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Winners from Chinese growth
It’s an old story – but we think it still has a long way to run
China’s growth will remain robust for the next decade
We focus on foreign companies with exposure to China – some
not obvious
A way to go
The slowdown in Chinese economic growth over
the past few quarters has worried many investors.
Having grown 11.9% y-o-y in Q1 this year, real
GDP growth slowed to 9.6% in Q3 (its slowest
pace, apart from the 2008-09 recession since 2004).
And, with the Chinese authorities sharply
tightening monetary policy after inflation reached
4.4% y-o-y in October, many investors worry that
growth could slow further. As a result, Chinese
stocks have performed sluggishly this year, with
MSCI China falling by 9% since early November.
We do not believe, however, that the China growth
story is anywhere close to an end. The consensus
continues to forecast about 9% real GDP growth in
2011 (HSBC forecasts 8.9%). In many ways, a
slightly slower pace of growth would make it more
sustainable and less inflationary.
China’s growth is not likely to slow over the
medium term either. It still has a lot of catching
up to do, with GDP per capita only 7% of that of
the US. When Japan, Korea and Taiwan were
growing at 8-10% a year, they were already much
richer relatively than China is now. China will
eventually have demographic problems, but for
the next decade its population will continue to
grow by 0.6% a year, according to the United
Nations (only fractionally slower than the 0.7%
over the past 10 years). Even now, 40% of the
population still work in agriculture, although this
comprises only 11% of GDP.
All this suggests that China will remain a key
driver of global demand over the coming years. It
is hard to exaggerate how important Chinese
demand is. It represents a large proportion of
global demand for commodities, for example. As
Table 2 shows, China last year comprised 59% of
global demand for iron ore, and over one-third of
demand for four other major metals. Perhaps more
100% of incremental demand for all six of the
most important metals.
It also uses 10% of the world’s oil, generates 18%
of the electricity and has 17% of mobile phone
subscribers. Last year, China carried out 21% of
the world’s capital investment (up from 6% at the
beginning of the last decade, see Chart 3); in the
past five years, 83% of the growth of investment
globally has been contributed by China.
China is, as yet, nothing like as important for
consumption: in 2007 (the last year of available
data), Chinese consumption was only 3.8% of total
world consumption, making China only the fifth
largest consumer market in the world (and barely
one-tenth of the size of the US). In the past five
years, China has provided only 7% of incremental
demand growth. But that is set to change: McKinsey
& Co estimates that Chinese consumption will grow
at a 8.3% CAGR until 2020, by which time China
will be the third-largest market in the world and
almost one-quarter the size of the US.
All of this suggests, then, that investors should
continue to look for companies exposed to China
growth. Although obviously some of these can be
found in China, the negatives of investing in
Chinese companies (excessively government
interference, poor corporate governance, risk in
executing expansion plans, expensive valuations
in attractive sectors) mean that our preference
remains to look for foreign companies with strong
and growing businesses in China.
Which foreign companies have the biggest
businesses in China? Table 4 shows the largest
foreign groups in China (compiled by aggregating
the revenues of all subsidiaries and joint ventures).
following sectors, where they believe foreign
companies’ exposure to China has not been fully
appreciated by the market.
Capital goods. This year capex in emerging
markets will be bigger than in developed
markets for the first time. In China, in particular,
wage pressures will push companies to increase
factory automation to keep costs down.
Luxury goods. Although China’s growth is
not exactly a new theme, our analysts believe
investors still do not fully appreciate the
impact of the rise of Chinese consumption,
particularly sales to Chinese tourists abroad.
Beverages. Chinese growth has been more
significant for spirits companies than for
brewers. We see Pernod Ricard (RI FP, OW,
EUR62.79, TP EUR75) as a particular
beneficiary, given its strong portfolio in
scotch, cognac and vodka and its 42% market
share in China.
Personal goods. Penetration rates have a long
way to go: per capita consumption of skin
care products are only 30-50% of the level of
mature markets, and also below the levels of
Russia, Brazil and urban India.
Building materials. Cement companies such
as Holcim (HOLN VX, OW, CHF64.65, TP
CHF75.0), for which emerging markets
constitute 59% of capacity, should continue to
see strong growth. We forecast 5.1% CAGR
of sales to 2050 for the company, the highest
among its peers.
Autos. China became the world’s largest auto
market last year. We forecast 11% growth in
auto sales in China in 2011, compared to 4.8%
for the global market. On our projections,
Chinese sales by 2014 will reach 21.9m units
(25% of the global market), compared to 15.8m
in the US. Our favourite stocks among
beneficiaries of Chinese growth are PSA (UG
FP, OW(V), EUR29.97, TP EUR39) and
Daimler (DAI GR, OW, EUR50.22, TP
EUR56) and, in Korea, Hyundai Motor (005380
KS, OW) and Kia (000270 KS, OW,
KRW48,950, TP KRW56,000).
Oil & gas. Chinese demand for oil and
natural gas will continue to be strong. This
should be positive for all energy companies,
but our analysts particularly focus on natural
gas, where concerns over global gas prices in
2010 have kept valuations cheap. We
particularly like BG Group (BG LN, OW,
GBP11.62, TP GBP16.15), one of the world’s
largest traders of LNG, an increasing amount
of which is being imported by China.
Utilities. China offers opportunities for
European utilities companies which can offer
technical innovation and technology transfer,
such as Veolia (VIE FP, OW, EUR20.3, TP
EUR27) (which already serves 25m people
with water services in China).
And obviously there are many Chinese stocks that
will benefit from domestic demand growth too,
although one has to be selective because of
regulatory risk. For example, in real estate our
analysts like companies with exposure to
commercial and high-quality residential property
developments such as Shui On Land (272 HK,
OW(V), HKD3.88, TP HKD4.70). We also think
that investors have become too pessimistic about
the outlook for infrastructure growth, and therefore
like select names in steel and building materials
(for example, Baosteel (600019 CH, OW(V),
RMB6.28, TP RMB8.50) and CR Cement (1313
HK, OW, HKD6.11, TP HKD7.40). We are more
selective in consumer-related companies because
valuations are stretched, but can find one or two
we like, for example, Intime (1833 HK, OW(V),
HKD12.10, TP HKD15.21).
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