China’s $585 Billion Renovation

The global recession has hit China in a big way. Over 67,000 factories have closed in the last three months. An estimated 50 million Chinese workers are now unemployed, according to the usually overly positive government estimates. Protests or “mass incidents” are springing up all over the country.

The official Chinese GDP growth rate plummeted 30% in the last quarter. Independent data coming out of the manufacturing sector, however, suggests a much sharper decline. Chinese stocks have been surging up and down, just as they have in the U.S. There are ways to profit from this global market volatility. China certainly presents a unique set of opportunities.

The fact is, the Chinese have been running surpluses for 20 years. They hold about $2 trillion in foreign exchange reserves and they’re about to start spending it in a big way.

Earlier this week, China announced a $585 billion stimulus package to get its economy back on track.

We’ve been so used to hearing about multi-billion dollar bailouts and stimulus packages that it’s hard to absorb the significance of this announcement. But as a percentage of the Chinese GDP (around $3 trillion), this stimulus package dwarfs the U.S. bank bailout. In fact, it amounts to about 20% of its GDP, whereas the $1 trillion bank bailout amounts to about 8% of U.S. GDP.

And guess what? China doesn’t need to borrow the money. It has around $2 trillion in foreign reserves.

Chinese workers are also great savers. They typically put 25% of their take home pay in low interest savings accounts.

Although China claims its economy is still growing at 6%, the data coming out of the manufacturing sector suggests this estimate is a bit too positive. You see, China is not a diversified economy. They make low cost goods (90% of the stuff at Wal-Mart (WMT)) for foreigners. When those foreigners (mostly Americans) stop buying cheap stuff, the manufacturers are in big trouble, and when a crisis affects China’s manufacturing sector, it has the potential to grind all economic growth to a standstill.

China just can’t develop a mature, less-cyclical economy that way. For China to diversify out of manufacturing, they need to radically increase their domestic consumption. But that is not going to happen overnight.

So what is China’s short-term solution? Spend a massive amount of money improving the nation’s infrastructure, which has been critically lacking for some time. The money is slated for water and energy projects, roads, railways, airports and low-income housing. The Chinese government is hoping the infrastructure stimulus package will function as a bridge into China’s next economic phase, a more diversified, sophisticated industrial society.

We can think of China itself as a carpenter who’s been steadily employed for 30 years, and is suddenly fired. At first he panics: “What am I going to do with myself?” But, then he takes a few deep breaths and realizes, “Hey – I’ve got savings. And I’m a carpenter. What a great time to renovate my house!” Of course, this isn’t going to solve all the problems overnight, but nobody really expects it to.

Kirby Daley a Hong Kong financial strategist said:

The China stimulus package is not the answer to all of Asia’s problems, although it is a step in the right direction.

Foreign analysts had been expecting the Chinese government to make a dramatic move to shore up its battered economy, but few predicted anything on this scale. The day of the announcement, the Shanghai Composite Index surged 7.3%, but quickly pulled back as analysts pondered the effectiveness of the strategy. There is some skepticism about how much of the spending is actually new.

There also are complaints that the construction timelines are too stretched out to have significant short-term effects. However, it will have to provide some much needed help for China’s worst problem: unemployment.

The Chinese government can’t afford – politically or financially - to have laid-off factory workers sitting around twiddling their thumbs. Therefore, the work will be done and the money will be spent.

China has about 30,000 miles of highways and one million miles of county level roads. A great deal of this roadway urgently requires maintenance. It also needs new rail lines, power plants, and water infrastructure.

Here’s the thing - it’s a virtual guarantee China will use its own suppliers whenever possible to get this work done. Some U.S. companies, like General Electric (NYSE: GE) are predicting benefits from this spending. At Q1 Publishing, we are skeptical that these benefits will translate into more than a few extra cents per share for the major multinational conglomerates.

However, there are certainly opportunities here for investors. China is trying to help its own economy. If the rest of the world benefits – fine, and if not - that’s fine too. This is why we expect China to spend the majority of this bailout inside its borders. As a result, to capitalize on the spending, it’s best to own Chinese companies.

Most of the bailout package will be spent on the raw materials and service-suppliers needed to build roads, bridges, and other infrastructure. We should be looking at companies who operate exclusively in that space. Here’s a few we would consider pure-plays on China aggressive infrastructure spending:

West China Cement [LSE: WCC] is definitely going to be very busy. It produces and sells cement, using environmentally sound practices, under the brand ‘Yaobai Cement.’ It has three production lines in the Pucheng area (100 miles north of Xi’an) which can crank out 1.5 million tons of cement a year. A massive new plant, however, is scheduled to be completed in the next six months, bringing total production to 5.8 million tons. West China Cement had sales of about U.S. $430 million last year. Its profits and operating income increased about 70% from the previous year.

Guangshen Railway (NYSE: GSH) is a $107 billion transportation company poised to benefit from infrastructure spending in China. It has a fleet of passenger trains that operate between Guangzhou and Shenzhen, in addition to Hong Kong. The company also has a freight services division, which transports oversized cargo and construction materials. An estimated $100 billion of the stimulus package will be spent on rail services. Railcars are often referred to as “turn of the century technology” but in fact they are more energy efficient than cars, planes and boats. Guangshen’s operating income doubled in 2007 and their gross profit surged 163%.

China Railway Construction Corporation [HKSE: 1186] is an integrated construction company which provides infrastructure design and production in the areas of railways, highways, bridges, tunnels, airports and ports, water conservancy and hydropower facilities, real estate and municipal projects. This $20 billion company is on the “buy list” of many institutional investors. China Railway will benefit directly from the $585 billion in infrastructure spending.

Times are tough. To make money in these markets you have to be clear headed about the existing opportunities. When a big country like China announces that it is going to be spending 20% of its GDP building roads and railways, fortunes are going to be made for the companies China chooses to support.

I’m willing to bet China is going to support companies within its borders first. For that reason, we are keeping an eye on the political and economic shifts overseas and finding the companies that will truly benefit from the bailout, regardless of where they trade. In the meantime, there is a historically proven, conservative investing strategy that will help you to rebuild your portfolio.

Disclosure: None

Comments

[Dan Lewis J...:]

Good article.

Another interesting question in China - as the Chinese Government owns certain companies in certain sectors, is it better to invest in these. I'm thinking China mobile rather than China Unicom etc. My thinking is that these companies will be preferred beneficiaries of any infrastructure development first.

2008 Nov 14 08:11 AM

[investor88:]

Good article, throws much more light than can be gleaned from just reading the newspapers. Plus we can zoom in on some companies like China Railway.

2008 Nov 14 11:48 AM

[huangthomas:]

Chinese central government has monopoly right to use the brand name "China". Any corporations have "China" in the name, they are all Chinese central-government-own... enterprise. "China" mobile and "China" Unicom are all "China" state-owned enterprise.

2008 Nov 14 11:52 AM

[HaavBline:]

huangtomas said: "Chinese central government has monopoly right to use the brand name "China". Any corporations have "China" in the name, they are all Chinese central-government-own...

This statement may or may not be true in CHINA. But it clearly is NOT TRUE from foreign investors' standpoint. Companies listed in foreign stock markets can freely pick their name. When China plays were HOT a few years ago, tiny companies that managed to listed in foreign markets loves to put CHINA in its name in order to enhance its IPO attractiveness,

One example off my head: China Medical Technologies (CMED), a NASDAQ listed small company registered in Caymen Islands. Or China Greentech (GRRF).

Don;t expect the Chinese Central goverment to bail you out if this small company gets in trouble.

2008 Nov 14 01:32 PM

[HaavBline:]

One of Author's recommendation: Guangshen Railway (NYSE: GSH) may not be such a good choice at all if you want to ride the China stimulus package. It may have been on of the better China play is the past, but I think it will face strong headwinds going forward.

Guangshen Railway serves the eastern flank of the Pearl River Delta, a region jammed pack of China's export manufacturers, is probably the hardest hit manufacturing base in China.

In addition, this stimulus package focus infrastructure development of rural and inland province which lags far behind the coastal provinces. Being the region benefits MOST in the last 30 years and already having some of the best infrastructures in China, the areas covered by Guangshen Railway is not likely to get a big share of stimulus money this time.

In fact, new trnasport infrastructure developments in the Pearl River Delta region connecting the eastern and western banks of the river delta may provide new competition to GSH.

2008 Nov 14 01:51 PM

[Tony Petroski:]

Help me through this: China has 2-trillion dollars in foreign reserves and "they're about to start spending it in a big way" in a $585 billion-dollar stimulus package concentrating on "infrastructure." This is not supposed to be good for foreigners, because the Chinese are going to attempt to push their consumers along to spend this money domestically because those foreigners aren't buying the "cheap stuff" as much as they used to. Are the Chinese paying their workers in dollars and yen? Just how does this 2 trillion stimulate domestic consumption?

2008 Nov 14 11:31 PM

[Urbane Gori...:]

Great article... And HuangThomas.. Thanks for the 'potential' lead.. It may not be accurate all the time, but is an aid in knowing which companies are SOEs (State owned Enterprises),,, And re: Foreign companies using 'China' in their name, let's not forget 'Canadian Solar; which is a Chinese company.

Also, seems to me Guangshen RR was already planning major expansions (Read this last year I think) and I suspect that the world will come out of this mess sooner or later. The Chinese plan should gear up the infrastruture to be ready for a revival..

jegan

2008 Nov 14 11:37 PM

[4118:]

huangthomas, you are wrong about the "CHINA" claim. Nowadays, Chinese government only own 8 sectors, the rest are all going to the "free market". These 8 sectors are essential for national security rather than for profitting, for example, natural resources(hydro, oil etc.), communication, transportation etc. No need to say, if foreign companies/nations own these sectors, they are placing their hands on China's neck. Indeed China's hit hard by this crisis, mostly because China's role in world trade and especially it's relationship with the U.S. However, don't forget that unlike U.S. China's not facing the credit crisis, and it has a huge domestic market. Without trading surplus from U.S. japan etc., China will continue to grow economically in the future, but to a lesser extent. Also, other than reserves, China has a lot of outgoing loans, especially to U.S., technically, China, Japan and other countries helped to boost American's consuming pattern in the last few years, americans owe money to these nations(trillions to japan and china), not to the banks in America, when you get a loan on your 2nd or 3rd car, that money's from Japan or China. without the loan, you won't buy that car, and they lose money(say in this example Japan loses money, coz they were not able to sell u their new Toyota).

In the near future(10-20 years), domestic market will be the major player for Chinese economy, replacing exporting(which will be around 40-50% of china's GDP at that time). After all, there are 1.3 billion customers in China. China's only exporting goods to us because our money's more valuable than theirs, for example, a new made in China mp3 player costs a Chinese $20U.S. if they sell it domestically, but if they sell it to an American, they charge you $30U.S., which is still much cheaper than a similar mp3 player that is made in U.S.( say $50). Then it's a win win situation for Chinese manufacturers and U.S. consumers. Plus, if we consider cost-efficiency, then chinese labor force's much better than ours(unions are the major cause i believe).

Therefore, China's has more potential than the united states, 1.3 billion people=work forces;=consumers;=wor... largest market. The chinese government kept their currency in check for reasons, import/export surplus, attract foreign investments=create job opportunities, and they intentionally make their standard of living lower than they should be by lending money to U.S. and save money(reserves). If they revalue their currency(most people believe it's undervalued by about 30%), and collect their money back, chinese people will be richer and able to purchase a lot more things than they are actually needed(like most of us in North America); and they will lost foreign investments because investing in china will not profit anymore since the costs are going up, and china's trading surplus will decrease substantially. Overall, they shift from exporting(manufacture) to service(domestica/inte... market because Chinese people have money to spend).

2008 Nov 15 12:45 AM

[M.R. Henderson:]

On WCC: I would want to know over the past few years what percentage of WCC sales have been to infrastructure projects before I considered cement after the last eight years of booming cement. Will infrastructure increases make up for the declines in property and manufacturing? Fixed asset investment in China 2007: 24% property investment, 30% manufacturing, 30% infrastructure. What companies beside Microsoft are increasing their investment in China? Apartment sales are slowing as prices are falling; how deep this goes remains to be seen, but few are brazen enough to be starting new property projects. And there has been a lot of building here. A Bank of China manager gave us a tour of an empty skyscrapers built just to improve property values. He said this has been done all through China to help prices. What would happen if these building managers started renting space on the sly?

As for a railway service provider from Guandong? That's the area hit hardest by the manufacturing slowdown so far. After this company is done shipping all the workers home, they aren't gonna be carrying more freight than they did last year. And with newly launched competition?

The last company mostly builds railroads. I invested in them after the Nigeria contract came up for renegociation, but this new developement that Beijing wants already strapped local governments to pay 3/4 of the BOLD infrastructure stimulus makes me worry that instead of helping a railroad builder, this package could saddle them with more debt.

From the FT: Beijing offers just quarter of stimulus funds
By Geoff Dyer in Beijing
Published: November 14 2008 23:35

Mu Hong, vice-chairman of the National Development and Reform Commission, a government economic planning agency, said Beijing would increase spending by Rmb1,180bn ($172bn, €136bn, £116bn) over the next two years – leaving local governments, state-owned banks and companies to provide the rest of the new funds.

If there's a way to create problems with the rapid ramp up of this "stimulus", I would say Beijing found it.

2008 Nov 16 09:35 AM

[MrBuzz:]

The investment that China is making is one that could be linked to longterm growth if done in a wise manner. It is like the US Eishenhower Interstate System and could produce a simlar result.

Tony makes good question. The amounts we use in Wall Street Speak are in dollars. But, the ones used inside China are of course Chinese Yuan. (today 6.83 Yuan to 1 dollar). That means if well spent. they can get lots of action for their money. But, often the communist system waste as much money as it spends. Our govenment waste as much as theirs does. But, our system of building makes dollars or Yuan's go much further and work harder.

My plan will be work well with what China is doing at home. It will make the company a few extra billion.

2008 Nov 16 09:59 AM

[User 342404:]

All numbers are in US dollars, convert to Chinese yuan it will be about 4 trillion.

Source: news.xinhuanet.com/eng...

Jan 22 12:45 PM