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The Chinese stock market has obviously been volatile lately, and is not a place for the faint of heart to put money down (as I wrote about last year for BusinessWeek). I personally sold off all of my Chinese equities in early January, and many of our clients thankfully did the same. I am slowly looking around for a few jewels now and will put my money in companies that are better run, like China Mobile (NYSE:CHL) or Netease (NASDAQ:NTES). Once the valuations become a little more reasonable long-term, these firms will keep making money because they have the management teams in place to offer the services Chinese consumers want.

While many pundits have been arguing that China’s bumpy stock market indicates a potential slow-down in China’s economy, I say that is balderdash. China’s economy is still humming along and there is little correlation with the strength of the stock market and the strength of the overall economy. Now, for China to truly reach an international level of strength economically, it will need a better functioning stock system for sure but right now do not look at the stock market and equate it in any way with the economic well-being of China.

Contrary to what many people believe, China’s economy is not being led by stodgy old reformed State-Run Enterprises but by entrepreneurs who have set up restaurants and little markets. They are relatively insulated from the stock market and are more concerned with increasing egg and steel prices – to me, indicating a real worry for stagflation. Although many stock-picking housewives got hurt in the recent downturn, most Chinese still have little money in the stock market. Instead, they put their money into illiquid investments like real estate or small companies like massage parlors or are earning a little money in time deposits.

Smart foreign investors will put money behind companies that are insulated from the volatility of the stock market once the markets calm down a bit. Sectors to get exposure to are those that cater to Chinese demands for leisure activities and luxury products.

The travel sector is booming and there certainly are several firms that are better positioned to handle the travel wants of China emerging 250 million strong middle class. I have always been a big fan of Ctrip (NASDAQ:CTRP) and continue to be so, especially as China has adopted e-tickets for all domestic flights. My firm, for instance, has completely stopped using the travel agent we used to use and now book all flights through Ctrip because it is more convenient. Moreover, I like the Ctrip VIP card which gets me discounts to restaurants throughout China.

Travel Boom

The China National Tourism Administration or CNTA estimates that China’s tourism industry will pull in a record $128.6 billion USD of revenues in 2007, an increase of 10% over 2006. More than 70% will come from Chinese tourists and not just for the wealthy foreigners visiting China for the first time.

International Travel

Twenty years ago Chinese citizens did not have the money or the political freedom to travel easily within China much less beyond its borders. Now that China is reaping the benefits of its economic integration with the rest of the world, Chinese citizens are increasingly curious about what lies beyond and they have the money to make their trips to Asia, Africa, Europe, and the Americas a reality. The growth rates are astounding.

China’s Ministry of Public Security estimates that in 2006 34.5 million Chinese left China to foreign destinations including Hong Kong and Macao. This is a 10% increase over 2005 and completely dwarfs 1995 when only 4.5 million Chinese made it overseas.

Chinese tourists are spending their money on different destinations for different reasons. And increasingly there is a destination for almost every Chinese traveler and budget. As of 2006, China had awarded 132 countries with approved destination status, an official approval allowing Chinese to visit. According to the Ministry of Public Security the most popular destinations for mainland tourists in 2006 were Hong Kong, Macao, Japan, Thailand, the Republic of Korea, Russia, the United States, Singapore, Vietnam and Malaysia.

Gambling

Macao especially has benefited from the increasingly heavy wallets of Chinese tourists as it has become the biggest gambler destination in the world, surpassing Las Vegas in dollars spent at around $8 billion USD. The city is under something of a renaissance with a huge influx of cash coming from the major Vegas casino players. This year 10 more ferry’s connected Hong Kong to Macao are planned to help accommodate the increased traffic between the two cities.

Although stock prices have gone up, keep an eye on Sheldon Anderson’s Las Vegas Sands Corp. (NYSE:LVS), Wynn Resorts, Limited (NASDAQ:WYNN) and MGM Mirage (NYSE:MGM), which all have their eyes on capturing profits.

Shopping Trips

Travelers with more money to spend are choosing to fly to Hong Kong, Europe and the US to go shopping for luxury items from retailers like Louis Vuitton and Cartier.

I went on a trip last year with my wife to Milan. We went shopping, too – I love Brioni and Kiton, which are hard to get in China and outrageously priced because of high import duties – and my wife wanted to buy Gucci and Prada. Seemingly everyone around us was from mainland China.

Domestic Travel

Even bigger than the growth in international travel is the surge in domestic travel. There were 1.5 billion trips taken within China in 2006 and growth is likely to remain solid for several years to come.

One of the major shortcomings of tourism in China in years past was the lack of affordable hotels. Chinese tourists were stymied because options were either at the very high end and only affordable for business travelers booking with an expense budget or seedy hotels that were not particularly comfortable.

The last few years have seen a lot of development in budget, mid and high range hotels in China from chains such as Wyndham Hotel Group (NYSE:WYN), Starwood (NYSE:HOT) and InterContinental Hotels Group (NYSE:IHG) and domestic brands such as Home Inn (NASDAQ:HMIN), and Jin Jiang Hotels.

The blossoming of midrange hotels with rooms that book for around $100 USD a night is a boom both for Chinese travelers who now have many more options when they take a holiday in Shanghai or Kunming but also for foreign travelers who also represent a sizable fraction of China’s tourism industry.

Home Inns operates 110 hotels in China and InterContinental Hotels Group which manages the Holiday Inn chain operates 56 hotels in China and is looking at having 125 in operation by 2008.

Conclusion

The recent downturn in Chinese equities was a welcome hit for those of us that were scratching their heads at the valuations some companies were getting. But the recent volatility does not indicate in any way whatsoever a downturn in China’s economy. Savvier investors will stay on the sidelines but cherry-pick the good companies.

Note: CMR analysts Ben Cavender and Anna Li contributed to this article.

Source: Investing in China's Tourism Industry