3 Stocks With Aggressive Expansion into China
Edgar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There is no question about the fact that companies look for top line growth in countries with an emerging middle class that has a voracious appetite for quality and improvement. One of those countries remains to be the powerhouse China. With its 1.33 billion population and $7.29 trillion nominal GDP, it attracts companies of all sectors to invest and do business respecting its country's laws and regulations.
The first company that needs no introduction, which is heavily expanding into the Great Dragon is Apple (NASDAQ: AAPL). China is Apple's second largest market that generated $7.9 billion in revenues for the first quarter of 2012. Sales of smartphones are on the rise in China with an astounding 288% y-o-y growth.
Currently 270 million Chinese citizens can afford Apple's products and given the current growth rate, the country can add another 57 million a year to its middle class. A recent survey that was done by researchers at Stanford indicated that the iPad penetration in China on July 20th had a greater impact at a high school in Beijing than it did in Palo Alto, California. This goes to show the brand loyalty being more fierce in countries like China, Korea, Japan, and Britain than domestically. In my recent trip to London, I spoke to a loyal gadget junkie who had the Apple logo tattooed on his neck while standing in line patiently for his newly released iPad. Another article of brand loyalty that left me in awe, was the boy from the city Anhui that sold his kidney to buy an iPhone. Steve Jobs not only redefined creative branding, but also raised the bar in terms of brand loyalty.
Despite Apple's success in Asia Pacific, due to its sheer size the tech giant is susceptible to China's economic sluggishness as well. The Chinese government has been the center of attention for obscuring economic data and masking the growth slowdown. Yuan manipulation was also the concern for a company that missed its last earnings results due to slower sales in the Asia Pacific region. Its $7.88 billion Asia Pacific division net sales came in lower than Europe's $8.237 billion, but operating income of $3.374 billion still held the lead position in comparison to Europe's $3.26 billion. Apple with its new 1.75% yield, boasts a strong balance sheet with roughly $100 billion in cash and has return metrics that are relatively high compared to other large-cap hardware/software companies. After opening its doors to China, it anticipates even stronger growth in the laptop computer, smartphone, and tablet markets with an expected operational EPS of $52.25 for 2013. While I disagree with some of the $1,000 target figures loosely thrown around by analysts, I project $750 as more achievable by next quarter.
The second blue chip taking its stride in China is Yum! Brands (NYSE: YUM), and it should come as no surprise since the fast food giant generates more than 40% of its revenue from the second largest economy versus McDonald's (NYSE: MCD) which generates 22% from sales in China and roughly 3% in net income. For some reason, the Colonel's fried chicken has became the ultimate favored fast food in China next to the Golden Arches. Yum! Brands has nearly 4,800 restaurants in China expanding in more than 800 cities. KFC became an instant phenomenon since 1987 when the first location was opened. Fast forward 25 years and you have one new KFC location opening up somewhere in China every day, ranging with more extensive menus that include seafood, soups, fresh vegetables and other desserts that are in harmony with local tastes and customs.
Share repurchases and targeting a dividend payout of 35-40% of its net income are not the only attributes the company is known for. To combat its 2-3% yearly price increases, Yum has also made the right strategic acquisitions to differentiate itself. In 2011 it acquired "Little Sheep," a private meat and condiment processing company with more than 300 chains and sales of $314 million a year. YUM's 10% same store sales growth and increase of 100 new locations a year target is impressive given the slowdown in China's growth and meager retailer sales.
The company projects to increase the number of units in China at 11% a year with a same store sales growth rate of at least 5%. This is in contrast to Yum Restaurants International target of 3-4% and same store sales growth of only 2%. One risk that remains to be a concern for the food giant is its volatile operating margins due to fluctuations in food costs. With the recent launch of Doritos Locos Tacos, the Taco Bell division is expected to boost earnings in upcoming quarters. I find YUM at $64.56 a bit undervalued from its $70 fair value calculation.
Lastly we can't leave Starbucks (NASDAQ: SBUX) out of the list, since the coffee king is slowly running out of locations to grow domestically. While it plans to open 600 new locations throughout North America in 2013, the projected number for China for the same year is 500. So far Starbucks has exactly 600 locations throughout China and opened its very first stores in Finland and Costa Rica last quarter.
Despite showing in-line earnings of $0.43 a share, Starbucks increased its revenues 13% to $3.3 billion and saw a global comparable store sales growth of 6%. While other quick service restaurant chains experienced dwindling margins, Starbucks explanded its operating margins 120 basis points to almost 15% and had a operating income increase of 22%. Per Howard Schultz comments,
Starbucks record Q3 results demonstrate the continued strength of our global business and brand, the success of multiple, highly innovative consumer packaged goods initiatives and continued acceleration of our China and Asia-Pacific operations".
The focus has definitely shifted towards China with estimated 2013 EPS earnings of $2.14 from the prior $2.04, representing a 15% growth rate. Even Starbucks's P/E ratio of 25.3 is among the highest of most stocks in the Food Processing industry, signaling that investors have rather high hopes for the company's future business prospects.
In recent years Starbucks went through a period of contraction as it closed down roughly 800 locations in the U.S. and 100 locations in Australia due to underperformance. It also reduced commercial paper and short term borrowings to zero in efforts to restructure and revitalize its capital structure. Given the aggressive Chinese expansion, the potential for 20% EPS growth over the next two years is attainable, if the coffee prices hold steady or decline from current levels.
edgarambart30 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, McDonald's, and Starbucks. Motley Fool newsletter services recommend Apple, McDonald's, Starbucks, and Yum! Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.