Charlemagne’s Mayo: top stocks for the Chinese snake

The Chinese Year of the Snake starts this month, its female ‘Yin’ replacing the masculine ‘Yang’ of the outgoing Year of the Dragon. 

However, with all due respect to the followers of feng shui, of greater importance are the once-a-decade leadership changes which see Xi Jinping and Li Keqiang assume power. 

While the transition seems to have gone smoothly, the incoming leaders face some new challenges. 

After more than 20 years of breakneck economic growth, the average Chinese citizen’s expectations have risen: income inequality has stretched to the extent that the country is now one of the most unequal in the world. 

This pressure is already being seen in a sharp rise in wages as labour becomes scarcer – China’s working age population declined last year for the first time.

The government has mandated a further rise in minimum wages, by 13% per annum in the current five year plan.  They also plan to increase social security spending from 10% of the total budget to 12% in the next three years.  

In other areas, the rebalancing of China has already proceeded impressively: the current account surplus has fallen from 10% of GDP to 2.6%, consumption is starting to rise as a share of GDP and the high growth of infrastructure and property investment have moderated. 

Key calls

In this environment, we prefer quality, well managed plays on the domestic consumer.  Hengan makes tissues, nappies and sanitary napkins, all of which are classic growth opportunities in an emerging market. 

Even within China, the poorer northwest has a nappy penetration rate of only one-fifth of the richer east and south, so growth seems clear as the country’s wealth broadens. 

We like its strong market position, its high margins (an expected gross profit margin of well over 40%) and its 20% compound profits growth.  A PE ratio of 23x this year’s earnings seems good value for such a high growth, high quality business.

In a similar vein, we like Belle, the country’s leading shoe retailer. 

China’s spending on shoes is only 35% of that of Korea and Taiwan and less than one-tenth of that of Hong Kong.  This is another very profitable business, with gross margins of over 55%, with double-digit earnings growth.