China on the march, again

Now it's the consumers, not the exporters, that are powering the mighty economic engine. Here's how investors can play the trend.

By Mina Kimes, writer-reporter

(Fortune Magazine) -- As the U.S. stock market tosses and turns, sustainable growth -- both in corporate profits and economic output -- seems far off. In China, on the other hand, recovery already seems to be a reality: Real estate, auto, and industrial sales have all bounced back this year, driving stocks on the Shanghai exchange up 50% since February. The velocity of the Chinese rebound surprised the World Bank, which recently increased its estimate for the country's GDP growth this year from 6.5% to 7.2%. Jing Ulrich, J.P. Morgan's Chinese equities strategist, thinks that figure is still too low. "China can still achieve 8% growth," she says. "Everything is happening very fast there."

Achieving even the World Bank target would be impressive indeed, considering that most other big economies are shrinking. But China isn't immune from the rest of the world's woes, because it still depends heavily on exports. The main reason growth is down from the double-digit levels of recent years is that China's manufacturers and shipping companies have been suffering from the global slowdown.

Other industries have found a surprising new source of demand: the Chinese consumer. "The rebound has been driven by the domestic economy," Ulrich says. "The consumer proved resilient -- and the government acted as a catalyst." By lowering taxes and issuing subsidies as part of a 4-trillion-yuan ($585 billion) stimulus, the state stepped up its efforts to turn a nation of savers into spenders. As a result, says Ulrich, growth is still spreading across the country despite the decline in exports. For example, in Sichuan province, the region in central China that was hit by a massive earthquake last year, the economy grew by nearly 11% last quarter. Nationwide, retail sales grew 15% in May, to 1 trillion yuan, with rural consumption outpacing demand in cities.

Because shares of many Chinese companies are not readily available to foreign individuals, the most convenient way to invest in the rebound is through mutual funds and exchange-traded funds (ETFs). The biggest ETF, with $9.5 billion in assets, is iShares FTSE/Xinhua China 25 Index (FXI), which tracks the 25 largest Chinese companies traded in Hong Kong. Shares have climbed 31% this year (through June 25), but are still down 25% from June of last year. If you want a fund manager picking stocks for you, Morningstar's Bill Rocco recommends Matthews China (MCHFX). Matthews China is up 39% this year, and has returned 20% annually over the past three years, vs. 4% for the average China fund. (Rocco adds the caveat that you should commit only a small portion of your portfolio to any single-country fund.) The fund carries an expense ration of 1.23%, below average for funds with large China holdings.

If you're hunting for individual stocks, there are now 72 Chinese companies trading on major U.S. exchanges, according to Bank of New York Mellon. Here's a look at three reasonably priced companies in different industries, all of which are benefiting from China's domestic boom. All are available as American depositary receipts -- ADRs -- on the New York Stock Exchange.

Despite its name, American Dairy (ADY) is a Chinese company, based in Beijing, that makes infant formula and other milk products. Hao Hong, an analyst at Brean Murray Carret, a New York City investment bank, says the market for formula is growing in China, where fewer mothers are breast-feeding their children. American Dairy was not among the several Chinese companies implicated in 2008 in selling melamine-tainted milk and infant formula. "Since then they've been taking market share from their competitors," says Hong. "Their products are flying off of the shelf." The stock has nearly tripled this year, but it still trades at just eight times estimated earnings for the next four quarters, compared with an industry average of 22, and analysts think profits will soar at an astounding 115% annual rate for the next five years.

Richard Gao, who manages the Matthews China Fund, says China's insurance industry will profit from the ascent of the middle class, as well as the aging of the population. "China is undergoing a structural change," he says. "It used to be socialist, with insurance coming from the government, but it's becoming more of a market-driven economy." Gao owns shares of China Life (LFC), which is the country's biggest insurer. China Life's profits fell 45% last year because of the Sichuan earthquake and investment losses, but the company's conservative portfolio of mostly bonds shielded it from the devastation its Western counterparts suffered in the global stock market meltdown. While China's insurance industry is still in its early stages, China Life already has a vast sales force of 716,000, which enabled it to boost premium income 17% in 2008 and increase market share to 40%. Despite the company's leading position, the stock trades at a slight discount to its main competitors'.

China Mobile (CHL), the world's biggest telecom, commands a 72% share of China's fast-growing market. That position gives it negotiating clout with phonemakers. (It already has a deal with BlackBerry-maker Research in Motion (RIMM) and is launching a phone equipped with Google's Android browser.) Yet its stock is slightly down from a year ago, in part because the government has reorganized the telecom industry to spur competition, merging a number of smaller firms to create two large rivals to China Mobile. Rusty Johnson, manager of the Harding Loevner Emerging Markets fund, says that the giant company can still expand both its margins and its customer base. It is adding 5 million customers a month and, he says, "it can sell value-added products, like mobile broadband, to existing customers."  To top of page

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