Chinese firms have been buying up foreign firms at a record rate, spending $68 billion in the first couple weeks of 2016, already half of the 2015 total. On March 1st, Business Insider reported that executives at Goldman Sachs (GS) believed that the recent cross-border buying spree was being done in order to prepare for a renminbi (RMB) devaluation. If the Chinese government is preparing for another round of devaluation, Chinese firms would want to move as much money out of RMB-denominated assets and into assets denominated in foreign currencies.
For American investors, that means stocks like Alibaba (BABA), Baidu (BIDU), and China Eastern Airlines (CEA) should be avoided.
That’s because Goldman’s theory is plausible, and may very well be the case. Exports fell by over 11% in dollar terms year-over-year in January, even though China devalued its currency last year in August. If the Chinese government wants to keep exports from sliding further, more RMB devaluation may be on the table.
Analysts are anticipating another round of RMB devaluation, and not just at Goldman Sachs. Currently, the RMB is trading at around 6.47 to the dollar. Morgan Stanley (MS) expects a dollar to buy 6.98 RMB by the end of 2016, and 7.3 by the end of 2017.
So how will RMB devaluation impact China stocks — and BABA, BIDU, and CEA in particular?
RMB devaluation will make the Chinese currency cheaper relative to the US dollar. A dollar will be able to buy more RMB after the devaluation than it did before. It will become more expensive for Chinese nationals to visit the United States, and cheaper for Americans to visit China. It will make Chinese exports cheaper and increase the cost of importing goods into China. Let’s look at the stocks that will likely be affected.
If the RMB weakens relative to the US dollar, then the revenues and earnings of Chinese firms will decrease when translated into US dollars, along with the value of their American Depository Receipts. Investors should avoid these stocks in the near-term.
China Stock to Sell #1: Alibaba (BABA)
China accounted for 98% of sales for BABA in 2015. The lion’s share of Alibaba’s revenue and earnings is denominated in RMB, so a devaluation will decrease the dollar equivalent of these.
Indeed, Alibaba has noted this in an SEC filing.
In an F-1 form which was filed in March 2014, BABA investors are cautioned about currency risks:
“Conversely, if we decide to convert RMB into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs, servicing our outstanding debts, or for other business purposes, appreciation of the U.S. dollar against the Renminbi would reduce the U.S. dollar amounts available to us. As of March 31, 2015, we had U.S. dollar-denominated unsecured senior notes outstanding of US$8.0 billion. If the U.S. dollar had appreciated/ depreciated by 10% against the Renminbi, our interest payments as to these debt would have increased/decreased by RMB246 million (US$40 million) in fiscal year 2015.”
When the Chinese government devalued the RMB in August last year, BABA stock fell from around $78 a share to as low as $65. More RMB weakness lies ahead, so investors should sell their Alibaba shares now.
China Stock to Sell #2: Baidu (BIDU)
Financial reports for BIDU contain a similar warning:
“Our revenues and costs are mostly denominated in RMB. Any significant revaluation of RMB may materially and adversely affect our cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, our ADSs in U.S. dollars….a significant depreciation of the RMB against the U.S. dollar may significantly reduce the U.S. dollar equivalent of our earnings, which in turn could adversely affect the price of our ADSs.”
An article written in 2014 argued that technology firms in China would outperform exporters since the RMB was appreciating. Now that the RMB set to weaken over the next two years, the reverse may be true. Like Alibaba, BIDU’s sales occur mostly within China. BIDU began trading around $170 a share at the beginning of August 2015, but after China devalued the RMB, they fell below $140. Since then, the stock has recovered, and is now trading at $187 a share, but a weak economy in China may cause Baidu’s rapid growth to slow, and BIDU stock to fall along with it.
China Stock to Sell #3: China Eastern Airlines (CEA)
CEA faces double trouble.
As the US dollar rises relative to the RMB, it will become more difficult to pay back US dollar debt, as it will take more RMB for Chinese borrowers to pay back the loans that they have taken out.
Chinese airlines have a lot of US currency debt. This makes them more vulnerable to an RMB devaluation, since not only will the dollar equivalent of their earnings decrease, but they will also face trouble paying back dollar-denominated debt. US dollar debt accounted for 79.24% of the debt of CEA in January 2016. CEA stock was trading at slightly over $40 a share at the beginning of August, but after the RMB was devalued, the stock fell to $26 a share, and it has stayed in that range since then, closing Friday at $26.28. Should the People’s Bank of China embark on another round of RMB devaluation, CEA stock may sink further.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned stocks.
