How to Play a Rebound in China
Callum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
China's GDP growth rate for the fourth quarter was 7.9%, higher than the 7.8% expected and higher than the 7.4% growth in Q3. Industrial production rose 10.3% in December year over year, and was up 10.1% in November. Iron ore prices have begun to recover, with prices rising as high as $158.50 a metric ton last week. Property prices were up 0.31% in December, the biggest gain in 2 years. The world's second largest economy seems to be stabilizing and 8% GDP growth (which is up from 7.8% in 2012) seems completely reasonable. The real question is, how can we as investors benefit from this rebound?
As I said above, iron ore prices have begun to recover and are up 80% since September as Chinese steel mills start to pick up steam as the economy grows faster and more infrastructure projects are underway. The cold weather in China has curbed local production, which boosted prices. While iron ore prices may be overvalued (according to many, including the new CEO of Rio Tinto), they still are much higher than their $87 a metric ton low. Rio Tinto (NYSE: RIO) is the world's second largest mining company and mines more iron ore than anyone else. While they did have to take a $14 billion write-down and have a management change, this could present a great buying opportunity for the long run. Management is now projecting that they will produce 290 million metric tons of iron by the end of 2013 and 360 million metric tons by 2015.
As China's industrial production growth maintains above 10%, iron ore prices will stay at these levels. The leadership of China is forecasting for 10% industrial expansion for 2013, and because China usually lowballs estimates (and manipulates them) they probably will exceed that number. Right now China's industrial capacity is only at 60% right now, but if Europe and North America turn their economies around (especially Europe), then that capacity can be utilized and China will consume more metals and minerals.
Weakness now but the future is bright
While there currently is weakness in the steel industry and overproduction has pushed prices lower, in the long term iron ore is a good place to be. The mining industry has consolidated while the steel industry is fractured, so they can maintain higher profit margins than the downstream business. China is currently spending $157 billion on infrastructure improvements on 60 different projects, Indonesia is spending roughly $200 billion on their own infrastructure improvements over the next 2 years (the program is running from 2010-2014), and America's infrastructure is severely lacking and will need an upgrade sometime soon.
India, China, Indonesia, and Latin America offer a ton of potential for infrastructure improvements and projects as these emerging economies continue to see strong GDP growth. China is the biggest factor in this growth, as they are 40% of the global steel market. BHP Billiton Limited (NYSE: BHP) is trying to boost its iron ore production up to 220 million metric tons by the end of the next fiscal year as it plays a rebound in China's economy. While BHP is a more diversified mining play, strong iron ore prices will benefit its bottom line and will help out its other divisions as stronger GDP growth leads to more mineral consumption.
BHP also has extensive copper operations, which in their last quarter was up 14% due to a 70% increase in copper-in-concentrate production at their Escondida mine in Chile. That mine is expected to see another 20% boost in growth for 2013. Total production for their Q4 was 295,200 metric tons. The reason why copper is important is that it is heavily used in industrial production (which is on the rise) and in the homebuilding industry (which is on the rise in both China and the United States). Investment in China's property development was up 16.2% in 2012, and is expected to continue to grow by over 10% in 2013. BHP's diversified portfolio makes it a great China play as it is able to benefit from growth from each industrial sector. BHP also saw a 11% rise in its petroleum production year over year in its latest quarter.
China's average wage is skyrocketing, with urban wages up 14.3% in 2011 (8.5% adjusted for inflation) according to the NBS (National Bureau of Statistics). Wage growth has led a boom in discretionary spending, which has greatly benefited Yum! Brands (NYSE: YUM) as more Chinese consumers go eat out. McKinsey Co expects the average disposable income in China to grow from $4,149 in 2010 to $8,185 by 2020. Also the middle class is rapidly growing, with an expected 300 million more Chinese citizens to enter the middle class over the next few decades, which would double the current middle class. Yum has been aggressively expanding into China to boost growth, and their strategy seems well played out. They have over 4,000 KFC (by the end of 2011) restaurants in China, over 700 Pizza Huts, and they are starting to roll out their East Dawning restaurants, which offer cheap "authentic" Chinese fast food. As China's middle class expands, wages go up, and more restaurants are opened, Yum is very well positioned to benefit from a Chinese rebound.
The whole world is hoping for a Chinese rebound to push our global economy out of this rut, primarily in North America and Europe. China's new leadership has given hints that they will lack some rules on FDI and monetary policy to spur growth on top of their little infrastructure stimulus package. Investors should often play macro trends as they can lead to the best returns. Out of these 3 stocks, Yum! Brands is the best play due to its high growth rates, the shift to a consumer economy in China, and its rapid expansion of stores in China (which has a population of 1.3 billion).
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