All hail the Chinese
World leaders have been queuing up to tell China it needs to boost domestic consumption, but the process may be further advanced than is widely appreciated.
Big names: established western brands are seen as a safe bet in China
Robert Zoellick, departing president of the World Bank, said last September: “It’s hard for me to see that a continued reliance on export and investment-led growth will work for China over the next 10 years.”
However, according to research from Barclays Capital, the Chinese government may have made more progress towards rebalancing its economy towards domestic consumption than official data indicates.
According to official figures, internal consumption as a proportion of gross domestic product fell from 62% in 2000 to 47% in 2010. Within that, household consumption slid from 46% to 34%.
By comparison, household consumption currently absorbs 79% of GDP in Japan, and 88% in the United States.
However, according to Yiping Huang, an economist with BarCap, the official Chinese data is unreliable, in particular tending to underestimate spending on services. Huang cited research by Xiaolu Wang, an economist at the Chinese National Economic Research Institute, which found that household consumption had been under-reported in 2008.
According to Wang, household consumption’s share of GDP was 38.2% rather than the officially reported 35%.
Drawing on Wang’s research, BarCap recalculated the overall domestic consumption proportion of GDP between 2000 and 2010. Although it fell steeply from 64% in 2000 to 50% in 2008, according to BarCap’s calculations, the process has since reversed, with consumption coming back to 54% by 2010 (see chart), well above the Chinese government’s figure of 47%.
Charlie Awdry, manager of the China Opportunities Fund at Henderson Global Investors, said: “Consumption growth in China is the bedrock of the investment case we take to investors. It’s the first item on the agenda.”
-- Fatter wallets
The key is the increasing wealth of Chinese consumers – and their growing willingness to spend it.
Wages are growing rapidly, according to Awdry. He said: “We’ve seen 12 months of wages going up in the mid-teens, and that’s not just for workers on production lines but also for people working in city fast-food restaurants.”
Last week, Foxconn, one of the biggest suppliers to US computer group Apple, announced wage increases of between 16% and 25% for its Chinese workforce.
Consumers are also increasingly willing to spend more of their growing wealth, according to Jerome Booth, head of research at UK fund manager Ashmore Asset Management, in part thanks to the much-maligned Chinese property boom.
Booth said: “It’s a classic example of the wealth effect. If you’re sitting on assets which are going up in price, you’re likely to spend more – even if you’re paying a hefty mortgage.”
However, for Booth it is the appreciation of the Chinese currency that will be the biggest driver of rebalancing the economy. With the renminbi having appreciated at an annualised rate of 5% against the dollar since June 2010, he thinks the process is well under way.
Booth said: “The Chinese central bank has been pushing to allow quicker appreciation for the renminbi, but was resisted by the export lobby. This seems to have resulted in a compromise target of 5% for now. But the currency could appreciate more quickly if the government decides it needs to crack down further on inflation.”
Nicholas Yeo, head of China-Hong Kong equities at Aberdeen Asset Management, said these movements were already having an impact on investment strategy. He said: “Exporters have been difficult to invest in as costs have risen – both due to currency appreciation and increasing labour costs. They also tend to have very little bargaining power with their buyers.”
By comparison, he said: “It’s easier to hold consumer goods stocks. They’ve got fatter margins and better pricing power.”
-- Businesses too expensive?
Gaining effective exposure to rising Chinese consumer demand is not a simple matter.
Consumer staples such as food and basic clothing should be a strong bet, but Awdry said: “While a lot of Chinese consumer staple businesses are very good, with strong balance sheets and good margins, they’ve become market darlings – they’re too expensive.” Tingyi, the Chinese noodle company that became fashionable is now trading at over 26 times its projected earnings for 2012. Awdry prefers companies exposed to growing Chinese demand for discretionary purchases. “I like the potential for wine in China. People are moving away from traditional, harder spirits – and there aren’t many competitors to the existing players, as it takes time to plant vines and establish a brand,” he said.
Archie Hart, emerging market equities fund manager at Investec, said car manufacturers were another good prospect with “an extremely strong growth trajectory”.
However, Aberdeen’s Yeo raised a difficulty that had to be negotiated before making any investment decision in China: “You need to be careful to pick companies that are able to set their own prices. A problem in the Chinese consumer market is that, when something is selling well, everyone piles in behind you, which erodes profits over time”.
One way in which some Chinese firms are seeking to strengthen their pricing power is by purchasing strong, existing brand names. Hart pointed to the purchase of IBM personal computing business by Lenovo, a Chinese PC manufacturer. He said: “The idea is that by buying stronger western brands you prevent your market being cannibalised by your rivals. It’s becoming an important strategy in China.”
Li & Fung, a Hong Kong company, has established a business called Trinity specifically to buy well-known western brand names and sell them on to the Chinese market.
Awdry said there are also plenty of ways to play the Chinese consumer boom without even investing in Asian companies.
US company Yum! Brands, which owns fast-food chain KFC, has been extremely successful in China, with its outlets in the country now generating around half of its global profits.