China investment themes 2017 | Part 3: Opportunities in consumer staples

05/04/2017

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In the third segment of the China investment themes series, Charlie Awdry and May Ling Wee, managers of the Henderson Horizon China Fund, share attractive investment opportunities in China’s consumer staples sector today.  

We previously discussed China’s burgeoning middle class and how their evolving consumption habits were boosting the country’s domestic internet, travel and lifestyle-related sectors. The same factors are also causing shifts in the area of consumer staples, creating attractive investment opportunities for discerning investors.

Brand premium

A joint study compiled by the EU SME Centre and the China-Britain Business Council reported that China surpassed the United States to become the world’s largest consumer market for food and beverage (F&B) products in 2011. More interestingly, an April 2016 McKinsey report shows that actual consumption volume growth has remained flat in many of China’s F&B categories. This is because the country’s growth in F&B spend was mainly driven by the large increase in price that Chinese consumers were willing to pay for what they considered premium or luxury brands.

This trend is clearly evident in China’s baijiu market. Kweichow Moutai (贵州茅台) is one China’s handful of brewers of premium baijiu, a distilled spirit often made from sorghum, rice, wheat, and corn, depending on the desired flavour. They are also a major beneficiary of Chinese consumers’ increasing incomes and purchasing power.

Established by the Chinese government in 1951 through consolidation of local baijiu shops, the company was initially geared toward the low-income market segment. Since then, Moutai has taken steps to capture the mid- to high-end demographic. In 2014, the company formed Kweichow Moutai Jiangxiangjiu Marketing to exclusively focus on sales and marketing of their mid to high end baijiu offerings.

The effort appears to have paid off. Moutai is now the leading brand among the premium baijiu space today, with their products retailing at an average of RMB1300 per unit. Compare this to their closest competitor, Wuliangye (五粮液), which retails their own brew for about RMB700 per unit. Moutai is growing volumes with high visibility thanks to its premium position, leading channel margin, and pricing system. In January 2017, The Financial Times reported that Moutai had overcome a temporary slump linked to the administrations’ anti-graft war to emerge as the world’s second-most-valuable liquor company after global giant, Diageo.

Analysts have also identified the company as currently the key beneficiary of ‘premiumisation’ in the Chinese spirits industry, over its peers. Moutai predicted that its sales revenue in the first quarter of the year would reach the equivalent of US$1.87 billion— a figure would marking a 25 percent year-on-year increase. The Chinese liquor company projects a 22 percent annual growth rate for 2017.

As a whole, baijiu remains the most consumed spirit in China, fending off attempts from Western spirits to capture market share. The trend shows no sign of slowing in the near future, as a recent study from Morgan Stanley and AlphaWise indicated that a majority of Chinese drinkers across age groups plan to maintain or increase consumption of baijiu.

Also, contrary to popular belief, the survey found that 59 percent of the baijiu drinkers surveyed aged 18-29 have consumed and intend to spend more on baijiu in 2017. This is significant given the increasing purchasing power of China’s 20-something generation. By all measures, Shanghai-listed Kweichow Moutai looks very well-positioned to capture that demand. 

Distribution power

Spirits are not the only domestically produced consumable good that’s seen their fortunes burnished in recent times. Food seasoning is another of China’s promising consumer segments, and demand has been strong. This has been driven mainly by catering demand and the consumption upgrade, as more and more Chinese consumers adopt a habit of dining out. The segment features steady growth, high barriers to entry, room for consolidation and a trend of consumers' trading upwards to more premium products.

In this space, Foshan Haitian Flavouring and Food Co. Ltd (海天味业官方网站) enjoys clear scale advantage. The size of its soy sauce business looms over the combined scale of the second through fifth ranked players to take a 13 percent market share in China’s soy sauce market.

The company is even more dominant in the oyster sauce space, where it takes a 46 percent market share. This is particularly meaningful when one takes in account that the figure represents a five time increase over the market share of the next largest player.


As a business, the company also benefits from strong brand recognition, continuous product R&D, well incentivised management and what is possibly the strongest distribution network in China’s seasoning industry.

The company boasts over 2,300 distributors, 15,000 franchisees and roughly 2 million point-of-sales locations. Its distribution network encompasses all major tier cities and half of county-level markets in China. Today, Haitian products can be accessed by customers in almost all of China. Its competitors’ networks have roughly only half the reach.

Haitian also carefully manages inventory across its distribution channels. For example, the company employs an automated enterprise resource planning (ERP) system which links all of its distributors. This helps the company to monitor channel inventory in a timely manner.

In March 2017, the company reported 2016 net profit of US$406.59 million, a figure representing 13.3 percent year on year increase in net profit.

Summary

Chinese consumers and their growing appetites have significantly boosted areas like the internet, domestic travel and consumer staples. But it is early days yet and the market’s potential is far from being realised.

We maintain that a considered, bottom up stock selection approach focusing on well managed, cash generative and consumer-focused companies is poised to capitalise on the opportunities offered by China’s vast yet nascent economy. 
 

Note: Reference to any specific company or stock is for information purposes only and should not be construed as a recommendation to buy or sell the same.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Anything non-factual in nature is an opinion of the author(s), and opinions are meant as an illustration of broader themes, are not an indication of trading intent, and are subject to change at any time due to changes in market or economic conditions. It is not intended to indicate or imply that any illustration/example mentioned is now or was ever held in any portfolio. No forecasts can be guaranteed and there is no guarantee that the information supplied is complete or timely, nor are there any warranties with regard to the results obtained from its us.


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Janus Henderson Horizon China Fund

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