Sunday, 17 February 2013

Investing in China’s ugly growth

Commentary: Opportunities lurk amid thick smog

By Craig Stephen

Reuters
Smog and other air pollution obscure the portrait of late Chinese leader Mao Zedong at Tiananmen Square in Beijing.
HONG KONG (MarketWatch) — They say China will grow old before it grows wealthy. You might have to add that it will choke to a standstill if it grows any faster.
Last week came the news China had displaced the U.S. as the world’s largest trading power by sum of exports and imports. Another first perhaps for the world’s factory workshop, although it is likely to be somewhat bittersweet as the costs of this growth mount.
This past month, pollution in Beijing has reached such proportions that it has been dubbed “airpocalypse” or “airmageddon” by Internet users. Roads have been closed and flights cancelled, amid thick-smog-generated pollution readings as bad as 30 times the maximum level deemed safe by the World Health Organization.
This pollution crisis underscores that China’s export-investment model of development is fast approaching its sell-by date, giving Xi Jinping’s new government another reason to push the agenda of reform.
But as well as potential policy reform, investors should look at areas where China’s ugly or uneven growth is reshaping consumer behavior.
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Granted, China’s unique brand of state capitalism has created an economic juggernaut. But it is also throwing up a range of distortions, from pollution to fake products to media controls, all of which can produce investable themes.
One way of playing pollution has been renewable energy, although a glut of supply in China’s solar energy has made this sector problematic.
That said, the share prices of various China-based solar stocks have picked up strongly in recent months. Various Japanese companies have also reported big increases in sales of air purifiers in the past weeks, which are fast becoming an indispensable household item.
Another consequence of pollution is that, apart from cleaning up, more people just want to clear out, at least temporarily.
A search for blue skies and fresh air provides another boost to outbound tourism, which is shaping up as China’s newest hot export. In the past decade, outbound Chinese tourists have increased from 16 million to over 70 million, and this trend is expected to continue.
Another attraction for overseas Chinese visits is not just clean air, but also better shopping. Shoppers are attracted to buy abroad as sales taxes are often less and products are less likely to be counterfeit.
A recurring problem in China’s dash for growth has been fake products, now including not just handbags and CDs but also foodstuffs.
In Hong Kong, this has given birth to a new form of shopping tourism for basic necessities, such as baby-milk formula. The scale of this cross-border trade has reached levels where authorities have even had to impose draconian quotas on sales of milk formula.
It has also reached a stage where worries over food safety are endemic in China. Surprisingly, Kentucky Fried Chicken is often marketed on its healthy reputation, not because deep-fried is low calorie, but because a foreign brand is trusted not to use counterfeit ingredients. This was the case, at least until recently, when owner Yum Brands YUM +0.16%  stumbled into trouble with its chicken supplies.
Arguably, this lack of trust in food safety is reinforced by another peculiarity to China’s economy: media censorship. This dates back to an earlier scandal, where authorities suppressed reporting of toxic baby milk containing melamine until after the Beijing Olympics.
Overall, the media sector has some of the heaviest regulation, from widespread censorship to restrictions on foreign participation in print or TV. This means the choices and quality of content have tended to be sub-par, with state broadcaster CCTV hugely dominant.
Yet there is still a huge demand for entertainment — which might also help take peoples’ minds off the gray skies outside.
One area where authorities have been loosening control is the movie business.
This has resulted in an explosion in China’s box office, with 2012 revenues growing 31% to $2.75 billion — and with China displacing Japan last year as the world’s second largest market, according to the Motion Picture Association of America. The 11,000 cinema screens in China are increasing at a rate of 10 a day and are forecast to double by 2015.
Hollywood is also getting a bigger slice of the action through production joint ventures, which give domestic distribution rights. As the appetite for movies increases, we can also expect more ice-cream, hot-dogs and soda to be consumed.
Perhaps there is a China box office theme giving added sauce to Warren Buffett’s recent acquisition of Heinz HNZ -0.30% ?
Another consideration is certain areas of the economy, such as education and health care, have not prospered under the current system. Both these sectors have plenty room for catch-up in the next phase of China’s growth.
Also, if the pollution doesn’t improve, expect a growing stream of mainland
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