Don’t Get Burned by China’s Slumping Consumer Sector Stocks

The economy is slowing, supermarket prices are falling and consumer confidence is slipping in China, a country with more than 1 billion shoppers.

china-mapThese and other signs of a weakening economy – including Monday’s news of a sharp decline in November for the official manufacturing purchasing managers index (PMI) – should give Chinese consumer sector stock investors a big cause for pause.

Pause is needed, for example, to separate consumer sector fact from fiction.

True, China is a strong market for consumer electronics such as Samsung Elect Ltd (SSNLF) mobile phones and Apple Inc. (AAPL) tablets. Cars built by China affiliates of Ford Motor Company (F) and Volkswagen AG (VLKAY) sell well. And it’s a great market for online retailers such as Alibaba Group Holding Ltd (BABA), underscored by the company’s revenue boon Nov. 11, when China celebrated Singles Day by shopping on the Internet.

But companies that make consumer sector basics such as paper products, packaged food, clothing and milk – to name just a few staples – have a lot less to celebrate.

“Generally speaking, basic consumer goods have been greatly affected in the course of this economic downturn,” declared a recent Qilu Securities analysis.

Among 28 food manufacturers trading on either the Shanghai or Shenzhen stock markets, Qilu said, 43% posted losses for the first three quarters of 2014. And 75% of the 32 beverage makers analyzed by the firm reported lower profits compared with the same period in the previous year.

The Hong Kong-listed Chinese dairy company China Mengniu ADR (CIADY), for example, is cutting prices and turning liquid milk into powdered milk due to “oversupply and weakened demand,” according to Goldman Sachs Gao Hua Securities. Another dairy, Shanghai-listed Inner Mongola Yili Indudustrial Group Company, has slashed some retail prices 28%, the report said.

Another Hong Kong-listed company in the consumer sector firing line is Hengan International Group ADR (HEGIY), which makes tissue paper, plastic wrap and napkins. The company’s first half 2014 financial report cited the challenges of “intense competition” among China’s paper companies amid “a general economic downturn.” Tissue paper sales account for about half of the company’s revenues.

Consumer sector companies listed in Hong Kong posted better, first-half 2014 financial results overall than those listed on China’s stock exchanges, according to a Deutsche Bank analysis. Year-on-year net profits for companies trading in Hong Kong rose an average 4.6%, the report said, while consumer staples companies listed on the mainland saw net income decline an average 6.9%.

“In general, the companies (Deutsche Bank) covered disappointed us on the top line as consumption was weaker than our forecast,” the report said.

Although major clothing makers and jewelry suppliers have already shifted business to retail websites and away from shopping malls, the China research firm CEBM said they haven’t dodged weaker demand. And as of August, the report said, some 80% of the nation’s shopping mall operators expected to miss annual sales targets.

There’s been little in recent macroeconomic data released by the Chinese government to suggest any near-term turnaround for companies selling basics to the nation’s consumers.

For example, the National Statistics Bureau said Monday the November PMI fell to 50.3, down a half point from October as the manufacturing sector cools. The monthly survey of purchasing managers also found most companies cut payrolls and inventories last month.

A separate bureau survey in October found consumer confidence slipping as well. An index reflecting the average consumer’s view of the “current economic situation” fell 3.1 points from September to 97.8 in October, the bureau said, while their view of the future declined 1.2 points to 107.2.

In another sign of weakening consumer demand, China’s October consumer price index rose just 1.6% year-on-year and not at all from the previous month. The rate in both September and October was the lowest since January 2010. Some analysts say China is on the threshold of a deflationary period. November’s inflation rate is due to be released by Dec. 15.

As of this writing, Eric Johnson did not hold a position in any of the aforementioned securities.

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