China’s slowing growth and market rout may dominate news flow, but the nation’s transition from an investment-led economy to one driven by services and consumption is also worthy of investors’ attention, says Kunjal Gala, Senior Analyst at Hermes Emerging Markets, who recently visited the country on a research trip.
New v old: In Q3 the Shanghai Composite fell 24.7%, exports continued to fall and growth slowed, darkening the top-down outlook. But positive data highlighting China’s economic transition also emerged: weakness in the heavy industries of the north is being offset by the strengthening consumer goods and services sector, which is expected to grow faster than others in the coming years. In September, consumer sentiment hit a 15-month high, showing resilience amid the market decline, and CPI inflation reached a 12-month peak during the month, mitigating fears of incipient deflation.
The income effect: The still-buoyant growth of urban areas is a key driver of consumption. According to the National Development and Reform Commission, 9.5m new jobs were created in the year to August, equivalent to 95% of the annual target. This should support consumer spending: in 2014, urban disposable income per capita grew 7%, contributing to a 10.8% rise in urban consumption expenditure per capita. On the ground, travel accessories manufacturer Samsonite said that products catering to the travel and tourism industry enjoyed by increasingly wealthy Chinese consumers are in demand, even amid the current market volatility. A BMW dealer in Shanghai said that sales of its high-end cars, too, are strong and the company is ahead of its targets for the year.
Sophisticated demand: The evolving demands of Chinese shoppers are also enabling related industries to expand and become more diverse. For instance, people now look beyond Coca-Cola in favour of newer products, such as energy and protein drinks. Such segmentation not only provides opportunities for new product lines, but also for businesses in supply chains, such as packagers. E-commerce is bringing more products to consumers, too: the penetration rate of online retail businesses surpassed that of the US in 2012, and online sales are expected to grow from 7.9% of total sales in 2013 to 12.4% in 2017. The impact of e-commerce is particularly high in the consumer goods sector, rising from 51.7% to 56.2% of total consumer good sales between March and December 2014.
Widening the net: But the consumer revolution is yet to truly march on rural areas. There are some signs of increasing consumption in these areas: net income per capita has risen consistently year-on-year and gained 11.2% in 2014, while consumer expenditure per capita in rural areas increased 14.8% between 2010 and 2013. However, e-commerce has struggled to reach rural areas, with only 6.4% of households shopping online in 2013. According to the Chinese businesses I met, better social security would facilitate this, as the safety nets in cities are far stronger than those in villages. A broader social security net is important to consumption as state-owned enterprise reform is likely to result in redundancies while the Chinese economy transitions to higher-value-added manufacturing.
Ensuring growth: Wages have risen dramatically in China over the past decade. But as the global economy slows and limits the appetite for low-end Chinese exports, it is imperative that China transitions to more advanced manufacturing to help sustain its economy and, crucially, consumption. This is something that Premier Li Keqiang advocated earlier this year and we found that a number of companies are increasingly adopting automation, robotics, online-to-offline commerce and advanced manufacturing to upgrade their operations.
Consumer solutions: We have written before about leading businesses such as Tencent and China Mengniu Dairy, both of which we met with recently and still view positively. We also visited logistics business Shenzhen International, at its South China Logistics Park. The company aims to benefit from rising consumption in China by converting the park from a pure logistics hub into a mixed-used space; it already has Jeep and Tesla sales outlets. This is not a one-off project, as Shenzhen International is building several new mixed-use parks. It recognises the opportunities created by rising consumption: the new facilities will offer cost savings to businesses currently burdened with the expense of using outdated networks while also benefiting from the growing e-commerce sector, which requires more complex logistics than bricks-and-mortar operations. The company is modernising its export-oriented infrastructure in order to serve the demands of the new China.
Behind the market volatility, Chinese consumers continue to spend, and we have found companies serving these customers that show robust growth. The Chinese consumer revolution may be adapting to the times by shifting online, but it is still marching on.
 China Daily Europe, ‘Growth target ‘can be met’ despite lower projections’, 23/09/2015.
 Jefferies Franchise Note, ‘When the Dust Settles…Will the China Consumer Come Back?’, 24/09/2015, p.27
 Jefferies Franchise Note, ‘Hard Choices: The Impact of E-Commerce’, 10/07/2015, p.15
 Jefferies Franchise Note, ‘When the Dust Settles’, 24/09/2015, p.30.
 Jefferies Franchise Note, ‘Hard Choices’, 10/07/2015, p.16
Is China in crisis?