LONG BEACH, California (Reuters) – The extensive economic, legal and social reforms pledged this month by Chinese leaders have gone over well with investors.
The Shanghai Composite Index rose 5.6 percent in the two days after details were announced.
The upshot of the so-called Third Plenum program is that key markets – in resource commodities, interest rates and currency – will be liberalized gradually, as will rules on land ownership. Perhaps most important, the government of President Xi Jinping vowed to chip away at the privileged status long accorded large state-owned businesses.
Rising living standards have given consumer spending a greater role in China’s economy at the expense of manufacturing for export, an activity that dominated the country’s economic life for decades. It is a trend that the proposed reforms are likely to support and one that portfolio managers believe investors in Chinese stocks should try to exploit.
“Domestic consumption is a better way to go,” said Brent Bates, a co-manager of the Invesco Asia Pacific Growth Fund. “Export companies are going to have a more difficult time as they see continued wage pressure.”
To profit from growing consumer spending power, Bates suggests investors bet on betting itself. He is optimistic about shares of casino operators in Macau, the special administrative region of China that has overtaken Las Vegas as a gambling mecca.
He particular likes Galaxy Entertainment Group Ltd, which made up 1.3 percent of his portfolio at the end of September.
Galaxy appears expensive at first glance, trading at about 28 times earnings, compared with 22, on average, for gambling stocks around the world. But he noted that the company’s returns on equity and investment exceed industry averages by about 50 percent.
The stock sells for about 60 Hong Kong dollars (about $8) a share, well above the mid-20s prices at which Bates bought the stock. He declined to state specifically what would cause him to cut the stock loose but said that Invesco’s managers consider earnings growth, efficient use of capital and valuation relative to growth prospects.
China has been building bridges, ferry terminals and high-speed rail lines to funnel visitors to Macau, Bates went on to say. Many of these visitors are of more modest means than the VIP gamblers Macau is known to attract and tend to produce higher profit margins for casinos. Galaxy is in a particularly strong position to handle the growing throng, in his view, because land is at a premium in Macau and the company has more to build on than do its competitors.
Edmund Harriss, manager of the Guinness Atkinson Asia Pacific Dividend Fund, also owns Galaxy, which he bought at about 27 Hong Kong dollars a share and called “a money-making machine.”
SMART PHONES, SMART MOVES?
Harriss’s other holdings include several technology stocks that he considers consumer plays because they stand to benefit from increased use of smart phones and personal computers for services like gaming and instant messaging: PC maker Lenovo Group Ltd- two purveyors of online gaming, NetEase Inc and Sohu.Com Inc, and Internet portal Tencent Holdings Ltd.
Harriss bought Lenovo, for just over 5 Hong Kong dollars a share- now it is selling at 9 Hong Kong dollars. He paid about $21 for NetEase and $47 for Sohu- both trade in the mid-$60s. He scored big on Tencent, paying about 80 Hong Kong dollars for the stock, which fetches more than 400 dollars these days.
Moving up to big-ticket items, he owns Baoxin Auto Group Ltd, whose growing network of auto dealerships focuses on high-end brands such as Land Rover, Mercedes and BMW. He paid just over 7 Hong Kong dollars for Baoxin, not far below recent levels.
THE EFFICIENCY PLAY
Another way that Harriss would take advantage of the Third Plenum is through companies that are likely to thrive as Chinese industry tries to accomplish the leadership’s goals of greater environmental protection and more efficient energy consumption.
“What you’re looking for are businesses that are able to operate more efficiently,” he explained, “because China is looking at industries with excess capacity and shutting down operators with heavy emissions.”
More efficient companies should be able to manufacture their products more cheaply and command a bigger share of their markets. A prime example that he offered is Anhui Conch Cement Co Ltd, which he lauded for using about 70 kilowatts of electricity to produce a ton of cement, roughly half the typical amount. Harriss bought the Anhui shares for about 35 yuan, or about $6. Following October’s Chinese stock selloff, the shares trade at what Harriss says is a bargain price of 16 yuan today.
Like Bates, Harriss declined to provide sell criteria for his stocks, but together they are 37 percent below his estimate of their fair value, he said.
The Third Plenum program is due to be implemented by 2020. There’s always a risk that it will turn out to be more talk than reform, but Harriss prefers to look on the bright side. Getting there, he suggested, could be half the fun.
“China stocks have been depressed for some time because investors have gotten it in their heads that China is on a path to stagnation and is unwilling to adjust its model.”
(The author is a Reuters contributor and the opinions expressed are his own)
(Follow us @ReutersMoney or here Editing by Steve Orlofsky)
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