Joint ventures in China are a time-tested and Beijing-approved way to gain access to the country’s enormous market. Yet in Tesco’s (TSCO.LON) case, theirs was more of a concession of defeat. This week the UK retailer agreed to a joint venture with China Resources Enterprises (0291.HKG) in which 80% of the new entity’s shares will be owned by CRE, and 20% by Tesco, creating the largest food retailer in China. The new enterprise will combine Tesco’s 131 stores and CRE’s almost 3,000 outlets in the country. Plagued by lagging sales and profits in China, Tesco has had little choice but to attach itself to a more seasoned and well-established supermarket retailer in China. But Tesco’s and CRE’s aggressive PR campaign trumpeting the “synergies” of the two companies have done little to clear skepticism over merging what are equally dismal retailers. Like Tesco, CRE suffers from weak sales – in Q1 2014 same store sales growth (SSSG) was negative. Sure, Tesco’s superior technology in customer analytics and supply chain management and CRE’s extensive retail network meshes well together, but it’s not clear how their combined strengths could turn the joint venture’s fortunes around in two to three years (their own optimistic estimate). Clive Black an analyst with Shore Capital in Liverpool, UK, said the deal nevertheless reflects business savvy from the company’s management. The new joint venture “doesn’t require Tesco to put more capital in China” and lets it refocus on the UK, where it recently took a bruising. It signed a similar deal in India with Tata this Wednesday. With “too many demands on Tesco’s balance sheet to deliver the sort of growth in four or five major countries,” he said, the retailer is curbing investment into international markets. Clever management can only go so far, though. “The very poor performance in the UK and a lack of confidence in the robustness of their earnings growth” has led Shore Capital to issue a “sell” rating on Tesco.
There’s money to be made from China’s romance with coal
China’s passionate love affair with coal is on the rocks. It’s not that leaders have found something else – although they continue to flirt strongly with natural gas and renewables, and are even seeing nuclear again – but more that it’s not cool to be with coal anymore (the dirty resource is being blamed for chronic pollution in northern parts of the country). Demand is so low that prices of thermal coal have been falling continuously since 2012 and are not going to stabilize anytime soon. Thermal coal supply is currently growing as we enter a strong season for hydropower production, which will further hurt demand for thermal coal as power plants switch over to a cheaper (and cleaner) source of electricity for this period. Still, China isn’t going to dump coal – almost two-thirds of its power comes from the commodity. Investors managing existing portfolios should favor Yanzhou Coal Mining (1171.HKG) over China Coal Energy (1898.HKG), analysts at Barclays Research said in a note. China Coal saw costs rise in 2013 while Yanzhou cuts its costs by 11%; Yanzhou also scaled back spending whereas China Coal poured in more cash into projects that will not see results for many years. Also, the outlook for coking coal, to which Yanzhou has higher exposure, is improving. But for anybody looking to enter the sector, China Shenhua Energy (1088.HKG) remains the top pick.
I don’t like you and you don’t like me, copper
Yet again, China is threatening to drive the price of copper into the ground. A government probe at a port city in northern China could reveal that companies that use the commodity as collateral for loans were counting the same batches of copper, stored at the port, several times over. If that proves to be true, banks could begin shying away from commodities finance in the fear that the copper which companies have promised simply doesn’t exist. That, in turn, could lead to quick drop in demand for the metal. The potential for ugly results from the probe has already pushed copper prices to a three-week low in New York. Traders will remember the dire outlook for copper in mid-March, when China’s flagging economy knocked more than 14% off the price. Although copper is often regarded as a solid proxy for the health of the Chinese economy, a small spike or dip in prices is often followed by rampant speculation that pulls the metal much further in the respective direction. That would likely be the effect if the port probe shows that companies have been fibbing about how much copper they actually have. If it starts tumbling, there could be no stopping it until it reaches the price of production, or the absolute lowest cost. Word to the wise: Don’t get trapped at the bottom of the copper mine.
IPO Watch
There is only one overseas IPO on the horizon, that of Qingdao Port (6198.HKG) today. In other news, Tianhe Chemicals kick-started its roadshow this week as it seeks to raise up to US$818 million in Hong Kong. The company has so far not been able to secure a cornerstone investor. Chinese companies that listed in the US in May have seen lacklustre progress in a sign that investor excitement in such stocks is waning