[ANALYSIS] China's reopening to help ease inventory woes

Travelers stand on an elevated walkway near an electronic schedule display at Beijing West Railway Station in Beijing, Jan. 18. China in December lifted its strict "zero-COVID" policy, letting loose a wave of pent-up travel desires, shortly before the country's most important time for family gatherings, referred to in China as the Spring Festival. AP-Yonhap

Swelling inventories, heavy price cuts drag down earnings results of Samsung, SK, POSCO and Hyundai

By Kim Yoo-chul

Even as the worst point of the COVID-19 disruptions has eased a bit, recently, its real impact continues to ripple throughout the world's leading economies including the United States and China.

The so-called "second-order effect" is still being felt all over, and addressing pending challenges could be considered as tricky as maneuvering through the initial shocks. One strong example could be found in inventories. Inventory levels have a direct effect on the cash flow of a company.

During the pandemic, high demand for tech, retail and home products worsened supply chain issues, draining the inventories of manufacturers and retailers. But higher inflation and shifts in consumer behavior have caused a lot of uncertainties for manufacturers as demand is now softening for end-products that saw substantial growth during the pandemic.

Sources inside Samsung Electronics, for example, told The Korea Times that the company didn't expect the size of the switch in consumer buying patterns, leaving it with a huge amount of unwanted inventory. As of the third quarter of last year, Samsung's inventory assets swelled to 57.3 trillion won, up 51.6 percent year-on-year, according to company data.

South Korea's export leaders including Samsung, LG, SK Groups' tech affiliates, steel manufacturer POSCO and Hyundai Motor are set to report bearish fourth-quarter earnings results mostly due to higher inventories, the level of which hasn't been seen in a decade, as well as weak product demand.

Still, the long lead times for end-products remains a key issue. The country's leading manufacturers, the core engine of South Korea's economy, will remain in a fragile position of worrying about the amount of "unwanted and unsold goods" both above and below manageable levels.

Travels arriving from China go to a COVID-19 testing center at Incheon International Airport in Korea, Jan. 14. A hoped-for boom in Chinese tourism in Asia over next week's Lunar New Year holiday looks to be more of a blip as most Chinese tourists opt to stay inside China if they go anywhere. AP-Yonhap

"Samsung's semiconductor and digital device-selling businesses are on track to continue massive promotions and markdown campaigns both via retail and client channels in a way to quickly drop inventory levels and advance the overall supply chain," an executive at the company said. Samsung is set to update its position on inventory levels for chips, TV and smartphones when it announces the divisional performance on Jan. 31.

Lifting of zero-COVID policy in China

Still, it's too early to talk about the phase of recovery in asset prices while U.S. Federal Reserve policymakers are aiming for additional interest rate hikes, and the resumption of activity in China could help top South Korean exporters reduce inventory levels, said analysts and economists.

"Analysts and economists are focused on studying updates of China's reopening policies, as a faster reopening of China, South Korea's top trading partner, means the increased possibility of the Chinese economy reporting a better-than-expected economic growth rate throughout this year. China's lifting of its zero-COVID policy will help Samsung, SK and LG Groups' tech affiliates and Hyundai Motor reduce their inventory levels faster than expected previously," Choi Doh-yeon, chief of research at SK Securities, said over the telephone.

Samsung operates a massive NAND memory chip plant in Xi'an, while SK, the runner-up of Samsung in the global DRAM market, has DRAM chip production facilities in Wuxi. LG Group's tech units including LG Energy Solution, LG Display, LG Chem, LG Innotek and LG Electronics operate plants in Nanjing. South Korea is one of the top foreign direct investors (FDIs) in China.

Because China is continuing to prioritize the economy over its zero-COVID policy, raising the possibility of a recovery in passenger flights, private consumption and even mobility, the onshore Chinese yuan has strengthened against the dollar recently. Plus, the price of other underlying assets such as sugar, oil, steel, copper and iron were extending gains, said ING Group and HSBC Holdings analysts.

Grain is offloaded from the Eaubonne bulk carrier ship after it docked in the port of Mombasa, Kenya, Nov. 26, 2022. Global prices for food commodities like grain and vegetable oil were the highest on record last year even after falling for nine months in a row. Russia's war in Ukraine, drought and other factors have driven up inflation and worsened food shortages worldwide. AP-Yonhap

The price of raw materials matters a lot to manufacturers, as it could impact consumer prices and ultimately hit company profitability.

"Investors have shifted towards betting on China's better-than-expected economic recovery this year. Yes, China's reopening is truly a positive factor in cutting pressure on inventory levels for major South Korean exporters which have higher exposure to the Chinese economy," said Koh Eui-yong, a senior analyst with Hi Investment.

Potential inflationary impact

While some economists and analysts have no big doubts that China's reopening could boost global growth, business leaders in South Korea and policymakers still have concerns about the detailed implications of the reopening of the world's second-largest economy, especially regarding inflation.

More to the point, thoughts are China's reopening would pose upside risk to inflation just as central banks across the globe are apparently soothing down their rate increases. Addressing the high level of inflation has been one of the top challenges for advanced economies.

Fitch Ratings Director Jeremy Zook said in a recent telephone interview that the Bank of Korea's tighter stance will cause inflationary pressures and predicts inflation to fall 2 percent by the end of this year, expecting the country's central bank will keep its current 3.5 percent base rate unchanged this year.

Peter Kim at KB Securities said, "Well, I would say the possible flipside of China's ending of COVID controls is, the improvement of China demand for consumer goods may have potential inflationary impact. A better China will increase the possibility of the Fed maintaining its hawkish stance toward basic rate."

Despite the Fed's repeated denials for its rate cut, treasury futures markets were still betting the Fed's policy rate will reach 5 percent before cutting back to 4.4 percent.

"It's fair to say businesses which have greater exposure in China are becoming quite positive on China's growth recovery thanks to a faster reopening and an easing of regulations in tech sectors. However, as China's reopening will have a direct impact on consumption not for facility investments, which could lead to an increase of hiring, the spillover effects onto advanced economies could be limited," said Jeong Yeo-kyung, a senior analyst at NH Investment.