IN THIS ISSUE:

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• It’s China – Jim – But not as we know it!

• The Red Dragon is burning through its industrial shackles

• Double your money as one billion Chinese consumers buy up

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From Gareth Stokes, Editor, The Investor’s Digest 

Dear reader,

A couple of days ago I attended a presentation by Sanlam Private Investments director of investments, Alwyn van der Merwe. He spent an hour trying to answer whether the world’s largest emerging market economy had reached a tipping point. The phrase “tipping point” happens to be among my favourites...

Economists use the term to describe the precise moment (as precise as you can be in the world of economic complexity) when one trend gives way to another. But that’s a "soft" definition. If you really want to get to grips with the concept you should read Malcolm Gladwell’s The Tipping Point, first published in 2000.

Gladwell defines a "tipping point" as "the moment of critical mass, the threshold or the boiling point". And so the fun begins.

Is China at a tipping point? And will this tipping point prove good or bad for investors? The wonder of economic analysis is we can answer yes or no / good or bad to the above questions, depending on the spin we put on our answer. The answers also differ depending on how we define this “tipping point”.

For Van der Merwe, this “boiling point” would be a roll over in Chinese growth. He fears – as do many other fund managers – that monetary intervention by the Chinese authorities could force growth in that economy to decline…

It would indeed be a precipitous moment if China’s GDP growth forecast was downgraded from the current 8%-plus to around 5% for 2012! After bombarding his audience with loads of macroeconomic evidence Van der Merwe concludes a “hard landing” in the Red Dragon nation is highly unlikely.

For me the tipping point would be a shift in the Chinese economy from its current manufacturing / industrial bias to a consumption model – a notion borrowed from the aforementioned presentation.

Why?

Because recent developments suggest China is moving up the value chain. It has sailed through the “get accustomed to the product” phase, finished with the “copy product” and “price leadership” stages, and now wrestles with the “innovation” concept. It’s China, Jim – But not as we know it!

How can I best explain this concept?

If you’re an avid golfer all you have to do is haul out your golf glove (assuming you bought it recently) and check the “made in” label. Surprised? Van der Merwe points out that five years ago your glove would’ve been manufactured in China. Today you’re just as likely to see the words Vietnam or Pakistan printed on the label!

This transformation has occurred because China has lost its edge in the labour pricing game…

How does this transformation change our investment strategy? 

South Africa’s auto giants will choke on China’s 20 million per annum parking lot!

If China’s growth motivator tips from manufacturing to consumption you’d better shift your investment focus. The "old" China used to manufacture anything imaginable and export it at the best price around the globe.

Nowadays a large slice of China’s production finds a home within the country’s borders. For example, approximately a quarter of the 80 million vehicles produced there annually are now sold in China.


Will they complete the transition? You bet they will! The Chinese government has singled out “accelerating Chinese household disposable income” as their 12th ever five-year growth plan. And the Chinese seldom miss these grand strategy targets! So, as China "tips" into the consumption growth trend, multi-national companies are tripping over each other to secure their slice of the action.

Anyone with a strong brand wants to be in China – because to miss out on the Chinese consumption revolution will be financial suicide. As Western consumption patterns grip the world’s largest emerging market economy, companies such as KFC and Starbucks see virtually unlimited growth potential…

How can we benefit locally?

I’ve become so bored with the “China equals commodities” debate that I’ve decided to shift focus slightly. Forget Anglo American and BHP Billiton. And forget Naspers-N too – of course their stake in TenCent is worth getting excited about – but growth in the tech sector could have reached its zenith for now. The company I’m going to tell you about today – and Van der Merwe likes this company too – is involved in the manufacture and distribution of luxury goods!

Let’s hope there aren’t any Rolex gangs in China!

By all accounts, Richemont (JSE: CFR) is the perfect play on the Chinese consumer. The group owns a number of leading luxury goods companies specialising in jewellery, watches and high-end writing instruments… I’m sure you’ll have heard of one or two of these: Cartier, Van Cleef & Arpels, Piaget, Vacheron Constantin, Jaeger-LeCoultre, IWC, Panerai and Montblanc!

In FY2011, Richemont sold a phenomenal €6.892bn of jewellery (€3.479bn), watches (€1.774bn), pens (€672m) and other goods and services (€967m). But this fantastic revenue-by-product feast is just part of the story. After all, we’re interested in this luxury goods company for its exposure to China. And Richemont’s geographical reach is impeccable.

In Europe, the group's sales are €2.588bn, in Asia €3.306bn and in the Americas €998m. With a whopping €1.645bn peddled in Hong Kong / China alone.

Bingo!

Local analysts are very impressed with the company’s prospects. And I certainly have a newfound respect for the company after sitting through Van der Merwe’s presentation. The Profile Media consensus for FY2012 (to 31 March 2012) is for earnings per share of 227.4c, with a price-to-earnings (PE) ratio of 19.94 times. 

By FY2014 Richemont should deliver 340.11c per share in earnings, putting it at a more reasonable 13.33 times PE. But I reckon the analysts have underestimated the Chinese consumers’ hunger for luxury goods. If that’s the case the share will be trading well beyond its current 4,535c in no time.

I’m comfortable buying Richemont up to R46 per share for my three-year portfolio. I’d be surprised if it doesn’t double by June 2014!

I’ll be back with another instalment of MoneyMorning on 21 July 2011.

Until then, let the profits roll,

Gareth Stokes
Editor, The Investor’s Digest