China consumer goods saturated but services to grow
Oversupply and labour costs hurting manufactures as economy shifts to services
Not all consumer stocks are poised to benefit alike from persistent income growth and household spending in China, analysts say, with the fortunes of the goods and services sectors set to diverge in the coming year.
Mass market consumer goods companies face lingering price deflation in a low-inflation environment along with flat sales volumes in overcrowded markets. Meanwhile, marketing and labour costs are rising, according to a report from BNP Paribas last week.
“We recommend investors reduce exposure to mass market consumer goods,” said Charlie Chen, a BNP Paribas analyst. “Reverse operating leverage is likely to hit these companies.”
Analysts say industries from food and beverage to retailing remain burdened with overcapacity, notwithstanding the suspension of expansion plans by many companies.
“Cutting obsolete and idle capacity in China is not easy and will take time due to social responsibility concerns,” Chen said.
Even if capacity can be reduced, the marketplace is increasingly crowded with competing foreign brands, which are winning consumer preference and becoming increasingly affordable amid lower transportation and logistics costs and reduced import tariffs.
BNP Paribas forecasts low single-digit growth in the snack food, instant noodle and dairy industries, where domestic firms have battled each other and now face popular import labels. It advises investors to reduce holdings in Tingyi, Want Want and Mengniu Dairy.
China’s liquor industry could be an exception. Although baijiu sales were adversely affected by the mainland’s anti-corruption drive, analysts say volume is recovering and leading established brands like Yanghe are poised to raise prices.
“Chinese baijiu brands are different from other food and beverage brands in that they typically have very long histories – usually over 100 years – and have specific cultural and geographic characteristics that cannot be easily copied,” Chen said.
As the mainland economy creaks towards services orientation, BNP says the factors weighing against goods are benefiting the services sector. Rising labour costs are flowing into higher services prices, while lower penetration means there is room to grow volume.
Chen said evidence that China had entered a services-driven stage of economic growth could be found in the fact that the services consumer price index had outperformed the goods consumer price index since mid-2012, a pattern he expects to continue.
A characteristic of that shift is reduced demand for material products and higher demand for products which require relatively less natural capital and more human capital, including health services, education, entertainment and travel.
BNP Paribas says the best bet is the education sector, with private education market growth having exceeded GDP growth and urban disposable income growth over several years. Stock picks are Tarena International and China Maple Leaf Education.
While the tourism boom is expected to fuel strong growth in the travel industry, analysts view it as less resilient due to risks associated with the breakout of epidemics, fatal accidents, terrorist attacks, diplomatic incidents or other events.
Cinemas are also well regarded, but analysts suggest Wanda Cinema is now over-bought, while Chen said SMI Holdings was reasonably priced with growth potential.