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3 shares making money in China – how are Tesla, Burberry and Rio Tinto coping?

Tesla, Burberry and Rio Tinto have made a lot of their money in China, but how are they coping with disruptions and the weaker economic outlook? Here’s a closer look.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

While most of the western world seems to have accepted coronavirus as something we’ll need to learn to live with, other regions haven’t quite taken the same stance.

China’s been implementing a strict zero-tolerance policy, which has had rippling effects across the global economy. Restrictions in key hubs like Shanghai contributed to the Chinese economy shrinking 2.6% in the most recent quarter. That’s put doubt over the country’s ability to hit its 5.5% annual growth target.

Given the sheer size of the world’s second largest economy, slower growth and ongoing restrictions impact businesses far beyond China alone. Here we’ll look at three shares with significant exposure to China and see how they’re coping with disruptions and a weaker economic outlook.

This article isn’t personal advice. If you’re unsure if an investment is right for you, seek advice. All investments can go down as well as up in value, and you could get back less than you invest.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Rio Tinto

Over 60% of Rio Tinto's revenue came from iron ore last year, and China’s the world’s largest consumer. Both factors considered, it’s hardly surprising China makes up for 57% of total revenue.

Source: Rio Tinto Annual Results 2021 , 23/02/22.

That makes Rio especially exposed to the Chinese economy, which hasn’t been the best place to be in recent months. A weakening economic outlook means markets are worried about future demand for iron ore. Given its main use is in making steel, when times get tough, building a new skyscraper’s hardly top of construction spending lists.

Despite the potential for easing demand, one of Rio’s main attractions remains very much intact. Its flagship Pilbara iron ore mine produces at incredibly low costs, expected in the range of $19.5-$21.0 per tonne this year. Compare that to current iron ore prices, at around $101 per tonne, and that leaves room for healthy profits.

Looking further ahead, Rio’s made the strategic choice to push away from iron ore into metals that contribute to global decarbonising efforts.

The group already has exposure to aluminium and copper, both of which are integral to building things like solar panels, electric cars, and renewable power generation.

Making hay while the sun shines, Rio recently announced it was buying the remaining shares in Canadian mining company Turquoise Hill for $2.7bn. The deal will boost Rio’s stake in what's expected to be one of the biggest copper mines in the world.

It’s worth noting though, committing cash to a new project, and achieving success are very different things. We’re seeing that play out in Serbia, where the government has pulled approval for a $2.4bn lithium-borate project.

Nonetheless, bringing the new strategy to life is propped up by a resolute balance sheet. A $0.3bn net cash position frees up cash for acquisitions or shareholder returns.

Rio’s exposure to iron ore demand and China could cause some short-term headwinds. That’s reflected in a valuation that’s come down this year, now below the longer-term average. Coupled with an 11% prospective dividend yield (variable and not guaranteed) and markets aren’t overly confident the good times are here to stay. We’re inclined to agree, but still think Rio has good long-term prospects.

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Burberry

Burberry has all but completed a strategy shift that’s seen it reposition itself right at the top of the luxury ladder. But new CEO, Jonathan Akeroyd, now has the task of injecting a bit more life into overall sales, where growth’s been hard to come by in recent years. Especially when compared to peers in the luxury market.

Year-on-year revenue growth

Source: Refinitiv Eikon DataStream, 22/07/22.

The shift in focus involved cutting ties with non-luxury partners and reducing outlet activity – say goodbye to in-store discounts.

So far, the pivot’s been a blessing to operating margins which have grown almost two percentage points to 18.5%. And analysts forecast further growth over the next couple of years – though that’s still some way below some of its peers.

Alas, plans to grow sales so far this year have been scuppered by a sizeable exposure to China. Lockdowns over the first quarter all but extinguished strong performance across the portfolio with comparable sales growth of 1% for the group. However, strip out China and that number rises to 16%, which suggests strong underlying demand.

China’s impact on performance is twofold. Lockdowns and strict testing regimes not only reduce footfall in Chinese stores, but also from Chinese tourists spending abroad.

Performance from here will probably remain subdued until China can put together a string of restriction-free months. It’s hard to see that happening as we approach winter, so long as the zero-tolerance policy stays.

Looking at things within Burberry’s control, the picture’s looking more promising than it has for some time.

Luxury fashion is all about image. Once you have a strong enough brand to attract customers with deep wallets, margins push higher and buyers come back for more. High-net-worth individuals are also less likely to shift spending patterns when living costs increase, which should be a positive in the current environment.

Using social media and influencers, Burberry’s been able to revitalise the brand right when it needed it the most. That doesn’t come cheap though, and we’d expect increased investment in marketing and revamping retail stores to continue in the coming years as the group tries to cement its position.

A solid balance sheet supports investment in the business and shareholder returns. The reinstated dividend offers a prospective yield of 3.2%. Remember though, dividends aren’t guaranteed.

Progress looks good, aside from the struggles in China. But there’s a long way to go in an environment fraught with challenges. That’s reflected, rightly so in our view, in a valuation well below some of the more established players in luxury fashion.

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Tesla

Ramping up production is no easy feat, even when you have the resources to build high-tech giga-factories like Tesla. As CEO, Elon Musk said recently, the factories are “gigantic money furnaces right now.”

That’s all down to economies of scale. Huge operations like this cost a lot to get up and running, and only start turning a profit once all the fixed costs are covered. From that point on, the real rewards can shine through.

It’s not been the smoothest ride so far though. Lockdowns in China meant the Shanghai giga-factory has been shut down for periods this year. Then there’s the ongoing issue of supply chain bottlenecks and labour shortages meaning output across a range of sites has been tempered.

Further lockdowns in China can’t be ruled out. A slowdown in economic activity could also put pressure on sales in the region, which were 26% of group total last year.

Those challenges fed through to second quarter results, where operating margin fell from 19.2% in the first quarter to 14.6%. Still, $2.5bn in operating income was up 88% on the prior year and monthly car production reached record highs by the quarter’s end.

Most of the current challenges should be short lived. And if demand remains strong, an operating margin in the high-teens or even into the mid-20s should be on the cards. Far exceeding those of traditional car makers.

There’s more to Tesla than simply the cars they make, though. Software is a huge part of the business case, contributing to advances in autopilot and self-driving, all the way to plans for autonomous taxis. These add-ons are already contributing to profit through a subscription model, and there’s scope for more as the technology evolves.

Another key competitive advantage is the treasure trove of driving data Tesla has access to. Each of its vehicles is padded with cameras and sensors all relaying driving data back to base. That’s not only helped advance self-driving technology, but it’s now driving revenue in other ways.

Tesla insurance has premiums based on a driving score. The ‘safer’ you’re driving, the lower the premiums. It’s early days, but this blend of technology and service offers additional growth opportunities.

Ultimately, it’s hard to not be impressed by the products, services, and technology at Tesla. The elephant in the room is the price to earnings ratio of 55.4. Tesla’s priced more like a high-flying growth disruptor than a car maker.

Investors should remember, growth needs to be better than good to live up to the current valuation.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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