Slowdown breeds caution in China



QILAI SHEN/BLOOMBERG A woman sits in front of electronic boards displaying stock information at a securities brokerage in Beijing, China, on Monday, Jan. 18, 20016. China’s economy slowed in December, capping the weakest quarter of growth since the 2009 global recession, as the Communist leadership struggles to manage a transition to consumer-led expansion. Photographer: Qilai Shen/Bloomberg


On a flight to Beijing earlier this month, Pittsburgh lawyer Dennis Unkovic was seated next to an international banker” – not an American,” he said, The banker was on an assignment that dovetailed with Unkovic’s own reason for making the long trip to China.

“His bank was giving a special seminar to the Chinese on outbound investment and what they need to do, ” Unkovic said.

A partner in the downtown law firm Meyer Unkovic & Scott, Unkovic has long specialized on international corporate work. During his four days in China, he met with five firms that are members of Meritas, a professional services network of 7,000 lawyers in 76 countries that Unkovic chairs.

“Across the board, everyone of those firms is looking for opportunities to invest clients’ money,” Unkovic said. “If they have extra money, they’re going to want to get it out because of the Chinese economy, and they’re looking to buy manufacturing and distribution facilities.  Thank God, Pittsburgh’s still a premier manufacturing center. This will be an important place for them to look.”

A continued slowdown in the Chinese economy may indeed offer new avenues for investment in U.S. cities such as Pittsburgh. And for the growing number of local companies already with a presence in China or those looking to sell into the country, there remains optimism over the opportunities the market presents, though with far more caution than before.

The bubble bursts

The world’s second-biggest economy is recoiling. Officially, China’s economy grew by 6.9 percent in 2015, according to the Chinese government, the slowest growth in a quarter of a century. Economists are dubious; many believe the number to be inflated. And, on Jan. 19, the International Monetary Fund cut its global growth forecast for China for the third time in a year, predicting 6.3 percent growth in 2016 and 6.0 percent next year, a far cry from the 7.3 percent in 2014.

A driver of the world economy in the aftermath of the Great Recession, the Chinese economy today is awash in crises.

After watching shares in the Shanghai composite index grow by 150 percent from mid-2014 to mid-2015, the bubble burst last summer. The index lost about a third of its value in a matter of days, forcing a chain reaction in world stock markets. The crash and devaluation of the Chinese currency helped trigger a massive outflow of capital, which Unkovic sees as analogous to the M&A boom of the late 1980s, when wealthy individuals and companies from Japan invested about $1 trillion in the U.S.

“The Chinese today are sitting on over $3 trillion in foreign currency reserves, and a lot of that is destined to go outside China in the next five years,” he said. “This will be much bigger than the Japanese bubble period, simply because the Chinese have more money.”

Since China devalued its currency late last summer, there’s been more “hand-holding” with clients doing business there, said George Hoffman, senior vice president for PNC Financial Services Group Inc.’s Global Treasury Management Group, who oversees a team of three advisers in Shanghai to assist business customers in China. PNC opened the office seven years ago, initially to help customers facilitate payments.

“There’s a lot of caution,” he said. “In light of what’s going on in China, they may need to take a closer look at who they’re doing business with.

There are tools that can help when things get choppier. Instead of getting paid in the traditional way through funds transferred, maybe . they want to look at a letter of credit to insure they get paid.”

The bulk of PNC’s clients conduct business in U.S. dollars, Hoffman said.

“They feel they’re minimizing risk and exposure,” he said. “We haven’t seen this (yet) in China, but with the dollar coming up and the renminbi going down, importing could become more attractive to the U.S. China doesn’t want to be an export economy, but when push comes to shove, they’ll look to boost it. Even if China slows down by 6 percent to 7 percent, half of that would equal the (gross domestic product) of the U.S., so there’s a lot of activity going on, and the type of client base we serve is one that will continue to benefit from that slower growth.”

Selling products into China is one area Hoffman said could become stressed.

“A lot of clients have opened up shop directly in China and have exposure to the Chinese currency,” he said. “We suspect that if that declines, we’ll see some issues.”

No turning back

When China began its shift to an industrialized economy in the late 1970s, two Pittsburgh companies – PPG Industries Inc. and Westinghouse Electric Corp. – were among the first to seize the opportunity to do business there.

Viktoras R. Sekmakas had a front-row seat for the massive growth spurt in the Chinese economy. Now an executive vice resident for PPG in Pittsburgh, he lived in Hong Kong from 2001 to 2011 and helped grow the company’s Asia-Pacific business, especially China. While he was in Hong Kong, PPG’s Chinese operations grew to where they are today 15 plants and about 4,000 employees.

“It’s been an incredible evolution of the country, if you think about how quickly it was able to evolve over this time period to something that we will not see another country do in our lifetimes,” he said.

And even with its signs of weakness and instability, PPG isn’t wavering in its commitment to China. In the same week earlier this month when the Chinese stock market took another nosedive, PPG celebrated the completion of a $20 million, 37,500-square-foot expansion of its Zhangjiagang manufacturing plant, where it makes a high-tech coating used in China’s burgeoning automotive manufacturing industry.

PPG executives said their internal projections showed an expansion of the Zhangjiagang plant, which was already owned by the company, would be a wise move. That was evident in its statement announcing completion of the expansion, in which it expressed confidence in the country’s sustainable growth.

Why is PPG so bullish on the Chinese economy? Because it’s in the driver’s seat, literally. PPG is the No.1 supplier of coatings to Chinese carmakers.

“There will be ups and downs. You will have the volatility in China, but the Chinese love their cars,” Sekmakas said. “It’s a big country, and a car is a status symbol.”

PPG also thinks it has a leg up on other manufacturers in the coatings business. As China deals with severe pollution issues, it’s asking for a transition to water-based coatings instead of the solvent-based ones of previous years. That’s what its new electrocoating facility in Zhangjiagang is all about.

“With China really starting now to push for a better environment as they evolve over the next 10 years – and this has been going on for a couple of years – they’re really pushing hard on technology,” Sekmakas said.

Having that technology – and having pioneered the technique decades ago – is a big advantage for PPG.

“If you have anything related to the environment, environmentally friendly products, you’re doing very well [in China],” Sekmakas said. “If you’re a consumer-related service, that’s doing well.”

And PPG is confident about its plans for continued growth in China. “We’re always looking at our plans…. It’s an $11 trillion economy. You have to be there. A company like ourselves, you’re going to have your ups and downs, but again, control what you can control and we’ll work through it. If there’s a downturn, we’ll have to adjust accordingly,” Sekmakas said. “From our perspectives, we’re not seeing that. We continue to be optimistic on China.”

Meanwhile, Westinghouse is in competition with GE, the French company Areva and others to build nuclear reactors in China, but its biggest competition might come from China itself.

Before its stock market crashed, China announced it would nearly triple its atomic power generation by 2020 and spend as much as $1 trillion on nuclear power generation by 2050. Westinghouse is expected to complete its first Chinese reactor by the end of the year; however, China is working on its own reactor: the Hualong One, which is being developed by the state-owned China General Nuclear Power Group.

“We believe the AP1000 has a very unique value proposition,” said Jeff Benjamin, Westinghouse’s senior vice president of major plants and products. “It starts with the design of the plant. We use passive safety features. And what that means is we use the laws of nature to help ensure that, in the event of unforeseen circumstances, we protect the health and safety of the public.”

In this seemingly benign statement, Benjamin is referring to one of Westinghouse’s competitors, GE, whose boiling water reactors were used in the Fukushima Daiichi nuclear plant in Japan, and which failed in 2011 after a tsunami hit the plant and sent it into a meltdown state. He’s also referencing the fact that Westinghouse’s signature reactor has been rigorously tested.

“We have about 7,000 person years of development and regulatory reviews into [the AP1000] design,” he said. “The second part of our value proposition is the unparalleled regulatory pedigree of our product.”

“There’s a tremendous amount known about the AP1000,” he continued. “It’s been extensively reviewed by multiple regulators [who are] very capable technically. They operate in a very transparent manner and, simply stated, we don’t know a lot about the Hualong One.”

Westinghouse currently is working on reactor projects in Sanmen County in southeast China, and Haiyang in Shandong province. Benjamin wouldn’t say how many additional units are under discussion with the Chinese government, but confirmed it’s more than one.

“We also continue to see good progress on follow-on units as wei!,” he said. “It really appears to us that China is continuing forward with continuing to deliver major infrastructure projects. To date, we haven’t had any impacts related to the recent downturn.”

‘It’s precarious’

Smaller area companies doing business in China aren’t as sanguine. Justin McElhattan, president and CEO at Industrial Scientific Corp., which sells portable gas detectors and offers gas detection services, said the Robinson Township-based company has seen its business slow.

“Our business has been soft in China this past year,” McElhattan said. “A portion of it is infrastructure spending, and mining is the other area where we are seeing lower output.”

The company has sales offices throughout China and plans to continue selling its instruments and equipment in the region despite the slowdown, although McElhattan declined to elaborate on the firm’s strategy.

“It’s a tough time right now in China,” he said. “You just want to be flexible.”

Brian Stein, president of Mars-based S&S Intersource LLC, described the Chinese stock market’s recent convulsions as the latest source of volatility for his company’s global business, which typically sources materials from China that are used in the steel-making process by clients in the U.S.

He finds his company riding a double-edged sword in which domestic customers are cutting consumption at the same time product costs from China are declining.

After dealing with currency volatility for years and a softening market more recently, Stein knew how his customers were likely to respond.

“I’ve got higher price inventory I’m sitting on, and they want to pay less for it,” he said. “They’re reacting swiftly to sudden changes. It’s precarious.”

PBT article (January 2016) (002)

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