Estée Lauder/Tapestry: China exposure goes from gain to pain

American companies once hugged China as a vital asset. Exposure to the world’s second biggest consumer market boosted group sales and share prices. Now the country risks becoming a liability. Investors may ascribe a China discount to corporate valuations for those which rely too heavily upon its consumers.

Consider US cosmetics group Estée Lauder and Tapestry, owner of the Coach and Kate Spade fashion accessory brands. Both issued full-year earnings forecasts that fell below expectations on Thursday, suffering sales hits following repeated rounds of lockdowns in major Chinese cities.

Tapestry generates about a fifth of its sales from China. It said revenue there fell more than 30 per cent during the June quarter. Estée Lauder has even more exposure there, about a third of group revenue. That weighting meant its Asia-Pacific income dropped over a fifth.

For companies operating in China, Beijing’s insistence on sticking to its draconian zero-Covid policy keeps causing problems. Covid cases reached a three-month high this week, suggesting more lockdowns and disruptions are likely.

Worse, rising geopolitical tensions and China’s economic slowdown also mean those buyers emerging from lockdowns spend with less vigour on luxury goods than before.

China no longer provides ballast against any US slowdown for both groups. Americans, too, are prioritising spending on experience and essential goods rather than discretionary goods. Meanwhile, a strong dollar saps the value of earnings made overseas, by far the majority of the fashion group’s top line.

Yet the valuations of these two companies vary greatly. Although Estée Lauder shares have shed over a fifth of their value since the start of the year, it still trades on a punchy 37 times forward earnings — above its pre-pandemic levels. It does have geographic sales diversity which Tapestry, on only 10 times, lacks. The US provides over half of turnover.

China’s economy narrowly escaped a contraction in the second quarter and any discussion of a rapid recovery is premature. Even so, any of that threat looks more priced into Tapestry’s shares rather than those of Estee Lauder.