How to Play China? Consider US Companies Executing There (CTRP, EL, EWY, HOT)

|
Includes: CTRP, EL, EWY, MAR
by: Shaun Rein

About a month ago, I went back to the US on a business trip and caught an Amtrak train from Philadelphia to New York. Groggy with jet-lag, I was reading the latest Dan Brown book when a fellow dressed in baggy pants and an Allen Iverson shirt plopped down next to me, beats booming from the buds stuck in his ears.

The man seemed to be in his early to mid 20s and his head was covered with cornrows. He pretty much ignored me until my head sort of weaved in slumber and hit him. I apologized profusely and told him that I was fatigued from my trip from China. Within a second, the glaze that had covered his eyes had whipped away as fast as Janet Jackson's clothes from her torso, and he got excited about China. He said China was so cool and that the Chinese Government was certainly doing a better job than Bush. He also said he wanted to tattoo a Mao face on his rather sizeable arms.

I then proceeded to have an entirely unexpected yet very enjoyable conversation until the next station stop.

The fellow’s bottom line -- he wanted to know how he as an individual investor could make money in China. He wanted to know if he should buy Chinese stocks and which ones. He said he had about $5-$10K saved up that he could invest, and he asked for my opinions.

For those of you who follow my thoughts, you know by now that my first point of analysis of a company is its management team. This might derive from my venture capital background, but I think a good management team can take a bad product and make it profitable, while a bad management team can take a good product and run it into the ground.

Unfortunately for the small individual investor, there really are not too many well-run Chinese firms that are on the Nasdaq. Aside from Ctrip.com (NASDAQ:CTRP) and a few others, I have not seen too many good firms here in China that the individual investor can buy a piece of and have some comfort in understanding what they are buying. And too many of the Wall Street and Hong Kong analysts really have no idea what is going on in China, so I am dubious about listening to their advice.

Smarter analysts often recommend getting exposure to China by buying Hong Kong and Korean firms that have exposure to China. One popular purchase of late is a Korean Index Fund (NYSEARCA:EWY), which has soared in the double digits in the last year.

I agree that this can be a pretty good option; however, I am also a little dubious about recommending an index like this for the small investor as the transparency in Hong Kong and Korean still is not as good as that if the US.

Thus, I recommended to the chap next to me on the train that if he wants to realize a piece of the Chinese dream, he should buy American companies that have big-time exposure to China and are well-run. This is a much safer bet -- you mitigate risk from corruption, back a company that is profitable in various regions of the world yet still get exposure to China.

Importantly, I figure, if an American or European company is savvy enough to run a business successfully in China, they can handle just about anything. Here are some companies I would look at. I briefly mention why these firms are good to look at. A future article will go more in-depth into my reasoning.

1. Starwood Hotels & Resorts Worldwide, Inc (HOT)

These guys really know how to do business in China. They are growing with all of their low and luxury brands -- St. Regis, Westin, Sheraton, Le Meridien, Sheraton 4 Points -- into both 1st and 2nd tier cities and thus can capture all segments of the market.

Their Starwood Preferred Guest Program is clearly #1 in the world and has caught on with Chinese clients too with members in the tens of thousands. In fact, the program is so wildly successful that guests overlook the age of some of their hotels – the Beijing Great Wall Sheraton comes to mind – in order to collect more points.

With the increase of business travel and tourists flocking to China, international brands will see a huge upswing. The price of the Westin in Shanghai is close to that in NY yet their margins are fatter because of lower labor costs. Moreover, a higher percentage of food and beverage sales accounts for their revenue than in most US properties as their hotels have became hubs of business and leisure activities.

They don't have accounts receivable problems that other industries have and their staff training is excellent. I personally am a Platinum Preferred Guest and continue to go back to Starwood's hotels. Marriott is a close second and is worth a look at too. The once strong Intercontinental Hotel Group is making some strategic missteps.

2. The Estee Lauder Co. (NYSE:EL)

Although they came late to the game in China compared to L'Oreal that just leaves more upside for them. We estimate that the cosmetic market in China will grow from around $8 billion USD a year to $12-13 billion USD by 2010 and Estee Lauder will capture a fat share of this.

With the fickle Chinese consumer constantly looking for the next hippest thing, Estee Lauder has the opportunity to move into China with new brands and capture market share. Their high-end La Mer has made a big splash, and we think Origins could be a huge hit if and when it comes to China. MAC is set to hit the affluent younger set by storm too.

Estee Lauder’s has been making the investment necessary in China to get better insights into the Chinese consumer. Their operating costs have been too high, but we believe that Estee Lauder can tweak its operations a bit in the coming quarters to bolster profits.

Right now L'Oreal has a commanding lead with its Lancome lines and will continue to grow steadily. But since L'Oreal has been so successful, it is harder for them to find avenues of growth the way Estee Lauder can. I would suggest looking at both companies strongly.

Related: Articles by Shaun Rein.