In the Rise of Chinese Consumerism Lies Opportunity

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A structural parameter of the phenomenon of global imbalances is the diversity of consuming habits among nations. Some spend too much, and others save too much. For a country, this is translated into a current account deficit or a current account surplus, respectively. For instance, the U.S. is considered to be the world's biggest spender with its current account deficit reaching $117 billion. In Greece, citizens are paying the price of a long lasting consumerism beyond their capabilities, which led to an enormous public debt.

China, on the other hand, holds the largest reserves worldwide, generated by an export-based growth strategy combined with a strict monetary policy. What is most interesting about the Chinese people is that, for them, household saving has always been an obligation derived from cultural beliefs. The Confucian tradition encourages thrift, self-discipline, and avoidance of any kind of wastage. This is one of the reasons that underlie China's high savings ratio.

Nevertheless, what happens when saving is no longer an option for China? The immense cash inflows derived from trade surpluses fueled the Chinese economy with inflationary pressures. The government tried to control inflation, and consequently a rise in the exchange rate of yuan, by performing monetary sterilization. Through the use of open market operations, China attempted to counteract the effects of a changing monetary base. This process insulated the domestic economy from an increase in price levels. However, it eventually triggered the boom of a real estate bubble mainly due to the parallel low real interest rates.

According to the G20's findings, a way to correct global imbalances and protect China from a future bubble threat is by reversing the domestic economic policy. In other words, China has to boost demand and reduce savings. For the first nine months of 2012, China's growth was consumption-led, with consumption contributing over half of the country's growth. This accelerating pace is expected to continue in the foreseeable future leaving room for the rise of a new middle class willing to spend its cash. The Boston Consulting Group estimates that, over the next three years, China will surpass Japan and become the second-largest consumer market globally.

This is a unique opportunity for foreign consumer-goods firms to penetrate into the Chinese market. Several U.S.-based firms have already made their move. Among the potential beneficiaries from what it is forecasted to be a historical surge in Chinese consumer purchasing-power are companies like Yum! Brands (NYSE: YUM), and Starbucks (NASDAQ: SBUX).

In the most recent earnings release, Starbucks reported net revenues for the China/Asia Pacific segment of $198 million, up by 23% on a year-over-year basis. Operating income generated from the same segment also followed an uptrend of 11%. Starbucks already has 600 stores in China. The firm is going to double its store base in the country by the end of 2015. Overall, the company anticipates meaningful returns by implementing a carefully planned expansion strategy.

It is not just investing in building new stores across Chinese cities. Starbucks is attempting a business transformation by embedding some of the region's cultural elements. This way it expects to attract consumers' interest and differentiate itself from its peers. At the moment, the stock is trading with a 10% distance from its 52-week range of $61.31. Out of thirty-one analysts tracked by Wall Street Journal, nineteen recommend a “buy” rating while five suggest that it will outperform the market.

Yum! Brands has a remarkable global reach. The company operates a wide network of 14,200 restaurants outside the U.S. and spread across 120 countries. Some of the firm's brands, such as Pizza Hut, and KFC show great international momentum. KFC entered China in 1987 and Pizza Hut in 1990. Today, Yum! has approximately 4,000 KFC restaurants in 800 Chinese cities and over 700 Pizza Hut restaurants in 120 cities. Localization is the major component of the firm's strategy in the country while pursuing its target of at least 20,000 units over the long-term. 

For the third quarter of 2012, the company demonstrated strong financial and operating performance that supported an 18% increase in its quarterly dividend. In China, alone, Yum! witnessed operating profit pickup of 22% driven by strong sales growth. Total revenues from its China division increased by 24% compared to last year. Over the past three years, the stock performed outstandingly by returning over 90%. Based on analysts' average target price it has a 13% appreciation potential.

Overall, both of the companies mentioned above are poised to benefit from the anticipated jump in the Chinese consumer market. Their existing strong position in the country and their wide economic moat in their respective fields enhance the possibility of double-digit growth rates over the next three years. Adapting to local circumstances is a key prerequisite for the successful outcome of their future expansion plans. 

FaniKel has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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