Smart Investing


March 9, 2012


Uncovering the facts about China and the US trade deficit

Last week I was watching "Out Front" on CNN with Erin Burnett, which featured an interview on a book called “Becoming China's Bitch.”

The book is about the United States' large trade deficit, and how, with China as the largest foreign holder of U.S. debt, things can only get worse going forward if nothing changes.

These were the words of author Peter Kiernan, not Burnett, by the way. This got me to thinking: What about all the U.S. companies that have opened businesses in China? More than 250 American businesses now have operations of some sort in China, and are benefiting from the Chinese consumer. This is not taken into consideration on the trade deficit.

I had also considered writing about one public company that does business in China, but the list was so long and so extensive that it goes from AT&T (NYSE: T), which has been in China for more than 20 years, to Zale Corp. (NYSE: ZLC).

I choose McDonald's (NYSE: MCD), which was just recently downgraded as you will see at the end of this column.

Think of all the dividends that American companies have been able to pay out, thanks in part to earnings they earned in China. Some of the products exported from China to the United States could be products made by American companies, which used American imports to make the product in China.

A study from the Federal Reserve Bank of San Francisco estimated that out of every dollar from a “Made in China” label, only about 45 cents goes to China for the cost of the original import.

Where do the other 55 cents go? This pays for services produced in the United States for things like transportation of the product. The product must get from China to the United States by boat or plane, and most of this is done by American companies. Once the products arrive here in the United States, they must be sold, and for that there would be marketing costs, such as advertising on TV, print or the Internet.

Someone got paid for that service, along with some salesperson who made a commission for selling the advertisement. And let us not forget about the cost of rent for the store in which the product is sold, along with the cost of running that store, such as utilities, upkeep and maintenance. Warehouses and distribution centers must also be paid for and maintained.

You may also wonder, or at least I did, how much of consumer spending goes to imports. The San Francisco Federal Reserve Bank looked into what share of total personal consumption expenditures in the United States goes toward imported finished goods, which include consumer products and also intermediate goods, such as parts for cars, machinery and the like. I was surprised to learn that only 13.9 percent of all consumer spending in the United States goes to imports, and that is both finished goods and intermediate goods.

I would have guessed that it would have been at least a third; this is why it is best not to guess, but to do the research and get the facts. With all the negative talk about China’s trade imbalance, you may be surprised to learn that for both final goods and intermediate goods, China only accounts for 1.9 percent of total consumer spending.

This brings me to the realization that, once again, the media and the average person reading what the media is spitting out are getting the hype, not the entire story. I remember back in the 1990s when the big fear was that Japan was buying all our real estate. I also remember that no one was looking at the fact that the Netherlands held far greater assets in real estate here then Japan did, but that didn’t make the news.

McDonald's last week had a pullback on some downgrades, but it had a nice run from August 2009 of $56 per share to a 52-week high last week of just more than $102 per share. The company has approximately 1,000 restaurants in China and said it expects to double that amount by 2013, an aggressive plan, considering it took the company 19 years to get to 1,000 restaurants. The company has a current PE of 19 and a forward PE of 15.3, based on the December 2013 EPS mean estimate of $6.33. McDonald’s grew its sales by 12.2 percent year over year, and its earnings per share by 15 percent, both above the industry average.

The restaurant industry is a high-debt industry, and McDonald's is no exception, with a total debt to equity of 87 percent versus the industry at 84 percent. The company had a nice ROE of 37.9 percent over the last 12 months, well above the industry average of 31.1 percent.

Investors will enjoy a current dividend yield of around 2.8 percent, and based on the numbers I would not expect to see a repeat performance of last three years going forward. Not to say it won’t go up, but the valuations are getting on the pricey side and expenses may be rising with the big expansion in China.

Wilsey is president of Wilsey Asset Management and can be heard every Saturday at 8 a.m. on KFMB AM760. Information is provided by Reuters.


March 9, 2012