Dr. P.V. Viswanath
10 Chinese Brands You Must Know
Barron's August 13, 2012
Beijing has begun to push consumption to kick-start its economy. Here are tomorrow's big beneficiaries.
By Kopin Tan
Shopping is still an unfamiliar pastime for the Chinese. Centuries of Confucianism emphasize the cultivation of virtue and ethics, not the creation of a snazzier wardrobe. Just a generation ago, Mao Zedong's Communist government outlawed personal property and purged the land of private possessions.
These days, however, Beijing would like nothing more than for 1.4 billion Chinese to shop until they drop -- or at least until its economy perks up. Having tripled China's gross domestic product over the past decade, the government now has pronounced that the country's heavy reliance on exports and investment for growth is "unstable, unbalanced, and unsustainable." Friday's disappointing Chinese trade numbers were just the latest evidence. Private consumption made up just 35% of GDP last year, down from 46% in 2000, and goosing domestic spending has taken on new urgency now that Europeans and Americans are no longer gobbling up goods churned out by China's factories. It's an unusual message from a communist regime: Materialism is the new patriotism.
As China tries to make consumption more conspicuous, Barron's decided to window-shop for 10 publicly traded domestic brands that stand to prosper. Make no mistake, many popular brands in China right now are foreign. General Motors (ticker: GM) sells more cars there than in the U.S., Apple's (AAPL) mobbed stores require security rivaling a U2 concert at Madison Square Garden, and Coca-Cola (KO) is as at home in China as anywhere. But as China's consumer class grows, the biggest beneficiaries will be its home-grown labels; by extension their stock prices should also do well over time. Consider Coke's 7,000% rise over roughly four decades or Apple's 5,000% gain in two.
By shorter-term valuation measures, the stocks of some of our Chinese picks aren't cheap (see table above) and, in a few cases, their immediate prospects are challenging. Some companies on our list are typical of an emerging economic power: Lenovo (992.Hong Kong), for example, is China's biggest computer maker, and Baidu (BIDU) is essentially China's Google (GOOG). Others are unique to Earth's most populous nation: Moutai (600519.China) makes a lethally strong liquor first mass-produced during the Qing dynasty in the 17th century, and today is the toast of choice for special occasions. Yunnan Baiyao (000538.China) produces traditional Chinese medicines that are finding their way into everything from toothpaste to tea.
There couldn't be a better time for consumers to plunk down more yuan. China's economic growth has slowed to a three-year low near 7.6%, but it's strongly supported by 13% year-over-year growth in retail sales. Although the country's economy is the world's second-largest, per-capita income ranks just 92nd. Beijing desperately needs income and spending to increase, not just to rebalance its economy, but also to appease its citizens and stave off social unrest. To encourage people to spend more and save less for a rainy day, Beijing is expanding retirement pension coverage from 250 million of its people today to 350 million by 2015. Expect further tax reforms and consumer subsidies. "As part of the long-term agenda, we anticipate accelerated enhancement of social welfare, pension schemes, education, health care, and personal lending," says Joseph Tang, Invesco's Hong Kong-based investment director, who sees discretionary spending outpacing GDP for years to come.
China's relentless urbanization will induce more of its citizens to open their wallets. By 2020, about 850 million Chinese will live in urban areas, up from 650 million in 2010, says a McKinsey study. One in every five city-dwellers will be a first-generation migrant, and the range of goods catering to this urban sprawl makes brand choices a bigger individual statement. From Shanghai to Shenzhen, you are what you wear, where you shop, and what you drive.
In some cases, there's still time for a local champion to emerge. For instance, our list lacks domestic luxury fashion brands, since most Chinese labels don't yet have the rich history to lure fashionistas away from Chanel, Hermes, and Gucci. Women's fashion is similarly commoditized, with little consumer loyalty.Domestic food brands are growing fast but susceptible to food-safety flubs, from melamine in milk powder to exploding watermelons over-sprayed with growth chemicals. And while the Chinese are becoming zealous travelers, China's big three airlines haven't built much of a reputation–except for surly service and rubbery cuisine.
In most areas, however, we found our favorite. Here's our selection of China's 10 top brands (in alphabetical order):
China's dominant Internet search engine controls 79% of its US$4 billion search market. Baidu -- whose name means "hundreds of times," and comes from a Song Dynasty poem about a man's search for an elusive beauty -- has benefited from Google's 2010 withdrawal from the mainland over a censorship spat with Beijing. But the brand also "owes its popularity to deep familiarity with the subtleties of Chinese language and culture," notes Millward Brown, a global brand research agency. The keystrokes to type requests in Mandarin are different from those for English. Baidu's grasp of the nuances of Asian-language search requests explains why it has also launched a Japanese search engine, its first outside China.
Baidu's next challenge: Cornering the newer, faster-growing market for mobile-device searches, where its share is just less than half. As a result, the stock currently trades at a much more attractive 27.7 times projected profit, well off the median of 54 times since its 2005 debut on Nasdaq.
The company has more than 683 million customers and the world's largest telecom network -- it even provided coverage from 21,325 feet when the Olympic torch traversed Mount Everest on its way to Beijing for the 2008 Summer Games. Its US$233 billion market cap is the second largest in Asia. But it's a behemoth at a crossroads. Its third-generation network is based on a standard used only in China, so it can't match the range of rival smartphones, including Apple's coveted iPhones. Subscriber growth is slowing, and new software on mobile devices is rapidly changing how people communicate.
Still, China Mobile (941.Hong Kong) has a massive war chest, including $48 billion in net cash, and is developing a quicker fourth-generation network. Americans tend to see their telecom providers as an annoyance to be endured, but in China, where news is state-controlled and information scarcer, the locals have a stronger attachment to their phones. For now, callers also can't switch providers easily without changing their phone numbers, which helps China Mobile hold on to customers.
The shares late in 2011 drew in respected value investors like AQR Capital Management's Cliff Asness and Dreman Value Management's David Dreman. The P/E ratio, at about 12, hasn't changed much since.
Great Wall Motor
Many Chinese would rather drive Audis, BMWs, or Mercedes-Benzes, but just 2% of the urban population has disposable annual household income of more than $34,000. The 82% who have between $6,000 and $16,000 care more about value.
Among local auto makers, Geely (175.Hong Kong) may have the more recognizable brand, since it makes passenger cars, including its charming hatchback, the "Panda." But Great Wall is China's leading SUV and truck maker and has a reputation for delivering good value. "I actually think Great Wall has a better quality perception in SUVs and trucks than Geely does in cars," says Earl Yen, portfolio manager of Shanghai-based CSV Capital Partners.
First-half results trumped estimates, with sales rising 29% and profit jumping 30%. Higher-margin SUVs drove 41% of sales, up from 33% a year ago. Car ownership in China is still low by global standards -- one for every 17 people -- and Great Wall is exporting more to Southeast Asia and the Middle East. No wonder shares (2333.Hong Kong) are up 49% this year, leaving other Hong Kong-listed stocks in its rear-view mirror.
For a household name, Haier is a bit of a mystery. It's the world's biggest appliance brand and owns 8% of the global market for white goods. Its Hong Kong-listed unit, Haier Electronics (1169.Hong Kong), is China's biggest maker of washing machines and heaters, while Shanghai-listed Qingdao Haier (600690.China) makes air conditioners and refrigerators. Yet analysts can't pinpoint the value of the state-owned parent, a collective belonging to employees (who do not receive dividends or know exactly what they own).
Even so, the brand -- Haier comes from the Chinese pronunciation of Liebherr Group, an early German partner -- is based on its range of products -- everything from robots to walk-in wine coolers -- and attentive after-sales service. Factory locations stretch from Southeast Asia to South Carolina. A network of more than 7,000 mainland stores helps sell Haier and third-party appliances in small cities and rural areas. Management's boast: it can deliver anything within 200 kilometers (124 miles) of its stores in 24 hours.
Such a reputation comes at a premium. Haier Electronics, for instance, fetches 10.6 times 2012 profit, above 7.7 times for its peers. Yet a government "Home Appliances to the Countryside" program that subsidizes purchases will expire in January 2013 and may have pulled sales into 2012. The soft housing market also is a flashing yellow light.
Some time in 2012 Lenovo should overtake Hewlett-Packard (HPQ) as the world's biggest personal-computer producer. The Beijing outfit, which bought IBM's (IBM) ThinkPad business in 2005, already sells one in three PCs in China, and its share of global PC sales jumped to 14% from 10% in 2011. An amazing 93% of its $30 billion annual revenue comes from computers, but it's starting to make other gadgets, too.
Shares of the future No. 1 trade at 14 times fiscal 2013 profit, versus peers' 9-10 times. But the stock has skidded 20% since early May as year-over-year growth in Chinese PC demand slowed from double digits to 5%.
Count on a 2013 recovery, however, as Chinese broadband service becomes more widespread and affordable, and as PC makers unveil new products. Internet penetration -- a proxy for computer use -- also remains low in China at about 36%, compared with nearly 80% in the U.S., and Lenovo's familiar name will give it an edge in winning over newer rural customers.
When China went to her maiden Olympics in 1984, millions watched on TV as the gymnast Li Ning won six medals, including three golds, to become the country's most decorated athlete. The "prince of gymnastics" put his fame to shrewd use, and today Li Ning is China's second most recognized sporting-goods brand, after Nike (NKE).
Now, however, the respected brand is in danger of getting left off the medals podium. It over-expanded after the 2008 Beijing Olympics (when its founder was airlifted into the opening ceremony to light the Olympic cauldron). Net income surged 52% in 2008, but by 2011, inventories had piled up just as Chinese shoppers were turning to cheaper Western brands. Profit plunged 65% last year, and shares (2331.Hong Kong) today are 4.68 Hong Kong dollars (US$0.60), down from HK$31 in mid-2010.
Management's task: To bring its apparel and equipment to market more quickly and cheaply, shift from the crowded casual wear segment toward higher-margin "performance gear" made of more sophisticated material, and appeal to younger people. Li Ning now sponsors the Chinese Basketball Association and is revamping with capital from private-equity firm TPG. Profit forecasts still look high, says Morgan Stanley analyst Robert Lin, but "the company has strong brand equity, boding well for top-line gains and margin growth in the long term."
Declared a national drink in 1951, centuries-old moutai is a clear, yellowish liquor fermented from sorghum. It's drunk in vast quantities as shots -- "gan bei," or bottoms up! -- and the knockout alcoholic level (as high as 53% of volume, versus about 12% for red wine) makes you forget it smells like soy sauce. No wonder Henry Kissinger once told Deng Xiaoping: "If we drink enough Moutai, we can solve anything."
Kweichow Moutai, the state-owned giant that makes its namesake liquors, saw profit jump 74% in 2011 to $1.4 billion. Revenue expanded 58%. There is some worry that Beijing's push to stamp out bribes and tighten its entertainment budget could cut into Moutai's exuberant sales.
The company is opening more self-operated stores to better control its distribution and fight counterfeiting. Its Shanghai-listed shares trade near an all-time high and fetch 19 times 2012 profit, above 18.6 times for Diageo and about 16 times for global-liquor companies. Still, Credit Suisse says Moutai deserves the top-shelf premium and makes it the No. 1 pick among Chinese white spirits.
When reigning badminton world champion Yu Yang was disqualified from the London Olympics for tanking a match, she quit her sport in modern Chinese fashion: She announced her retirement -- "Bye bye, my beloved badminton" -- on her Tencent microblog.
In a country where news is scrubbed by Beijing and large gatherings frowned upon, Tencent—China's biggest and most diversified Internet company -- has become the people's public square. Tencent has the world's largest customer base: 721 million registered users for its instant messaging service, 552 million social-networking users, and 373 million micro-bloggers like Yu Yang. Nearly 72% of revenue comes from an Internet services unit dominated by a maturing online games platform, so Tencent has expanded into other areas, like faster-growing e-commerce, online advertising, and mobile services by providing ringtones and text messages.
"Tencent has so far been the most successful company at monetizing its user base," says Invesco's Tang. Revenue grew 45% last year to $4.5 billion, while operating profit rose 25%. Shares (700.Hong Kong) are up 54% this year and aren't cheap at 27 times 2012 profit, versus 16 times for global Internet stocks and 15 times for Google. But that's a vote of confidence that Tencent will stay ahead of China's maturing Internet boom.
The average Chinese drinks less than half the beer consumed by an American, and just a third of that guzzled by a German. Yet China's vast population makes it by far the world's biggest beer market. China Resources Enterprise (291.Hong Kong) may have a 22% market share from peddling cheap beers. But it's the No. 2 volume leader, Tsingtao (market share: 14%), that has the older, more famous brand -- and the coveted toehold in the faster-growing premium aisle.
Tsingtao is a Chinese beer with German grandparents. Founded in 1903 by Anglo-German settlers, it was reportedly brewed to strict German standards and with mineral water from China's Laoshan Spring. Even today, that hoppy Pilsner taste helps it wash down quickly and easily.
Chinese beer consumption climbed 5% last year, but Tsingtao's volume grew 13% while profit increased 14%. Grain costs are a concern, but brewers can raise prices, and at about $0.80 a liter, average selling prices of beer in China are still low compared with the global average of $2.20. No wonder Japanese breweries are circling, with Asahi taking a 20% stake and Suntory forming a joint venture with Tsingtao. The stock (168.Hong Kong) trades at a full-bodied 25 times profit.
Legend has it that Yunnan Baiyao, which means "white medicine from Yunnan province," was concocted in 1902 by a man who scoured the countryside, testing bushels of herbs. From ginseng and other astringent roots he made a white powder widely used to stem bleeding when China fought Japan during World War II. After he died, his widow handed the secret formula to the government.
But just how do you sell traditional Chinese medicine in the 21st century? The state-owned company began putting it in capsules, bandages, skin creams and beverages. After a five-year push, the brand has snagged 10% of China's toothpaste market, and is now targeting the bigger shampoo and pharma-cosmetics segment.
From 2006 to 2011, sales more than tripled to $1.8 billion, while profit quadrupled. Raw-material inflation bears watching, and margins could fall as Yunnan competes in the crowded hair-care sector. But Morgan Stanley sees revenue growing 14% in 2012 and profit rising 24%. The stock reflects its recent success, trading at 28 times earnings.
These are high expectations, but pressure is a privilege all big brands must embrace.