The outbreak of the coronavirus has shifted a spotlight on how globalisation has shaped supply chains and led to international demand. The Stoxx Europe 600 Index, for instance, albeit representing European companies, generates only 45% of revenue within Europe, with the rest of sales attributed to consumers in North America, Asia Pacific and Emerging Markets. In terms of supply, globalisation of production builds on the notion of exploiting a country’s competitive advantage, such as labour, technical expertise and production inputs. As a result, the sequence of processes involved between the production and distribution of products, known as the supply chain, has become more global over time.

According to the World Trade Organisation, China has established itself as the world's largest exporter. This implies that China has become a fundamental component of the global manufacturing system. The province of Hubei, which is at the heart of the Coronavirus epidemic, is considered a manufacturing hub and thus its lockdown and closure of factories for longer than the traditional holiday period of the Chinese New Year has raised concerns over supply chain risks.

Following the end of the extended holiday period, production capacity is nowhere near full. Last week, the Hubei government extended the closure of companies in the province by another week till the 20th of February, except for those companies considered critical to the healthcare system in containing the virus, treating patients and providing daily necessary goods.

Meanwhile, several companies have come forward with their own concerns over the consequence of the coronavirus outbreak on production lines. Auto industry players, such as Hyundai, Fiat-Chrysler and Nissan were vocal over concerns of lack of parts from their suppliers. Hyundai and Nissan temporarily closed their factories and Fiat-Chrysler cautioned against the possibility of halting production in its European factories. Apple supplier Foxconn, currently running on below capacity levels, increases the risk of impacting iPhone sales and production of AirPods.

The extent of the disruption is also dependent on inventory strategies. While a Just-In-Time inventory approach aims at reducing costs through the concept of receiving input goods as needed in the production process, this also leads to a quicker depletion of inventory in the current scenario where inventory levels cannot be replenished as expected.

On the demand side, consumption is also being disrupted by the coronavirus outbreak. While companies are not yet quantifying the negative impact on revenue, several companies have shed light on the situation on the ground, with retail shops remaining closed or opening at reduced hours.

Similarly to other companies that have a significant exposure to the Chinese consumer, owner of luxury brand Gucci, Kering communicated a strong drop in traffic and sales in its retail shops in China over past weeks, and implemented initiatives such as postponing costs, that aim at protecting the profitability of the Group. Alibaba, despite being an online based company, also communicated that the current situation is limiting the delivery of packages and will leave a negative impact on the commerce business.

Evidently, the current outbreak has exposed the dependency on China in the supply chain process and as a global consumer. The extent of supply and demand disruptions ultimately depends on the duration of the outbreak, with productivity levels expected to return to normal once the outbreak is contained. However, from the demand side, despite that one may argue that consumption will be deferred, given that the outbreak impacted the Chinese New Year holiday period it is unlikely that companies will experience full recovery of lost consumption.

Disclaimer:

This article was issued by Rachel Meilak, CFA Equity Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.