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3 Foreign Companies To Tap Into China's Consumption Upgrade Trend

by: Urbem Capital

Consumption upgrade is one of the key secular trends happing in the China market.

The consumer market in China is extremely competitive, with a handful of examples where seemingly wide moats were easily destroyed.

We detail our screening strategy along with three picks.



China has the third-largest consumer market in the world by household final consumption expenditure, after only the US and the EU. The country is evolving incredibly fast and is going through a profound transformation in terms of consumer behavior - e.g., more urban, more connected, less traditional.

A couple of years ago, we heard a lot about consumption upgrade, but more recently, consumption downgrade became the focus of discussion. The consumer economy is not a black-or-white situation, and we believe that both trends do co-exist. Either upgrade or downgrade reflects the attitude towards spending in different categories.

We understand that many investors have concerns here and there when it comes to directly buying Chinese companies. Hence, in this article, we would like to explore the investment opportunities in this regard by searching for some foreign companies that can ride well the secular trend of consumption upgrade in China. First of all, we set a couple of ground rules for screening as follow -

  1. The company must have a leading market share in China (an indication of the economic moat);
  2. The business is growing at a double-digit rate at the moment;
  3. The underlying industry is expected to grow at a double-digit rate for the next few years (offering decent long-term opportunities);
  4. The brand is not a new entrant in the China market;
  5. The business mainly competes with foreign players instead of local ones (this should eliminate companies like Apple (AAPL), Starbucks (SBUX), Yum China (YUMC));
  6. The management is willing to spend on digitization.

So below are the three finalists of our picks.



France-based Hermès International SCA is the designer, manufacturer, and marketer of high fashion luxury goods, with specialization in leather, lifestyle accessories, home furnishings, perfumery, jewelry, watches and ready-to-wear.

According to Bain & Company, Chinese spending represented 33% of the global luxury market in 2018, and it has expanded rapidly (see below).

Source: What’s Powering China’s Market for Luxury Goods?

Meanwhile, the Mainland China luxury market posted a 20% growth in recent years, primarily driven by millennials and SHEconomy (see below), with a total market size of almost $25 billion.

Source: Bain

At Hermès, Asia Pacific (mainly Greater China Region) is the largest revenue source (40%) with the fastest growth (almost 18% p.a.) among all regions, and far exceeds the second position (Europe excluding France with 17% of total sales).

Source: 2019 Half-year Results.

Source: 2019 Half-year Results.

Regarding the China luxury market, Hermès does not have an as large market share as its competitors, such as Louis Vuitton (OTCPK:LVMHF) (OTCPK:LVMUY), Gucci, do, as it mostly deals with the ultra-high-net-worth segment. This strategic focus on the very top-tier consumers enables the business to earn superior cash flow margins and ROIC in a less cyclical fashion.

One common mistake that we observed from both domestic and foreign consumer brands is that many of them pay too much attention to the market in megacities like Shanghai, Beijing, and Guangzhou. Hermès has a store presence in major tier-2 cities in China (as shown below), which should position the company well to capture future growth. The company recently opened new stores in Changsha, Xi'an, and Xiamen.


China is probably the most digitalized country in the world with unique usage, habit, and consumption patterns among consumers. To adapt to the specificities of the large and dynamic market, the China subsidiary also invests in various digital initiatives, including the launch of the new site, which offers online sales throughout the country, as well as the omnichannel event "Silk Mix," which combines a pop-up store with a WeChat mini-program.

Nike (NKE)


Oregon-based Nike is the world's largest supplier of athletic shoes and apparel and a major manufacturer of sports equipment.

With over $30 billion in market size, China's sporting goods industry is the second biggest market in the world behind the US. The total sports-related industries in China account for just 0.7% of the GDP, compared with the US, where sports contribute to 3% of the GDP.

As of annual growth rate, 11% in China is significantly higher than the 5% recorded in the rest of the world, mainly due in large part to massive consumption of cultural activities from a rising middle-class population with a growing interest for a healthy life and healthy body. The fact that only one-third of the country's urban residents often participate in a sport should also be taken into consideration. That percentage is expected to rise to 40% by 2020, according to the General Administration of Sport of China.

Moreover, the Chinese government is implementing a wide range of reforms to support the sports industry. Within the framework of the national fitness plan, the government aims to use sports to advance all sectors in the country, including industry, state, and society, and to grow all sports-related industries to 1% of the GDP.

Nike is a rare American company that puts China as a standalone report region, showing the management's commitment to business development in the country.

Although Greater China only represents 17% of Nike's total revenue (see below), its sales growth has been tremendous - i.e., 21% YoY in FY2019 and FY 2018 - highest across all regions.

Source: 2019 Annual Report.

Source: 2019 Annual Report.

You would even see a more stellar year-over-year increase from the EBIT perspective - 31% in FY2019 (see below).

Source: 2019 Annual Report.

For so long, Nike has been the leading player in China's sportswear industry. It and its long-time rival Adidas (OTCQX:ADDDF) (OTCQX:ADDYY) controls more than 30% of the overall market. Top local brands, such as Li Ning (OTCPK:LNNGF) (OTCPK:LNNGY), Anta (OTC:ANPDF) (OTCPK:ANPDY), share just 10%.

In our opinion, Nike China has been doing a decent job of building the growth engine through branding, government partnership, and D2C businesses (especially on the digital side).

We believe that the fashion element injected in the Nike brand, along with high-quality products and marketing expertise, would enable the business to gain a substantial and growing share of mind among Chinese consumers. It is reasonable to anticipate a sustainable double-digit growth in the region ahead for the mid-run at least.






France-based L'Oréal S.A. is the world's largest cosmetics company and has developed activities in the field concentrating on hair color, skincare, sun protection, make-up, perfume, and hair care.

What we see is a great appetite of Chinese consumers. There is also more and more income that has to be spend.


[Chinese consumers] not only want to buy more products, but they want also higher quality products, better produts, more expensive products, which is extremely positive.

Jean-Paul Agon, CEO, CNBC interview, October 2018.

Driven by L’Oréal Luxe, China is now the group's 2nd largest market with head offices, an R&D center, two factories, and the company’s four divisions present with its 15 flagship brands.

According to its 2018 Annual Report, L’Oréal generates almost 30% of its total sales from the Asia Pacific, the majority of which, is contributed by the growing SHEconomy in China.

Source: 2018 Annual Report.

This revenue share is not a super impressive number, but looking at the growth rate, one should realize why the Chinese market has been so strategic for L’Oréal. For the 1st half of 2019, the sales of China region grew almost 40% YoY (see below), compared to the 10% average of the APAC market. As the No. 1 beauty group in China, L’Oréal appears to be taking full advantage of consumer evolution taking place in the region.

Source: Investor Presentation, 9/12/2019.

In our view, the management has been doing great in at least two things, which have primarily contributed to the company's success in this country - branding, and digitization.

Thanks to its comprehensive portfolio of brands, from mass market to luxury products, from haircare to dermo-cosmetics and the investments to make sure that those are the favorite brands of Chinese consumers, L’Oréal is well-positioned to leverage the industry tailwind of low-to-mid-teens annual growth in this roughly $40 billion market. For example, launched in China back in 1993, Lancôme was is the first brand to tap into pockets of the new middle-class Chinese women trading up to luxury. Today, Lancôme is the No.1 luxury beauty brand in the country. Other brands like Giorgio Armani, Yves Saint Laurent, and Kiehl’s also gained a significant share of mind among Chinese beauty-seekers.

At the same time, L’Oréal has conducted meaningful acquisitions for the region to keep up its growth momentum and to widen the gap against its peers, such as Estee Lauder (EL), Unilever (UN) (UL), Shiseido (OTCPK:SSDOY) (OTCPK:SSDOF). For example, last year, the company acquired Stylenanda, a very trendy makeup brand that fits the growing appetite of Chinese Millennials for Korean brands.

As part of the digitalization strategy, L’Oréal has focused on e-commerce in China where it already makes almost half of its sales online (up from only about 2% in 2012 and compared to 13% for the business globally). The China subsidiary also took many extra initiatives, including the partnership with e-commerce giant Alibaba (BABA) on the first AI-driven mobile acne analysis application and the launch of its AR make-up application on WeChat (OTCPK:TCEHY) (OTCPK:TCTZF) (China's No.1 social media).

Source: Investor Presentation, 9/12/2019.

Last but not least, consumer spending on beauty products is something that even a tenuous economy cannot shake. It is highly likely that L’Oréal may continue to grow its business in China at a healthy pace even if the economic slowdown materializes as many people fear.


The consumer market in China is considered highly competitive. It is not uncommon to see big international brands failing in this country. In the meantime, we believe that consumption upgrade and downgrade co-exist due to the rapidly evolving consumer behaviors and attitudes. Therefore, from an investment perspective, we would like to stay ultra-cautious when it comes to picking long-term winners in this space.

We recommend Nike, Hermès, and L'Oréal for betting on the consumption upgrade trend in China, according to our stringent ground rules for screening. Unfortunately, all of the stocks appear a bit overpriced at the moment. But they should deserve some spots on the watch list of those long-term bulls of the China consumer market.

Disclosure: I am/we are long NKE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Mentioning of any stock in the article does not constitute investment recommendations. Investors should always conduct careful analysis themselves and/or consult with their investment advisors before acting in the stock market.