Tensions between the United States and North Korea have flared in recent weeks after Pyongyang conducted missile tests. President Trump, meanwhile, recently ordered strikes in Syria and Afghanistan and has stated that the United States will not tolerate much more belligerence from North Korea.
Neither side looks likely to back down. North Korea put its army on ‘maximum alert’ and the United States is moving warships within striking distance.
Even a brief conflict is sure to scare the markets into a correction, but one group of companies could see an even bigger risk from geo-political instability.
Is The World Marching To War?
A day before President Trump met with China’s President Xi Jinping, North Korea tested an intermediate-range ballistic missile capable of reaching the U.S. territory of Guam. These missile tests are nothing new for the belligerent Asian nation but recent tests have raised the stakes in its game of nuclear cat-and-mouse with the West.
Satellite images show what could be preparations for a sixth nuclear test at Mount Mantap, the mile-high peak where North Korea conducts its nuclear tests. While a nuclear test has yet to be conducted, the country showcased its new submarine-launched ballistic missiles at the recent Day of the Sun celebrations.
The United States has responded by rerouting the aircraft carrier Carl Vinson and several warships from exercises in Australia to the Western Pacific around North Korea as a show of force.
President Trump tweeted recently that North Korea “is looking for trouble” and that if China cannot make its communist neighbor back down, “We will solve the problem without them!” North Korea responded that if the United States attacked, it would respond against American military bases in the region “within minutes,” hinting at preparations for a confrontation.
While China has recently softened its support of North Korea, it has always backed its neighbor in the past. Chinese trade with North Korea increased 37% in the first quarter of the year versus the same period last year and Beijing considers Pyongyang an ideological partner in the region.
China’s state news agency, Xinhua, quoted the country’s foreign minister last Friday warning of “storm clouds gathering” and that the United States, South Korea, and North Korea “must shoulder that historical culpability and pay the corresponding price” if war were to break out. This was taken by many analysts to signal that China might not be willing to play arbiter to the extent President Trump would like.
Who Has Most To Lose In A War With North Korea?
Any conflict in the region would surely heighten tensions between Washington and Beijing, putting Chinese companies in the United States at risk. Even if the current tension is resolved, the potential for further Sino-American conflict over the next few years is high and could curb investor sentiment in Chinese-owned firms.
AMC Entertainment Holdings (NYSE: AMC) is the largest cinema operator in the United States and majority owned by China’s Dalian Wanda Group. The acquisition of Carmike Cinemas last year makes the cinema operator by far the largest in the United States by number of screens. AMC has expanded control through purchases in other industries within entertainment.
Cinema operators have struggled against the trend to digital streaming. This trend contributed to a fall in operational cash flow at AMC of nearly 8% last year. Balance sheet debt doubled to $3.75 billion on the Carmike acquisition and the company will need to prove synergies from the deal if it is going to satisfy investors. Shares already trade for 26.7 times trailing earnings, a premium of 20% to industry peers.
Construction and heavy-machinery manufacturer Terex Corporation (NYSE: TEX) was bought by China’s Zoomlion last year but could find itself missing out on a Washington-fueled infrastructure boom if relations with China deteriorate.
The company has a $386 million pension deficit that is weighing on cash flow and struggles against best-of-breed heavyweights like Caterpillar. The company’s service network is weaker than its peers and very limited capital spending may mean an even bleaker future. Revenue plunged 32% last year to $4.4 billion for its second consecutive year of falling sales and earnings turned negative for the first time since 2009.
Syngenta AG (NYSE: SYT) has been approved by the U.S. Federal Trade Commission and the EU for its acquisition by ChemChina, giving it massive reach into the agro-chemical industry. While consolidation may help support prices and cut costs in the agro-chemical industry, the group continues to face a challenging market. Record crop production over several years has weighed on grain prices and translated into declining demand for chemicals.
As a pesticide producer, the company is exposed to a litany of environmental and health scrutiny that could be used as a political tool in a Sino-American crisis. Sales fell for the second consecutive year last year, dropping 4.6% to $12.8 billion. Shares trade for 36 times trailing earnings, a premium of 16.5% to the industry average and 62% higher than the company’s five-year average price multiple.
Risks To Consider: Even a direct conflict with China around North Korea does not guarantee that Chinese companies in the United States will be targets, so look for shares that are already richly valued with limited upside.
Action To Take: Consider hedging your risk in Chinese-owned companies operating in the United States by avoiding specific names or selling protection with options.
– Joseph Hogue
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Source: Street Authority