A new model for investing in China as rural incomes grow
02/01/2013 8:30 am EST
You don’t suppose they actually meant it?
Recent data says, absolutely. In 2012 rural incomes rose faster than urban incomes—that’s three years running. Rural income from benefits payments rose 21.9%, twice the rate in urban areas, as the government increased its spending on healthcare subsidies by 36%. And since poor families tend to consume a higher portion of their income than the wealthy, the growth in rural incomes should help with the goal of rebalancing the Chinese economy toward consumption.
What does this mean for investing in China?
It’s certainly not time to throw out the traditional model, which has stressed the shares of exporting companies and of the commodity producers that fuel their growth. Nor to abandon the shares of companies that cater to the rising incomes—and in some cases rising wealth—of city dwellers. China’s urban population accounts for about 53% of China’s total population of 1.35 billion, according to the National Bureau of Statistics. But rural spending in 2012 was less than a fifth—at $447 billion—of urban spending.
Still given the way the trend is trending in China, I’d recommend adding a stock or two or three from companies positioned to profit from growing rural incomes. Retail sales in rural regions did grow by 14.5% in 2012, faster than the 14.3% growth for retail sales in urban areas. That's the first time that’s happened in three years. (Growth for both rural and urban retail sales were down last year from the 16.7% and 17.2%, respectively, recorded in 2011.)
But to understand what companies will do best in this changing Chinese landscape, you have to understand that the biggest beneficiaries of a rise in rural incomes aren’t actually rural areas, but China’s small and medium-size cities. In this post I’m going to begin by explaining how China’s “rural” trend works to benefit China’s smaller urban areas. And then I’ll give you the names of three stocks that I think are well positioned to profit from the way rising “rural” incomes work on the ground in China.
There’s no doubt that official rural incomes are rising. Rural per-capita net income grew 10.7% in 2012, according to the National Bureau of Statistics (versus 9.6% for city dwellers.)
Part of that is an increase in government “transfer” payments for pensions and healthcare. Part of it is an increase in farm incomes as agricultural production and prices rise. But a big part of the increase comes from growing wages for China’s army of migrant workers—230 million by official count—that aren’t really rural at all.
China’s system of household registration—known as hukou-- prevents migrant workers from rural areas from getting permanent residency status in the urban areas where they work. They make their money working in the city and they’re seeing wages rise thanks to government policy and China’s growing shortage of workers for factory jobs. But officially these workers are still residents of the rural towns of their origin. They aren’t eligible for education or health care in the urban areas where they live. But their incomes count as rural for official statistical purposes.
In February 2012 the State Council announced a major effort to tackle the non-registered migrant worker problem. The government will implement a policy to help migrant workers register in urban areas.
But not in all urban areas. The government will continue policies to limit the growth of the country’s biggest cities such as Shanghai and Beijing. The new registration policy will be targeted at helping migrant workers attain resident status in small townships and small to medium-size cities. In effect as these policies are implemented migrant workers who are now registered in rural areas will become residents of the small and medium-size urban areas. And in government statistics they will take their incomes with them. Gradually many of these formerly migrant workers will actually move their families from rural areas to these small cities. In these cities these still relatively low-income workers will see their discretionary incomes increase as they become eligible for government-funded education and healthcare.
From this perspective the “rural” income story is actually a “Tier 3 cities” story. China has 12 Tier 1 cities with populations of 5 million or more. These are the cities in China most familiar to most of us—Beijing and Shanghai, for example. But Tier 1 cities account for just 9% of China’s population. Tier 2 cities number somewhere between 23 and 60, depending on your definition.
But 160 of China’s 655 cities fall into Tier 3. With populations of 1 million or more individually, China’s Tier 3 cities represent a total market of 300 million. That’s roughly the size of the U.S. market.
And Tier 3 cities represent an extraordinary opportunity for the right companies. Yes, the growing incomes in Tier 3 cities make them attractive new markets for companies like Yum! Brands (YUM) and McDonald’s (MCD) that have expanded from Tier 1 to Tier 2 cities and now need new worlds to conquer. But when these Western and Chinese big boys arrive, they’re going to discover other Chinese companies in place. These companies have been building positions in Tier 3 cities for years. They know local markets and have tailored products for local markets. At least initially much of the growing income in Tier 3 cities will go to these incumbents. Only gradually will some of the most flexible and innovative big players grab a piece of this market.
Buying into these Tier 3 masters and even into the flexible big players that will gradually work their way into these markets isn’t always easy. Many only trade in Hong Kong or Shanghai. It’s not that hard for U.S. investors to buy on the Hong Kong market these days. In the following suggestions I’ve tried to give a mix of Hong Kong- and New York-traded stocks.
Hengan International Group (1044.HK in Hong Kong) sells disposable diapers under the Anerle brand name. It is China’s largest tissue paper producer and the country’s second-largest diaper producer. The company has focused on building its brand and sales network in rural areas. (Baby products in any part of China’s market should do well during China’s 2005-2020 baby boom. The boom is projected to peak in 2016.)
Sun Art Retail Group (6808.HK) is the biggest operator of hypermarkets—12.8% market share--in China so I wouldn’t say that it has focused on rural or Tier 3 cities. But the joint venture between Taiwan’s RT-Mart and France’s Groupe Auchan has beaten Wal-Mart (WMT), Tesco (TSCO.LN in London or TSCDY in New York), and Carrefour (CA.FP in Paris or CRRFY in New York) to a pulp in China by fine-tuning a combination of Wal-Mart style prices and selection with features that draw in local shoppers accustomed to selecting their own fresh fish from tanks and buying dishes such as steamed pork buns and fried noodles from store kitchens while they shop. The company’s experience in hiring local managers and then giving them the room to adapt to local markets will be a huge edge in tackling Tier 3 cities. (Don’t overlook a regional chain such as the Suguo stores operated by China Resources Enterprise (291.HK in Hong Kong or CRHKY in New York.))
Tingyi Holding (322.HK in Hong Kong or TCYMY in New York) owns Master Kong, the second most valuable brand (2011 survey data) in China after Sony. That plus an extraordinary distribution network gives Tingyi the ability to expand sales of its instant noodles (the company is the largest instant noodle producer in China) and beverages (including soft drinks) to new markets in smaller cities and rural areas as incomes rise.
Another name I suggest you watch is Gree Electrical Appliances, but at the moment the stock trades only in Shanghai (000651.CH.)
A final stock that’s fits this shift in China’s economy is Home Inns and Hotels Management (HMIN) but those shares are already part of my Jubak’s Picks portfolio http://jubakpicks.com/ .
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Home Inns & Hotels Management and Tingyi Holdng as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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