The Monday Edition- Beneficiaries of China’s Consumer Spending

By Yaser Anwar, CSC of Equity Investment Ideas

In this week’s report I breakdown: The Catalysts For China’s Consumption Growth (increase in PPP, consumption boosting policies etc) and Beneficiaries of Consumer Spending (PG, BIDU, MCD, LVMH etc.). Thank you in advance for your time!

Catalysts For Growth: Consumption Boosting Policies (Tax cuts and increase in PPP)

• There are three key drivers of the increase in Chinese consumers appetite: economic growth, rising income per capita and currency appreciation. The per capita income in China has grown from $280 per year two decades ago to over $5.6+K (PPP method, Atlas method= $1.5K).
• China’s population of 1.3 billion+ translates into consumer dollars going in cars, houses and electronics. Measured on a purchasing power parity basis, China in 06 stood as the second largest economy in the world after the US, although in per capita terms the country is still lower middle income with 130 million Chinese below international poverty lines.

• Private investment and enterprises alongside consumer spending have been blossoming resulting in a Chinese economy that is more robust and stable than it has ever been. Why? China has made several changes that should help boost consumption, such as:
• 1) The threshold at which income tax kicks in was doubled to USD$200/month, which means people at the lower end of the income scale, who spend more of their extra income, will have more to spend.
• 2) The elimination of the agricultural tax nationwide will likewise give rural residents more disposable income. Previously, rural residents had to pay the tax regardless of income or profit.
• 3) Civil servant wages are expected to rise this year, in connection with reform of the civil servant pay system, according to Premier Wen Jiabao’s Government Work Report.

• "Over the next ten years, estimates range from anywhere between 150m to 300m people! Such a rapid urbanization represents one of the most dramatic population shifts in History. It presents China with both challenges and opportunities.
• Around 80% of China’s growth in the past ten years has come from its cities. Over that period of time, China has added nearly 200 ‘new’ cities. There is little doubt that China’s urban migration requires massive capital spending: housing, schools, sewer systems, power plants, transport system… all need to be built if China is to avoid its cities spurring shanty-towns such as Cairo, or Calcutta."** GaveKal Ad Hoc Comment ‘Part 1: Why We Remain Bullish’ Wednesday, April 4th, 2007

Beneficiaries of Consumer Spending

• 1) Coca-Cola (KO) has held a rather commanding and consistent position in the non-alcoholic beverage segment in China in the past three years. Coca-cola retains its strong popularity among non-alcoholic beverages and is consumed most in Shenyang (38%), Guangzhou (34%) and Xi’an (36%).
• Coca Cola consumption spread relatively evenly among the different age groups, with the 50-59 age bracket having the highest share of 29% and the 20-29 age bracket having the lowest share at 25%. Another play would be Global Bio-chem Technology Group, which is a major syrup provider to the growing cola market in China.
• 2) Procter & Gamble (PG) is well positioned in household and personal care products through its Pampers brand in diapers and its Olay brand in skincare products.
• 3) With the acquisition of the PC division from IBM, Lenovo owns the top PC brands in China and became the third largest global PC-maker, selling around 8 million annually in China alone. In China’s PC market, Lenovo commands a 35% market share, double that of Founder, which comes in at second place with 14%.
• 4) LVMH is best positioned in the luxury goods segment through its Christian Dior brand in perfumes and Louis Vuitton in leather goods. Swatch Group has a very dominant position in the premium watch segment through owning the top three brands: Longines, Omega and Rado.
• 7) In the Internet space, Sina Corp is the strongest franchise in Chinese portals, Tencent Holdings in chat rooms and online games through its QQ brand, Baidu in search engines and Ctrip.com in online travel.
• 8) China is the world’s largest cell phone market with a 450 million cellphones in use there now (source CNN Money). Mobile phone handsets is dominated by Nokia, Motorola and Samsung Electronics.
• 9) McDonald’s owns 750 restaurants in China. It plans to build another 250 by the opening ceremony of the 2008 Olympics, and half of these new restaurants will be drive-thrus vs. less than ten MCD’s restaurants in China have drive-thrus.
• 10) Singapore Airlines with its positive recognition in China, looks well positioned to benefit from the overseas travel trend of Chinese and Intercontinental Hotels Group. IHG, the largest hotel operator in the world, is building 11 new hotels in China this year. Overall, they plan to build another 61 hotels in China before the end of 2008.
• 11) China Construction Bank is benefiting today from its first-mover advantage in the mortgage business, but ICBC has used its strong customer network to claim the leading position in both debit and credit cards.
• 12) Commencing in 1988, the new Chinese interstate network should total 175K km by 2050. To reach its goal, China will have to lay more than 3K km of highway every year for the next 44 years. J.D. Power and Associates estimates vehicle sales in China will double over the next three years.
• Denway Motors, a Chinese car manufacturer currently in a joint venture with Honda, a play on the growing ability of Chinese workers to buy automobiles. Restrictions on low-emission, economical cars have begun to be eliminated in areas such as Shanghai, which should boost sales.

That’s all for this week, thank you for your time.

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