China Research Trip: How are the China consumer stocks travelling?

2017 has already has been a stellar year for Chinese equities, with the MSCI China Index now +14.5% since January 1st, ranking it as one of the best starts to a calendar year for any world equity index since the GFC. The strength in a number of the China consumer names is of particular interest: the Global X China Consumer ETF +19% since the start of the year would imply that investor sentiment at the very least continues to grow in the space. So what is the current state of play for the ASX-listed China facing businesses? We visited China this month to find out.

Given two members of the Ophir team have Chinese-language speaking backgrounds and extended family networks through the region, we are fortunate to have some degree of competitive advantage when seeking to understand the emerging China growth trends. This background helped both portfolios significantly in 2015 when we identified the pending growth in vitamin and infant milk formula stories early, and we continue to travel to the region regularly to monitor developments in the space and search for new opportunities.

Both Ophir portfolios continue to hold a position in A2 Milk (A2M), who’s branded infant milk formula product has grown significantly into China and continues to see market share growth. We took the opportunity this month to visit a number of end customers, e-commerce platforms and product competitors to gauge the current state of the markets. From our channel checks, there still remains a significant market opportunity for the brand to grow into, particularly given it still sits under the radar of the larger and more established branded offerings.

The space saw some industry-wide discounting toward the end of 2016 as a result of an excess inventory build, although this was primarily concentrated within the more mass-market and premium product offerings – our analysis would suggest the inventory build is being worked through and will likely subside by May and June. Importantly, the elevated inventory levels haven’t impacted the ‘super-premium’ brands, including A2. The recent production upgrade from NZ-listed competitor Synlait would indicate other competitors are positioning themselves for further growth in the region and we remain equally comfortable with our own growth forecasts for the business.

One small negative was the bulk of domestic industry players we spoke with didn’t feel the recent loosening in industry regulation would actually have any great effect on the operating environment. The announcement this month from China’s Ministry of Commerce of no pending regulation changes in cross-border trade for food products saw rallies of +10-15% in the share prices of names such as Blackmores (BKL) and Bellamy’s (BAL). While a degree of that may have been short covering, we would remain cautious that both names could have some optimism baked into their share prices here, given the feedback from end users.

The skincare space is a more recent hotspot for consumer activity and the demand for premium and organic skincare continues to grow well. South Korea has been a huge beneficiary of this demand growth, with outbound shipments of Korean makeup products totaling US$1.56bn in 2016, a more than three-fold increase from the US$300m exported in 2013. However, recent diplomatic tension between the two countries (in reaction to South Korea’s decision to allow a US missile defense system within its borders) have led to a number of economic sanctions on Korean exports, including the cosmetic industry and, bizarrely, the cancellation of a number of K-Pop music group tours. The supply squeeze will likely open up opportunities for new players and there are opportunities to play this in Australia via names such as BWX Limited (BWX) or Trilogy International (TIL)– if either begins to gain traction, one would expect to start to see an impact on their reported market share numbers over the next 3 months. We will continue to monitor.

On the resources demand side, the spot price performance of various bulk commodities clearly indicates where the current sentiment sits and the feedback on the ground remains equally optimistic. China PMI data remains firm, while the PPI inflation readings (a measure of price rises in upstream industries such as mining and agriculture) rose +7.8% for the month to the highest level since September 2008. A large component of growth is again coming out of the home construction side, with an added tailwind from the massive ‘one belt, one road’ transport infrastructure initiative. This comes at a time when domestic steel production capacity has been steadily reducing– hence the surging steel and iron ore prices of recent months. Of most interest to us this trip was the insight that the most recent round of steel production capacity cuts have come out of ‘real’ or existing capacity, whereas last year’s capacity reduction largely came from smelters that had already been sitting at idle.

The demand drivers for steelmaking components, therefore, continues to look relatively firm - coking coal, particularly, looks like it can stay elevated for some time given both domestic supply and North Korean supply has been reduced and current inventories are being drawn down. This thematic will likely accelerate over the coming months as a result of the recent QLD coal mine shutdowns following Cyclone Debbie. Iron ore demand remains relatively robust, albeit we are mindful that supply inventories at Chinese ports are now building at a time when seasonal restocking has looked to have peaked.

Contributed by Ophir Asset Management