While fear over a trade war between the U.S. and China has been growing for most of the year, its effects on the economy have yet to be seen.

The U.S- imposed tariffs on imported steel (25%) and aluminum (10%) in March were promptly countered the following month by Chinese tariffs of up to 25% on 128 American products. Washington has since proposed tariffs on $34 billion in Chinese goods to take effect July 6, and China has said it will impose tariffs on $50 billion in U.S. goods on another 659 product categories.

The potential effects of currently proposed trade actions appear relatively modest with a hit to the U.S. economy from 0.1% to 0.3% and a loss of up to 80,000 jobs, according to a study by the Tax Foundation. The major indexes have given up gains for the year but have not sold off dramatically on the trade worries.

#-ad_banner-#But Wall Street may be missing a bigger problem for U.S. consumer companies in China.

Dual threats from increased competition and a backlash of consumer sentiment against American brands could hobble companies that have hoped to support sluggish domestic sales with revenue from China.

While sales in China are still relatively small for most U.S. brands, a few consumer names have pinned their hopes on the country. Those hopes could soon turn to despair.

Collateral Damage Of The U.S.-China Trade War
Local brands gained market share in 21 consumer product categories with average sales that grew 7.7% against international brands, which grew just 0.4%, according to a report by Bain and Kantar. Data from the report shows that a wide range of product categories from toothpaste to infant formula have seen steep market share losses averaging 10% over the past five years.

Chinese brands commanded three-quarters of the $97 billion market for consumer goods in 2017, up from just two-thirds of the market in 2013.

The biggest risk may not be from trade policy but from the growing sense of nationalism around brands and a potential backlash against American brands in China. It wouldn’t be the first time Chinese consumers turned on an international brand for nationalistic reasons. Japanese car-makers Toyota and Honda both saw car sales plunge more than 40% year-over-year in September 2012 when the two countries sparred over the Diaoyu Islands in the China Sea.

U.S. Brands With The Most To Lose In China
Only 121 companies in the S&P 500 break down revenue to show exposure specific to China but many have been focusing on the world’s second largest economy.

Total revenue exposure to China is estimated around 5% but several consumer names have built a much larger dependency. These companies have publicized their success in China as one of the few sources of growth. That dependency may now become a burden on earnings expectations.

Nike (NYSE: NKE) worked hard to grow in China with disappointing results after its big push during the 2008 Olympics. The company booked 15% of sales in China during the fourth quarter, an increase of 35% year-over-year against sales growth of just 13% globally. The Chinese division is one of its most profitable as well, accounting for more than a third (35%) of EBITDA in the quarter.

International business now accounts for over 55% of total revenue and may be susceptible to this theme of weakness in American brands overseas. Nike reported strong first quarter growth to beat estimates but is now trading at 31.4 times trailing earnings, and shares have jumped 34% over the past 12 months.

Starbucks (Nasdaq: SBUX) has long had its eye on China growth as critical to its continued success. The company acquired the remaining 50% interest in its joint venture with the East China company last December for full control of over 1,400 stores for $1.4 billion.

Starbucks doesn’t break out China sales but booked $1.19 billion from the China/Asia Pacific region, 20% of total revenue, in the second quarter. Regional sales were up 54% over same period last year versus growth of just 7% for rest of the world.

A potential backlash against the iconic American brand could come at the worst time imaginable. Starbucks has recently struggled with slowing sales growth and announced strategic priorities including closing 150 U.S. locations. Long-time CEO Howard Schultz and the company’s CFO have announced their retirements, leaving the company to fill a management gap. Shares are down 16.7% over the last year but still trade for 21-times trailing earnings.

Yum China Holdings (NYSE: YUMC) was spun off from Yum Brands (NYSE: YUM) in 2016 but remains a trademark licensee of the original company. China accounted for 27% of KFC system sales with growth of 9% last year versus a decline of 1% in U.S. sales. For Pizza Hut, China accounted for 17% of global sales with 7% growth year-over-year.

The restaurants reported a disappointing first quarter with a 5% decline in sales at Pizza Hut and just 5% year-over-year growth for KFC. Profitability halved to 10.5% as the company struggles to return to faster growth. The company opened 691 new restaurants last year and 185 in the first quarter.

The brand has already suffered two public incidences in 2012 and 2014 involving selling expired products and a supplier-related issue with excess antiviral drugs being fed to its livestock. Shares have traded flat over the past year but still price at 25.6 times trailing earnings.

Risks To Consider: China sales are still a relatively small percentage of total revenue for most U.S. consumer names and broader global growth could support these companies.

Action To Take: Avoid consumer names that could be hit on negative sentiment for American brands in China as well as other repercussions from U.S.-China trade relations.

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