China has to be the hardest first world economy to get accurate information on in decades. While just a week ago many thought the weakness in China's construction and real estate sector would drag down economic growth. Today multiple companies and analysts are changing their tune on the red tiger.
While data coming from China always has to be taken with a grain of salt, several recent reports suggest China's economic recovery is beginning to accelerate.
First, as I've talked about in several recent articles, China's largest real estate developers are not seeing consistently higher apartment sales in China's largest cities. This is important since China's real estate sector seemed to be in bubble territory after local governments had built ghost cities in major urban areas.
Second, shipping companies who have been bearish for nearly a year are now starting to talk more bullishly about a recovery in the second half of the year. Just recently, Morgan Stanley reiterated comments from Greek shipping company Cosamere, calling for higher rates in the second half of the year.
A third and final point, China's trade data has turned markedly positive as its exports enabled the company to report a trade surplus for the first time in multiple quarters. This is important for a number of reasons, since China is the most leveraged large economy to the eurozone- its biggest customer.
Chinese stocks and U.S. stocks in the S&P 500 leveraged to the Chinese real estate and construction industry have underperformed the broader indexes and their tracking exchange traded funds (such as SPY) by a wide margin. Let's compare two of the largest mineral producers in the world that principally sell into China to the S&P 500.
As we can see, the weakness in the Chinese real estate and construction industry has been pronounced despite some isolated strength in Chinese internet plays like Baidu (BIDU).
Still, Chinese markets have been very weak as well compared to their Western counterparts. Let's look at the chart.
As we can see, the weakness in the Chinese real estate and construction sector has affected the entire Chinese tracking index (FXI). So, if China is truly beginning to recover at a faster pace, who will benefit most?
I think the companies best positioned to benefit from a strengthening recovery in the Chinese real estate and construction industry are some of the smaller mineral companies such as Cliffs Natural Resources (CLF), Walter Energy (WLT), and Macarthur Coal (MACDF.PK).
Cliffs Natural Resources is a Cleveland-based company that has repositioned its business to focus more on iron ore than metallurgical coal in the previous years. Cliff's acquisition of Portman's several years ago gave it added exposure to the seaborne market, and today the company is a strong play on Chinese demand for iron ore. Today's share price of nearly $70 is almost 50% below the company's three year high, and Cliff's management team has been very skillful at making acquisitions during down periods as well.
Walter Energy is an Alabama company that principally sells in North America. It is the world's largest publicly traded company in the metallurgical coal business, a mineral or product used for steel production. While Walter Energy is more leveraged to North America, the company benefits from pricing power that it gets as Asian demand picks up. Walter also exports a good deal of its product overseas. While Walter doesn't produce as much in the Australian market, the company sometimes benefits from supply disruptions in Australia likes floods and other natural disasters.
Finally, Macarthur Coal is a small to mid-cap company that produces a rare and higher margin form of seaborne coal that is pulverized and has lower levels of volatility. In addition to receiving several recent takeout offers from coal giants like Arcelor Mittal (MT) and Peabody Energy (BTU), Macarthur coal is small and heavily leveraged to the seaborne market, which is dominated by China.
To conclude, most Chinese stocks and companies heavily leveraged to the Chinese real estate and construction industry have moderately to significantly lagged the broader indexes. While stocks like Apple (AAPL) and indexes and their tracking exchange traded funds like SPY have been the best performers of the past, new leadership may take the market higher.
Today, some of the largest players in the iron ore and metallurgical space like Rio Tinto (RTPPF.PK) and BHP Bilton (BHP), have rock solid balance sheets and the ability to borrow at historically cheap rates. With the economic data in China improving and these stocks trading at multi-year lows, investors and traders can get long these strong but fairly small companies with a favorable risk-reward setup and a genuine possibility of takeout offers.