China investment themes: consumer staples

04/05/2017

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In the third and final instalment of a series on key China investment themes, Charlie Awdry and May Ling Wee, China equity portfolio managers, discuss the opportunities in China’s consumer staples sector.

We previously talked about China’s burgeoning middle class and how their evolving consumption habits are boosting the country’s domestic internet, travel and lifestyle-related sectors. Here we explore how these same factors are also creating attractive investment opportunities in the area of consumer staples.

Brand premium

According to a 2011 joint study by the European Union SME (small and medium-sized enterprises) Centre and the China-Britain Business Council, China surpassed the US to become the world’s largest consumer market for food and beverage (F&B) products. This should come as no surprise, given China’s large population.
 
But more interestingly, the volume growth, or how much people are actually consuming has remained flat. Instead the driving force behind the growth of China’s F&B space is the large premium that Chinese consumers are willing to pay for what they consider to be ‘high-end’ products.
 
A key beneficiary of Chinese consumers’ increasing incomes and purchasing power is Kweichow Moutai (Moutai) a brewer of premium baijiu, a distilled spirit often made from grains such as sorghum, rice, wheat or corn. 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 products.
 
These efforts appear to have paid off. Moutai is now the leading premium baijiu brand, with products retailing at an average of RMB1,300. Moutai’s closest competitor, Wuliangye, retails at around RMB700. 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 is the world’s second-most-valuable liquor company after global giant, Diageo.
 
Analysts have also identified the company as the key beneficiary of ‘premiumisation’ in the Chinese spirits industry. Moutai predicted that its sales revenue in the first quarter of the year would reach the equivalent of US$1.87 billion−a 25% year-on-year increase. The Chinese liquor company projects a 22% annual growth rate for 2017.
 
As a whole, baijiu remains the most consumed spirit in China, and is fending off attempts from western competitors to capture market share. The trend shows no sign of slowing in the near future, as a Morgan Stanley cross-category China Alcoholic Beverage Survey indicated that younger consumers are still opting for the Chinese liquor (first chart).
 
Distribution power
 
Food seasoning is another of China’s promising consumer segments, with strong demand mainly driven by the growing trend for the Chinese to dine out. The food seasoning sector typically enjoys steady growth (second chart), high barriers to entry, and is a beneficiary of consumers' preference for premium products.  
 
In this space, Foshan Haitian Flavouring and Food Company enjoys a 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% market share in China’s soy sauce market.
 
The company is even more dominant in the oyster sauce space, where it has 46% of market share by volume. This is particularly meaningful given that the figure represents a five-fold increase over the market share of the next largest player.

As a business, Haitian also benefits from strong brand recognition, continuous product research and development, well incentivised management and one of the strongest distribution networks in China’s seasonings industry. The company boasts over 2300 distributors, 15000 franchisees and roughly two million point-of-sales locations.
 
Haitian also carefully manages the quality of its distribution channels. For example, the company employs an automated enterprise resource planning (ERP) system, which links all of its distributors, helping the company to monitor channel inventory in a timely manner. In March 2017, the company reported 2016 net profit of more than US$406m, representing a 13% year-on-year increase.

Summary

Chinese consumers and their growing appetites have significantly boosted growth in areas like the internet, domestic travel and consumer staples. But it’s 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 consumer-focused companies is best suited to capitalise on the opportunities offered by China’s vast yet developing economy.
 
Note: references made to individual securities are for illustrative purposes only and should not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase the security.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

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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Issued by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial Conduct Authority) and Henderson Management S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier).

We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Past performance is not a guide to future performance. The performance data does not take into account the commissions and costs incurred on the issue and redemption of units. 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. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change. If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially.

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Specific risks

  • Shares can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • Emerging markets are less established and more prone to political events than developed markets. This can mean both higher volatility and a greater risk of loss to the Fund than investing in more developed markets.
  • Changes in currency exchange rates may cause the value of your investment and any income from it to rise or fall.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.

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