Monday 23 April 2018

Richard Curran: A Chinese hard landing will be painful for us all

Could Smurfit Kappa CEO Tony Smurfit have waited a little longer, and got it cheaper? Photo:Maxwells
Could Smurfit Kappa CEO Tony Smurfit have waited a little longer, and got it cheaper? Photo:Maxwells
Richard Curran

Richard Curran

When the Chinese New Year formally begins next month, it will be the year of the monkey. But as far as the stock market is concerned, 2016 is shaping up to be more of a dog.

The automatic suspension of the stock market on Thursday, triggered after it shed 7pc in its opening 30 minutes, does not augur well for equity investors, the currency or the economy. The bad news is that its reverberations will continue to be felt around the globe.

Thursday's market suspension was triggered by a fall in the Chinese currency. This is fuelled by a slowdown in the economy, which saw manufacturing contract for each of the last five months of 2015.

Chinese investors are asking some tough questions. For example, why is the market automatically suspended for a day when the CSI 300 index falls by 7pc, given that a 10pc fall in any single stock already triggers a suspension in trading in that stock.

Friday's decision to get rid of the automatic circuit breakers helped restore some stability, but what has really changed in the Chinese economy overnight?

The overall Chinese regulatory response has been predictable and controlling. It introduced new rules that, from January 9, investors can only sell 1pc of their shares in a company over a three-month period and planned reductions in shareholder stakes must be disclosed 15 days in advance.

The rules would prevent fresh investment in Chinese stocks, which would reduce demand, but existing investors will not be able to sell out. In turn, Chinese stocks will be artificially over-valued as investors form a long slow queue for the exit door.

Like the circuit breakers, these too may have to be rescinded. It all paints a picture of an economy that is slowing at a much faster rate than official figures would suggest.

The Chinese have pumped around $800bn into orchestrating a soft landing. After its first big stock market wobble last summer the state began supporting stocks by buying up shares. Goldman Sachs estimated that the government had spent $234bn supporting the stock market in July and August.

It ended up owning around 6pc of the tradeable stocks on the Shanghai and Shenzhen exchanges.

The impact closer to home will take several forms. Concerns about the economy will weaken the economies of trading partners around the world. It will drag down the share prices of companies in the US or Europe which have large exposures to the Chinese market.

Further falls in the value of the currency will trigger devaluation pressures in the wider region, while emerging economies that are heavily dependent on China will suffer further.

Ireland has relatively modest exports to China, and our stock market gained around 30pc in 2015. But what happens in China, doesn't stay in China.

The Chinese stock market and currency may simply be adjusting to reality, in which case, it has to happen at some point. It just won't be painless.

Rather ominously, 2016 has opened with an Asian-driven bare knuckle ride.

Did Smurfit Kappa bag its Brazilians too soon?

Paper and packaging giant Smurfit Kappa got a very positive reaction to its €186m acquisition of two Brazilian packaging businesses - Industria de Embalagens Santana (INPA) and Paema Embalagens (Paema). Both are privately owned integrated packaging businesses.

The combined operations have three recycled container-board mills with a total capacity of 210,000 tonnes and four corrugated facilities. The net assets of INPA and Paema on September 30 2015 were €30m and €6m respectively.

It is an important strategic move for Smurfit given its strong position in the region and the fact that Brazil is a huge Latin American market.

At a multiple of below eight times earnings, and that is before the benefit of synergies, Smurfit appears to have capitalised on the uncertainty in the Brazilian economy to get in at a cheaper price than normal.

The question is whether Smurfit Kappa chief executive Tony Smurfit could have waited a little longer, and got it even cheaper.

Brazil is heading into a tough year. The economy contracted by nearly 4pc last year and is expected to shrink by another 3pc this year. That could be a very hopeful estimate. Inflation is heading for 10pc and its deficit hit 9.3pc in 2015.

Following high-profile political indictments, more political instability is coming in March. Brazil's main trading partner, China, also seems to be heading one way - and it isn't up.

Even the grand main avenue of the business capital of Sao Paulo was without its usual extravagant Christmas lights over the festive season because of lack of a sponsor.

Some commentators have included Brazil on a list of countries that might even need an IMF bailout in 2016.

Smurfit won't be worried about the short-term economic picture and will see these deals as strategically important for the long haul. Plus, if he sat back and waited eight months for a cheaper price, the whole deal could have fallen apart.

Credit rating agency Fitch was less enthusiastic, not because of Brazil's woes but because it marked a shift of strategy towards acquisition and shareholder returns instead of debt reduction.

Fitch revised Smurfit Kappa's outlook to 'negative' from 'stable'. It said this reflected Smurfit's faster than expected ramp-up of acquisitions and shareholder returns at a time when its financial profile has not yet improved to a level that is commensurate with its 'BB+' rating. The Brazilian deals brought to €350m the amount spent on acquisitions in 2015.

"We will monitor the pace of acquisitions and their successful integration into the group over the next 12-18 months", Fitch said

One assumes Tony Smurfit won't be too concerned about the Fitch note because he has landed an important missing piece of Smurfit's Latin American jigsaw. Still, things could go a bit nuts in Brazil in 2016.

Spinning like a top over US multinationals and tax

Is the Government trying to have its cake and eat it, when it comes to multinationals paying more Corporation Tax in Ireland?

Last week, announcing Exchequer returns that were €3bn ahead of target, Michael Noonan suggested that foreign multinationals are laying down deeper roots in Ireland and paying more tax here.

He linked the scrapping of the Double Irish tax loophole, with firms increasing R&D activity and paying more tax here.

The obvious question therefore is, why didn't he or his predecessors do it sooner?

There has always been an implied threat that if we didn't allow global multinationals to pay relatively little tax here, they would up sticks and leave. Accountants, lawyers, tax advisers, strategists and politicians have always argued that abolishing these loopholes would drive away investment and jobs.

Now, the Minister for Finance is saying the opposite and suggesting that it is encouraging them to lay down deeper roots and pay more tax here.

Higher Corporation Tax receipts is good news but comes after a deeply painful five-year austerity drive. Have we all been sold a pup for years on the impact of international corporation tax arrangements?

The response would be that a new global crackdown on corporate tax residency and loopholes has changed the environment and allowed us to tighten up legislation without losing investment.

But can we be sure this is the case?

If Noonan's explanation for a lasting higher tax take is correct, then we really have played a bad game of poker with some multinationals, especially since 2008.

Sunday Indo Business

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