Having long been viewed as one of the world’s leading manufacturers, China is now being considered by investors in a different light
China has long been considered one of the world’s leading manufacturing hubs. But top industry commentators, including renowned stockpicker Anthony Bolton, are predicting the economic drivers of the country are now shifting away from exports towards the domestic economy.
The Fidelity manager’s £471m China Special Situations trust is heavily weighted towards stocks in the consumer sector including retailers, such as department stores, sports goods, electrical goods, jewellery and other consumer areas like wines and spirits, restaurants, hotels, cars, telecoms and some internet names.
However, investors, having piled into consumer-related stocks, have left valuations high. This is forcing managers to look for alternative ways to play the theme.
Mike Kerley, manager of the Henderson Far East Income fund, says for income investors in particular, getting exposure to consumer-related areas is tough unless you are prepared to pay for it.
Taking time
He agrees the Chinese economy is moving towards a consumerist society, but thinks it will take time for this theme to come to fruition.
“The whole set-up of the social security system in China needs quite a lot of change,” Kerley says. “That is why you have this huge pool of savings. People save for a rainy day because there is not the same healthcare, unemployment or pension provisions we are so used to in the West.
“China will not stop saving overnight – we need to see reform in the welfare system before we see a full adoption of a consumer society. That will take a number of years.”
Kerley is exploiting the consumer theme within his portfolio indirectly through cheaper sectors exposed to the general growth trends and the move towards consumption rather than directly through consumer stocks.
“If you ask me what I like and what I own it is different because of valuation,” he says.
“Consumer staples – anything food- and beverage-related – look interesting as a sector but the stocks are way too expensive. The sectors offering value are not the ones with direct exposure to the consumer theme.”
Beneficiaries of trends
He believes the best way to play the theme is through financials, which are beneficiaries of consumer trends – banks in particular and to a lesser extent insurance companies.
“These are areas where people are looking to do something with excess savings – maybe it is consumption, maybe being more efficient with their investments,” he says.
He owns the three longest listed banks in the country: Bank of China, Industrial and Commercial Bank and China Construction Bank.
He also sees value in some of the smaller more regional banks. This is because in the same way the Chinese economy is trying to become more consumer-related, he sees Chinese banks moving away from loans to state-owned enterprises towards more consumers.
Aberdeen’s head of China equities, Nicholas Yeo, agrees consumer names are expensive so plays the domestic story by investing in the energy sector.
“The consumer space is broad in the sense it is not just purely consumer stocks,” he says.
He owns a number of energy companies such as PetroChina and Sino Gas and Energy within his Global Chinese Equity fund.
“Relative to pure consumer plays, energy companies are more reasonable in terms of valuation. There are some concerns about valuations of pure consumers with some trading on 30x or 20x earnings,” he adds.
Yeo also plays the consumer theme by investing in Hong Kong domestic consumer names. He favours companies that do not achieve 100% of revenue or sales from China.
“They are not pure China plays; they are Hong Kong/China plays. They tend to be less favoured by investors investing in China so the valuations of some of these stocks are cheaper than the pure mainland Chinese consumer names,” Yeo says.
Hong Kong quality
He notes that the management quality of Hong Kong companies is better than in mainland China, a factor he considers more important than valuation.
“A lot of times corporate governance can be quite doubtful in mainland China. Hong Kong is first world when it comes to law and regulation and it has been a financial centre for a long time,” he says.
Quanqiang Xian, portfolio manager of the First State China Growth fund, holds a number of consumer stocks in his top 10 holdings.
He says despite the fact a lot of good news about consumer stocks is already priced in, as a value-driven investor, he feels there are names where valuation can be justified because of the long-term growth potential of the stock.
He has, however, sold some of the more expensive consumer names.
Although the consumer theme is popular among managers, Baring’s William Fong believes exports will continue to play an important role in Chinese growth.
He says manufacturing companies have been diversifying their export markets into emerging market countries and moving up the value chain by producing more high-value goods. He believes these trends will help offset slowdown in the US market.
Growth caution
Fong holds exporters within his portfolio but he is cautious about export growth in the near term.
He says: “In the first half of this year, some export companies enjoyed strong growth momentum because of the lower base last year and the restocking from the US. We think these two positive factors will disappear gradually so we have become more conservative with export stocks but we still try and find companies that demonstrate market share gain and growth momentum in a down market.”
Yet Fong admits economic growth in China in 2009 shows exports no longer drive the market.
“China achieved over 8% GDP growth for the full year,” he says. “If you decompose economic growth numbers I would expect they were half driven by domestic consumption and half by infrastructure spending.”
He believes going forward China is unlikely to depend on exports again. He expects the Government will continue to help the economy depend more on the domestic rather than export front.
He favours consumer discretionaries because he says you can find more stocks trading at reasonable valuations with growth potential.
