Interesting commentary on the China market by an analyst, with...

Interesting commentary on the China market by an analyst, with also comments on A2M further down. A2 rated as a hold based on potential selling down of shares by directors in May/June.

Key takeaways –market demographics

 China will be the biggest market in the world shortly.

 Demand driven economy. Domestic consumption accounted for 76% of China’s GDP growth in 2018 due to the rising purchasing power of the middle-class.

 Falling birth rate –Fell 12% in 2018 to 15.2m babies. First child births will continue to decline given the cost of living is rising. Over 50% of the new births are the second child and this trend will continue to grow as having a second child is a sign of prosperity.

 Aging population -Last year, the number of Chinese over 60 reached 249.5m to outnumber those under 16 for the first time in history. There will be over 500m by 2050. China's one child policy means the current retirees are the first generation to have only 1 child to look after 2 sets of parents. This is a problem and destabilises the tradition of taking care of the elder generation.

 Over the next decade approx. 500m people are expected to move into the cities and industrialised jobs from rural communities. Urbanisation is happening at 40-50m people pa.

 Tier 2 and 3 cities with smaller populations and GDP remain a significant and largely untapped source of growth. 70% of the increase in Alibaba's active consumers in the last quarter came from Tier 3 and 4 cities. Tier 1 cities make up just 5.1% of China’s population. Government wants to curb population growth in Tier 1 cities, citing 'big city problems' and shift the

Key takeaways –government relationships

 Australia/China Government relationship isn’t as bad as you read in the press, but it is far from perfect. Since late 2017, the relationship has gone through a difficult period. This has happened in the past and the relationship has improved. The current relationship is better than it was six months ago, however there are issues. There will always be difficulties.

 Australian exports continue to grow strongly to China (bi-lateral trade is up (+11.7% to A$170bn), particularly resources, agriculture, consumer products, tourism etc.

 China Australia Free Trade Agreement (FTA) has helped trade. In its fourth year now. Most tariffs are now heading to 0%. Makes Australian products more competitive.

 China US Trade War is getting closer to an agreement. If one is achieved, don’t think everything is suddenly perfect. Key will be if China sticks to the deal. Australian Government

Key takeaways –regulatory environment

 Government in cracking down on the daigou and encouraging trade through CBEC platforms (increasing bonded warehouses, reducing tax). Chinese daigounow needs to be registered as a business (have a license), pay tax etc. Should reduce fake products. All about protecting the consumer.

 Australia Post‘ concept stores’ in Australia are seeing no slowdown in the daigou trade.

 From 9 April, China State Council cut the tariffs from 15% to 13% for baggage brought by individuals and products mailed into China on food to expand imports and consumption.

 SAMR approval delays to sell into bricks and mortar–merging of departments into one has delayed approvals. Vitamin companies need Blue Hat approval (costly and lengthy process) and infant formula companies need SAMR register to sell in traditional retail formats.

 While the regulatory environment may change, the Chinese Government knows its people want imported food products.

 Australian imports are minuscule vs what China can produce. Therefore Brand Australia can’t become too big.

 China Government wants to grow and support its dairy industry however there isn’t enough farmland, cows or processing to make a material difference. 40% of the land in China is polluted.

Key takeaways –consumer trends and preferences

 Chinese continue to want foreign products. They want choice. The middle class doesn’t trust its domestic production, particularly dairy.

 Child inherits parents/grandparents apartment therefore they don’t save and spend on luxury goods/services. Luxury goods represent success.

 Chinese are obsessed about living forever. Big focus on health and beauty products.

 The Chinese want our clean, green, quality and importantly safe products. Blueberries, avocados and coffee are growth categories in the food/agrispace.

 Need to have a strong brand presence in Australia to have legitimacy in China. Need scale, a genuine brand, capital and distribution agreements to be a success in China.

 Quality Australian and New Zealand brands have a strong shelf presence in China (particularly in Tier 1 and 2 cities). They sell at a material price premium in China vs at home.

 Counterfeit is an issue –however it is also a sign of a brand’s success.

 Australian products are popular in China due to the daigous/tourists (1.4m Chinese visited Australia last year). Most Australian companies haven’t been good at marketing in China.

 China is not one economy –each region has different consumer characteristics and purchasing behaviour and marketing approaches need to take this into account.

Key takeaways -consumer trends and preferences

 Chinese demand for imported international brands has created a huge, high-growth market for cross-border e-commerce (CBEC). Over the past couple of Singles’ Days, Australian products have been the third and fourth highest ranking country. CBEC has less regulations and is easier to sell on. It is often cheaper for Chinese shoppers to buy Western brands from cross-border platforms than to buy them from Chinese shops.VAT has recently reduced to 9.1% from 11.2% which should further support CBEC demand.

 China’s internet population stood at 829m at the end of 2018.

 WeChat is the most prevalent sales channel/tool for Australian businesses.

 Chinese are addicted to their smart phones. They skipped the credit card phenomenon and pay on their phones. Alipay has over 900m registered users

 Chinese are the most researched consumer ever. Need a deep understanding of the product first to buy it. Celebrity endorsements help. Scanning QR codes with a smart phone provides the consumer with detailed product information.

Economic update:

 China economic news is improving. Although growth has slowed, it is far from over. Stimulus such as tax cuts etc are helping. In March, China’s manufacturing PMI had its largest gain since February 2012. The on the ground view is very different to press reports with 72% of businesses having a positive

Key takeaways –‘New Retail’

 New Retail, digital and mobile payments are fundamentally changing the way consumers research and buy products.

 In 2017, 'New Retail' was introduced by Alibaba’s Founder Jack Ma.

 New Retail aims to remove the distinction between online and offline retail and marketing experiences. Called O2O –offline to online.

 Alibaba has developed HEMA stores -a department store offering high-quality domestic and foreign FMCGs and produce. Outletsprovide a physical and digital shopping experience. Every item on shelf is supported by a digital source of comprehensive product information and usually some other media (scan the QR code with your phone). HEMA offers home delivery in under 30 minutes to customers.

A2 Milk Company (A2M)

 A2 Platinum infant formula, milk and milk powder have a strong presence in China.

 A2 Platinum infant formula benefits from SAMR approval –can sell in bricks and mortar (1H19 sales were 15% of infant formula sales).

 Continues to win market share in China and trade strongly.

 Spending a lot of money marketing in China and increasing its resources on the ground.

 Has not experienced any adverse impacts from the new China e-commerce rules.

 Feedback was A2M has done a good job in China and parents know the brand. It has strong government relationships.

ASX listed China leveraged consumer picks

Buy:

 TWE–attractively priced relative to its long dated strong growth profile.

 AVG –value play at ~35% discount to NTA, growing branded sales and gradual return on capex.

Hold:

A2M –rate this company highly however management share sale in May/June could provide a more attractive entry point.

CGC –diversified business, industry leader and strong management team, looking for a more attractive entry point for downside protection against agri risk (volatility in price and volumes).

SHV –improved operating conditions and rising almond price is largely factored into its share price.

Too expensive:

BKL –3Q19 trading update will likely disappoint. Underperforming vs Swisse. Need to appoint a new CEO (potential to clear the decks). FY20 PEG ratio of 2.0x.

FNP –great portfolio of brands and assets however need to deliver (execution has been an issue) and trading on premium multiple.

BAL -after strong share price appreciation, SAMR is starting to be priced in. Short term downside risks. Share price will likely retrace the longer it takes to receive SAMR.