May 10, 2019 05:54 PM / Fitch Ratings / Header Image Credit: scmp.com
US-China trade tension may become a longer than expected headwind for US corporations as the prospect of additional US tariffs, retaliation from China, and prolonged negotiations rise, says Fitch Ratings. Although credit implications are limited, risk mitigation via pricing actions, supply chain adjustments, localized production, and end-market diversification could increase in importance due to the need to manage ongoing trade uncertainty.
Earlier this week, the US accused China of reneging on prior concessions and confirmed tariffs on $200 billion of Chinese imports could increase to 25% from 10% on Friday. The possibility the tariff could be extended to another $325 billion of imports not already taxed was also raised. Tit for tat tariffs began in early 2018. Major sticking points in trade negotiations include technology transfer and intellectual property.
The state of the US-China trading relationship is an important issue for US corporations, due to the size of the Chinese market, intricate global supply chains and the potential knock-on effects on the global economy. The recent turn of events should not translate into broad-based near-term credit risk but shocks linked to widening protectionism could have negative credit implications for individual corporates across multiple sectors.
We view the industrials and technology sectors as most vulnerable to retaliatory actions due to a higher relative dependence on China for revenue. Aircraft, engines, equipment, parts and soybeans top the list of US products exported to China, according to the US Census Bureau. Boeing (A/Stable), Intel (A+/Stable) and Texas Instruments (A+/Stable) receive more than 20% of revenue from China.
However, a potential increase in the existing 10% tariff and an expanded list of goods subject to US tariffs could raise risk for other sectors, such as retail, which relies heavily on imported merchandise. The National Retail Federation stated a sudden tariff increase would severely disrupt US business, especially small companies with limited resources to mitigate the effects, and American consumers will face higher prices and US jobs will be lost if the government's threat becomes a reality.
Some US corporations have tariff mitigating strategies, such as long-term contracts, diversified end-markets and localized production, already in place. China-based and other non-US production facilities allow US companies to sell into China tariff free, helping to circumvent retaliatory actions. Most vehicles sold in China by Ford (BBB/Stable) and General Motors (BBB/Stable) are produced locally by their China joint ventures, which improves their ability to navigate trade issues with China. China is a key market for US auto manufacturers because new vehicle sales in China represent about 30% of global auto sales.
Honeywell (A/Stable) indicated on its last earnings call that mitigation actions are in place to address the effects of potential tariffs on remaining items imported from China. Caterpillar's (A/Stable) material costs are affected by tariffs. However, significant geographic and product diversification of equipment manufacturers, such as Caterpillar and Deere (A/Stable), partly insulates them from the effect of retaliatory actions.
Other companies are adjusting supply chains and raising prices to neutralize the margin effect of tariffs already in place in addition to higher material, freight and labor costs but could choose to absorb higher tariffs. We believe pricing flexibility will be preserved to some extent by low inflation and a strong job market, providing at least a partial offset to higher tariffs. However, additional tariffs could negatively affect margins of some US corporations, at least initially, even if the incremental cost is passed on to customers, due to the lagged benefit of price increases.