A consuming interest in China

Access Asia's Paul French gives on-the-ground insight into the China consumption story.
There have been a number of Hong Kong listings this year that ought to be beneficiaries of the increasing levels of Chinese consumption û sportswear company Xtep and department store operator Maoye International are two notable examples û but they have underperformed a poor market. Is this because there is something wrong with the fundamentals of Chinese companies, or is it due to a lack of investor confidence? Paul French, founder and chief China analyst of Shanghai-based research firm Access Asia, talks about how the consumption story has panned out.

Do you think that investors interested in China have become too enthusiastic about the consumption story?
A couple of years ago, a lot of people, led by the Chinese government, started really selling hard the Chinese consumption story. People like us said that domestic consumption is interesting, but it's not going to replace exports and investments as the main driver of the economy. There is an interesting consumption story in commodities, but the story is a lot less interesting in consumer goods.

But a lot of these guys bought into it hook, line and sinker, because they believed the government's official retail sales statistics, which is not something you should do if you're intelligent. And they decided that consumption was the future.

They also bought this ludicrous idea that the Olympics was going to boost consumption, for which there was no methodology, it was just something that people said. It didn't happen. If you look at some of the Olympic baskets of stocks that some of the banks put out, they all massively underperformed. They threw in some of the steel and cement guys û they were never going to make much money from the Olympics considering it was a drop in the ocean compared to China's overall consumption of those things. It was always the case that retail sales were going to be a bit drab over that period because of the restrictions, and we're in an inflationary environment anyway.

How much of the China consumption story was hype?
It was massively, massively hyped. So a lot of analysts became real bulls on the consumption story. And then of course the last set of numbers to come from the retailers and brands were not so good and now they have gone into complete denial about it and have become bears. There's no animal in the middle with these guys û they're just one thing or the other.

There are some numbers that are very worrying, particularly car sales. Car sales have stagnated completely. That is a disaster because there is a massive amount of production capacity so at the moment there is an incredible amount of inventory building. That is going to be a big problem.

There are some weak numbers from the retailers. The key numbers for retailers are same store sales, or like-for-likes. And some of those are a bit weaker. But they are not in negative territory, it's just slowing growth. Overall we're not really worried about it. We've had this consumption boom, which was simply linked with people having more money in their pockets. There's been a bit of inflation, wage growth has topped out, a little bit of slowdown on the stock market and in properties, and we're seeing a bit of a correction. But on the whole, retail sales are still growing. Some of the listed retailers have not performed very well, but overall the sector is very good from the ground level. The problem is, as always, you can't buy China: you can only buy listed companies with an exposure to China. If I could buy the China story, I'd buy it. But would I buy Chalco? No.

After people have paid their day-to-day expenses, such as housing and rent, how much is left for non-essential consumption?
People should still have more money in their pockets. If you look at average wage growth over the past five years compared to average cost rises over the past five years, people should be ahead. Inflation has only really been in food, and only in specific sectors of food, mostly pork, which has only affected certain types of people, like the poor or the unemployed. The average middle-class Chinese by and large won't have noticed it.

That's not true of petrol prices, which is one of the reasons that car sales have ground to a halt.

Are there any other macroeconomic trends that are affecting consumers or retailers?
ThereÆs one thing that nobody ever talks about. People always say that itÆs inflationary pressure, itÆs negative wealth from the downturn in the property and stockmarket, itÆs a post-Olympic slump, we've had terrible weather conditions. But what people never talk about, what the listed retailers never talk about û obviously û when they talk to the analysts is that they are "a bad retailerö. Some retailers are doing very well, some are not, and quite often that's due to the fact that they are not very good at what they are doing.

Are Chinese consumers interested in cheap and cheerful things or are they becoming more inclined to splash out a bit?
It depends on who you are. If you haven't got much money, it's cheap and cheerful. But when it comes to foreign brands, they are not interested in those people, because they haven't got money for the things they are selling. They want middle-class people. Foreign brands still invariably beat Chinese brands all the time.

What people are looking for is quality. People are very quality conscious. They feel that they get that more from foreign brands and you get more status from them. Even though the earnings are looking good at the moment, I wouldnÆt hold stocks like Li Ning.

The Chinese sportswear sector, including companies like Xtep, has performed particularly badly recently, do you think there is anything fundamentally wrong with the sector?
Yes, they are not called Adidas or Nike.

Do you think that they could develop their own brand equity?
No, they can't. It's a simple money equation. People like Li Ning and Anta, because they sell at a lower price, they rely on the people that can't afford to buy Nike and Adidas. What no-one really expected was that inland province wage growth would be so strong that people are leapfrogging Li Ning and Anta and going straight to Nike and Adidas. We all thought that wouldn't happen for a few years.

At the same time Nike and Adidas have really ramped up their distribution, so Li Ning doesn't really have a massive advantage in terms of the distribution network anymore. So they're starting to get squeezed.

If people can afford it, they will go for a pair of Adidas rather than a pair of Li Ning.

The one exception to that is a company that I like a lot, a company called China Dongxiang, who are the people who own the rights to the Kappa brand. That's a massive story. They are manufacturing here, they are doing the design here, they've got their own shop and they are doing no advertising. And they are selling a load of stuff. They're able to do this because people think that they are buying an Italian brand, not a Chinese brand.

If you wanted to cash in on increasing rates of Chinese consumption, which sectors would you focus on?
Commodities. The commodities story is the one where everyone has made money. Chinese retail is fine, but look at the price of the stocks û they are trading at 20, 30, 40 times earnings. You'd have to have one big consumption boom to meet those targets. If you're holding them for a long time, maybe that's ok, but by and large I wouldn't necessarily get into the retailers.

It's a commodities story, this is still where the money is. But I wouldn't necessarily buy Chinese commodity companies, I'd buy BHP or Rio Tinto.
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