Invest in the Chinese buying spree, suggests J.P. Morgan

“Three-inch throats are deeper than the sea.” J.P. Morgan uses this old Chinese adage to indicate the vast potential growth of the country’s food and other domestic consumption sectors.

The bank predicts that Hong Kong-listed Chinese consumer plays will remain resilient and outperform the broader market in the coming months or years, helped by the country’s increasing wages and rapid urbanisation that allow hinterland residents to take part in the shopping frenzy enjoyed by their counterparts in coastal areas.

Companies that play in the staple or low- to mid-end consumer segment are especially attractive bets. “Unlike the tier-one large-cap China consumer names, which are mostly trading at (price-to-earnings ratios of) 35 to 40 times, the low- to mid-tier names are trading at valuations in the teens and offer more than 20% growth in earnings per share,” Frank Li, head of China research at the bank, told reporters yesterday.

The menswear and luxury product companies also demonstrate strong earnings prospects as Chinese men attach increasingly more importance to their clothes, and growing household incomes boost the demand for expensive items such as Rolex watches and BMW cars, according to the bank.

Indeed, despite the general easing of growth momentum in industrial activity, China’s domestic consumption remains on a solid upturn, with headline retail sales rising 22.5% in July.

That is a fairly rewarding result of Beijing’s efforts to turn zealous savers into shoppers. To encourage spending, the central government has launched “old for new” purchasing plans for home appliances and passenger vehicles; and policymakers in more than 10 provinces and municipals have required employers to raise the minimum wage by an average 20% this year.

Hong Kong-listed Hengan International, a Chinese producer of sanitary napkins and baby diapers, and Changyu Winery, a Shandong-based winemaker and retailer, have seen their share prices appreciate 50 times since 2001, according to J.P. Morgan. Also on the bank's stock pick list are China Yurun Food and Dongfeng Motor.  

The rosy prospect is encouraging some Chinese retail consumption players to float shares in Hong Kong. Magic Holdings, a Guangzhou-based maker of facial masks, kicked off the bookbuilding yesterday for a Hong Kong initial public offering that could allow the company to raise up to HK$660 million ($85 million). The company is offering 200 million primary shares at HK$2.40 to HK$3.30 apiece.

Magic, which is selling moisturiser and whitening facial masks nationwide at Rmb10 ($1.50) apiece, plans to use 60% of the proceeds to advertise existing products and to build new production facilities. BOC International is managing the transaction.

Other listing hopefuls from the China mainland include Boshiwa, a children’s wear retailer, and Besunyen, a herbal tea producer. Both are currently pre-marketing for a Hong Kong share sale.

Both Hong Kong and mainland stocks showed dramatic volatility in the first half. The Shanghai SSE index dropped 26% in the first six months of this year, while Hong Kong's benchmark slid 7.7% during the period.

Although China’s equity markets will remain volatile in the coming months, because of downward earnings revision pressure, the markets will rebound by the end of this year, with Hong Kong’s Hang Seng Index to advance 15% in December, said Li. Shanghai stocks will see a similar rebound, he added.

In an interview with FinanceAsia in late June, Citi’s regional strategist, Markus Rosgen, said Asian stock markets will rebound after the summer, helped by attractive valuations and abating concerns about global growth.

However, concerns over Beijing’s tightening measures, which constantly haunt the stock markets on both sides of the border, a rise in the consumer price index and asset inflation risks, mainly on the property front, could dampen investment prospects, according to J.P. Morgan.

It’s worth noting that food prices – especially grain, vegetable and pork prices, which are key items driving food inflation – have been on the rise since early July because of domestic and external supply shortages. The worst floods in a decade have pushed up agricultural prices across the nation and, in some cities, the property bubble shows no sign of easing.