. (EL.N) is similarly popular in China; Dennis McEniry, president of ELC Online, noted that the Internet is driving a growing proportion of its sales in the region. “By 2015 it is expected that China will become the number one e-commerce market in the world, and we are aggressively pursuing that opportunity,” McEniry said. Both Fossil and Estee Lauder were among those companies offering negative third quarter guidance, in spite of their success so far in selling their products to the Chinese market. A slower growth rate in the region will put further downward pressure on earnings expectations.
U.S. companies likely will continue to rely heavily on China and other Asian markets for revenue growth, especially as long as the U.S. economic recovery remains lackluster and sluggish. Still, investors should be both cautious and realistic; growth abroad is likely to slow down as well. It is up to investors to discern whether the stocks in their portfolios belong to those companies with a focus on China that will be able to tap into new markets of consumers eager for certain kinds of American products, or whether they are more vulnerable to slower growth and a more cautious Asian consumer.
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