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How the China Trade Tirade Delivers Dividend Deals

November 07, 2018

One of the bigger threats to the success of the US economy and stock market of late has been the developing trade tirade between the US and China. The US has imposed tariffs on a growing list of Chinese finished and input goods, which is impacting a host of US companies that have relied on these. And with China’s tariffs on goods from the US, many companies have seen a pinch on their sales, as well—and it could get worse.

According to Bloomberg Analytics, when you look at the companies in the S&P 500 Index that draw more than 25% of their revenue from China, you see an average share price drop of 14% over the past three months. And yet, when compiling the forward earnings estimates for those same companies, only a fraction of those same companies had negative changes to their earnings forecasts into 2019.

For companies sourcing goods in China, the news is a bit better. For companies that source goods in China in the S&P 500, they have been found to have only fallen by 5.7% over the trailing three months, and their forward earnings estimates as compiled by Bloomberg have largely remained unchanged. Yes, this comes as operating margins are projected to fall by less than 10%. However, that compression in operating margins is actually a little less than for the overall collection of the 505 stocks in the S&P 500.

So, there’s the news peg of the China trade impacting companies, and then there’s the reality of the actual impact from the trade tirade.

But that doesn’t stop the markets from taking a swipe at companies and their stocks, particularly during the recent jolts in the general stock market. And for companies that aren’t faring as well as they could be, the China trade story makes for a nice cover when rolling out guidance as well as the next round of earnings announcements.

Meanwhile, at the end of this month, the Presidents of China and the US will be having a mini-trade summit while they are both attending the G-20 meeting in Buenos Aires, Argentina. While many pundits are taking the stance that little will come of the meeting, I have a different take. I see that there will be some eased tensions and some announcements that will be beneficial for lowering the impact of the trade news peg on the markets.

First, China’s economy continues to slow in its economic growth. And given that it has been working to move from infrastructure stimulus projects towards increased domestic consumption, the trade threats are weighing on confidence and the government in its efforts to get consumers more engaged in the economic growth of the nation.

Second, the more crucial measurement of China’s overall flow of funds from trade and other financial transactions is rapidly deteriorating, despite soaring sales to the US. The current account balance that tracks net transactions across its borders is moving towards a negative balance as a percentage of its overall gross domestic product (GDP).

 

China’s Current Account Is Getting Unbalanced

Source: Bloomberg

China needs the US over the immediate and the longer-haul time frame as it works to develop its trade and financial flows with other nations.

China is also currying favor with President Trump. It just announced a series of trademarks for Ivanka Trump’s company in China. I know that this is small beer, but it shows that some folks in Beijing are learning from their recent mistakes in trade negotiations with the US. In turn, providing something for President Trump to cite as a victory would go far for improving negotiations.

On the US side, the midterm elections saw losses for the Republican Party in some agricultural producing states that are feeling the crunch from tariffs on soybean and pork exported to China. And the same was seen in some industrial areas that are cited as being harmed by US industrial import tariffs on industrial products from China such as car parts.

This provides some incentives for the US to change course, and could lead to some concessions before the 2020 general election.

In the meantime, as noted above, there’s the rhetoric, and then there’s the reality when it comes to the trade tirade. So, with the negative talk in the markets and the general jolt of last month, here are some good companies paying nice dividends that are largely outside of the China story—or are actually setting themselves up to deal well with China despite the trade tirade.

I’ll start with a company that’s really not onshore in the US or China. Carnival Corporation (CCL) is one of the largest cruise ship companies in the world. With ten lines and 100 ships, it has a capacity of 215,000. It operates around the world, with half of its revenues in North America and the rest concentrated in in Europe and Asia.

Carnival plays well with China, as it just announced a co-op with China State Shipbuilding Corporation (CSSC). The co-op will build two new ships as well as acquire two existing ships from Carnival’s Costa line. The co-op will focus on ports in China, with a focus on local market tastes.

This is a big deal, as it shows that Carnival not only gets a further toehold on the shores and the pocketbooks of China, but that it knows how to deal with Beijing (which I know from my past banking and fund management careers is a big deal).

The company continues to see revenues rising at a trailing-year rate of 6.80%. And with fat operating margins running at 16.00%, the company delivers a good return on its capital of 10.00% and an even better return on its shareholders’ equity at 13.10%.

It has little debt, as it is only running at 22.50% of assets. And it pays a nice dividend of 3.40%, after the payout increased 26.67% over the past year.

The shares were down in October, but are beginning to rally back. They are also a relative bargain, with the recent discounting by the market bringing them down to only 1.66 times the book value.

Next is Waste Management (WM). The company is a trash hauler and treatment company with operations in North America. Waste isn’t going away, and if anything is getting more pervasive in the market.

Recycling is really being challenged, largely driven by China’s curtailing of imported waste for recycling. The result is that communities around the US are having to reduce what they accept for recycling, forcing more trash into the bins that Waste Management is paid to collect.

Revenues are climbing, following a rapid reversal of the declines seen in 2015—the trailing 12 months have seen gains of 6.40%. Margins in the trash business are good with the company operating at 18.20%. This is driving a return on shareholder’s equity to a whopping 39.90%.

Debt is a bit higher than I’d like, at 43.50% and the current ratio is at a bit of a deficit. But given the rising revenues, it is well serviced.

The dividend is okay at a yield of 2.10%, after having been raised by 8.01% over the past 12 months. It is a bit pricey on a price-to-book basis, at 6.11 times, but the price-to-sales ratio shows it as a better value at 2.60 times. And showing how defensive it is as a stock, it bucked some of the broader market selling in October and for the past 12 months is outperforming the S&P 500 Index.