China Sector Analysis: Consumer Staples

As the fifth installment in an ongoing series that explores the 11 major economic sectors in China, this piece provides an in-depth look at the key stats, notable companies, and thematic tailwinds that characterize China’s Consumer Staples sector, tracked by the Global X MSCI China Consumer Staples ETF (CHIS).

Background

Since the 1980’s, China’s population dramatically shifted from a largely rural, agrarian society, to one defined by middle class city dwellers. The profound effects of this shift continue to impact China’s economy today, as citizens’ rising wages drive the formation of new consumption habits to fit their urban lifestyles. One area that exemplifies these changes is the non-discretionary component of Chinese consumer purchases. Rather than depending on one’s own farm or on a local markets for everyday food and goods, Chinese consumers are increasingly turning to stores for manufactured goods like snack foods, beverages, and home supplies.

Due to shifting preferences and a growing consumer class, the Consumer Staples sector exemplifies both growth-like and defensive characteristics. Sales growth expectations for the sector are 2.5 times higher than US Staples. Yet last year, Consumer Staples was the best performing sector in China amid an outbreak of swine flu and protracted trade tensions, which truncated supply and initiated a shift towards more defensive assets.1 In the first quarter of 2020, amid unprecedented disruption from COVID-19, Consumer Staples continued to outperform the broad MSCI China Index benchmark, leading it by 7.8% through March 10th.2

China Consumer Staples: Sector Breakdown and Key Stats

China’s Consumer Staples sector experienced rapid growth over the last decade as the economy and middle class expanded. The sector’s total market cap multiplied nearly 10x, from approximately $70 bn in 2010 to more than $700 bn by the end of 2019.3 The sector, however, is still only a third of the size of its US counterpart, which stands at roughly $2.1 tn.4 In addition, Staples represents just 4% of the broad MSCI China Index whereas US Consumer Staples make up approximately 8% of the S&P 500.5 This is all despite the fact that China has a larger middle class than the entire population of the United States.

China’s Consumer Staples sector is largely domestically-focused, which is evident by its high domestic revenue exposure (roughly 98%).6 The sector includes several of the largest companies listed in mainland China, driving A share representation to a high 47%. By comparison, only 16% of the Consumer Discretionary sector is A shares.7 Given the high proportion of A shares, access to the sector for international investors was largely limited until just a few years ago when China democratized access to the onshore equity market via the Stock Connect program and subsequently many of these companies became included in major emerging market indexes.

Less than 1% of the Consumer Staples sector are state-owned enterprises, whereas companies in older sectors like Materials, Energy, Utilities, and Financials, tend to be more export-oriented and have between 34-40% SOE representation.

Recent demand for defensive exposures and strong performance caused valuations for China’s Staples sector to expand. While China’s markets typically trade at a discount to the US, the Consumer Staples sector features valuations that are similar to its US sector counterpart, as demonstrated by price-to-earnings (P/E), price-to-sales (P/S), and forward Price to Sales (Fwd. P/S) multiples.8 China’s Staples sector remains cheaper, however, from a price-to-book (P/B) metric and is projected to experience higher sales growth over the coming year.9

American Depositary Receipts (ADRs) are stocks of Chinese companies listed on American stock exchanges. A shares are listed on domestic stock exchanges in China and have been historically difficult to access. P Chips are stocks of companies operating in China, listed in Hong Kong, and incorporated in the Cayman or British Virgin Islands. Red Chips are stocks of companies based in China, incorporated abroad, and listed in Hong Kong. H shares are stocks of companies incorporated in China and listed in Hong Kong. Holdings are subject to change.

Industry Breakdown

Four major industries make up China’s Consumer Staples sector. Roughly half of the sector is made up of Food Products, a third by the Beverage industry, and nearly 15% split between Personal Products and Foods & Staples Retailing.

Holdings are subject to change

  • Food Products: China’s Food Products industry is competitive between domestic firms, and increasingly so with international competitors that are lured by the enormous potential of China’s market. Two of the industry’s biggest companies in China – China Mengniu and Inner Mongolia Yili – control over 40% of the dairy market, which has expanded beyond milk and eggs to yogurt and big foreign brands. Competition is especially strong within the growing snacks segment of the industry, growing alongside the urbanization trend.10

INDUSTRY LEADERS: China Mengniu Dairy, Want Want China, Tingyi

  • Beverages: Moutai is an alcoholic beverage and is the national drink of China. As a type of Baiju, Moutai is made of wheat and sorghum, and is increasingly popular both in China and abroad. Drinks such as Moutai give the sector some discretionary qualities because of the growing appetite for higher-quality alcoholic beverages and the increasing popularity of these drinks abroad. China is also one of the world’s largest beer markets and is home to industry leaders such as Tsingtao.

INDUSTRY LEADERS: China Resources Beer, Kweichow Moutai, Wuliangye Yibin

  • Personal Products: this industry supplies China’s populations with sanitary napkins, baby and adult diapers, and other personal hygiene products. Companies like Hengan International are finding new ways to unlock potential growth opportunities, including the integration of technology or e-commerce platforms, in the same way Procter & Gamble successfully did with its products in the United States.

INDUSTRY LEADERS: Hengan International, By-health, Shanghai Jahwa United

  • Food & Staples Retailing: This industry is China’s equivalent to Walmart, Target, and Kroger, and remains relatively insulated from outside competition. These companies work closely with distribution platforms and technology providers like Taobao and Alibaba to help product manufacturers scale and distribute their products at a national level. Convenience stores, supermarkets, and hypermarket companies in China also benefit from vast data on China’s population, and deep international supply chains, which they use to prevent foreign rivals from competing on price and variety.

INDUSTRY LEADERS: Sun Art Retail, Yonghui Superstores, Yifeng Pharmacy

For Top 10 Holdings of CHIS please click here. Holdings are subject to change.

Current and future holdings are subject to risk.

Headwinds & Tailwinds: Demographics, Policies, and Trends

Tailwinds: Despite the destabilizing impact of COVID-19 this year, companies in the Consumer Staples sector remain well-positioned as consumers prioritize buying basic goods. As transmission of the virus decelerates in China, the sector is expected to return to its longer-term growth story, drafting behind growing consumption trends in China.

  • Consumerism: Much of China’s population relocated to cities in pursuit of higher wages and therefore greater disposable income. Since 2010, the percentage of the population living in cities increased by nearly 3% annually and the disposable income of urban households increased by nearly 10% per annum.12 Consumption overall is growing faster than GDP as the government orchestrates an economy-wide shift from manufacturing to consumerism. According to the National Bureau of Statistics (NBS), retail spending alone rose 9.1% y-o-y in 2018 and 5% in 2019, while GDP increased 6.6% and 6.1% respectively.13 Looking forward, consumption is forecasted to continue growing by an average of 6% annually as the country becomes more consumption-oriented.14
  • Government Support: China’s government plays a critical role in boosting consumption throughout the country. In 2019, the government instated cuts on Individual Income Tax (IIT) designed to increase overall spending by individuals. In response to the coronavirus outbreak, local governments are distributing prepaid vouchers to encourage consumption. In some cities, like Nanjing, which planned $45 million of distributions, vouchers are targeted at supporting the most vulnerable, including lower-income earners and union members, to prevent a contraction in consumption.
  • International Trade: After a difficult 18 months of trade tensions with the US, Chinese Consumer Staples companies may see the international climate slowly improve with the signing of the Phase One agreement and future negotiations for a Phase Two deal. Under Phase One, tariffs on food and agriculture cut into some firms’ margins. Should these tariffs reverse, input costs should normalize allowing for margins to expand.
  • Partnerships and M&A: Strategic partnerships and M&A are increasingly common across the Staples sector, whether in production, distribution, expansion, or digital transformation. By helping modernize older companies with the implementation of digital transformation strategies, these partnerships should help drive additional growth within the industry.

Headwinds

  • Aging Population: As a result of China’s one-child policy, longer life expectancies, and declining birth rates, China’s senior population is growing rapidly. During the years that the one-child policy was in effect, life expectancy in China extended from 67 to 75 and fertility rates decreased from 2.8 to 1.7. China’s ageing population presents considerable social and economic challenges, including headwinds against future consumption.
  • Increased International Competition: PepsiCo, Procter & Gamble, and Walmart have been in China for decades. And while they have strategic partnerships with leading Chinese companies and e-commerce platforms, these firms have largely struggled to gain a foothold within China. As Chinese markets continue to liberalize foreign investment, and demand for western goods grows, international firms will penetrate the competitive landscape in China.
  • Private Labeling: Private labeling is when third parties produce goods for a retailer. It is a popular trend in the food and beverage industry in developed markets and is beginning to pick up in China, as well as the broader emerging markets. Private labeling may encourage competition and greater consumption, but could also work against established name-brands.

Conclusion

With the world’s largest population, and second largest economy and equity market, some might expect China’s Consumer Staples sector to be a global leader by market cap. However, the sector is still in its infancy, suggesting substantial future growth potential. As China transitions to a middle-income economy fueled by domestic consumption, Beijing will continue to rely on the country’s enormous middle class to drive growth. Given the size of the consumer base and their distinct preferences, domestic firms within the China Consumer Staples sector are among the best-positioned to potentially benefit from this long-term shift. At the same time, Consumer Staples firms have exhibited more resilience against growth shocks, like global health crises and trade tensions, a defensive element to the sector.

 

Related ETFs:

CHIS: The Global X MSCI Consumer Staples ETF seeks to invest in large- and mid-capitalization segments of the MSCI China Index that are classified in the Consumer Staples Sector as per the Global Industry Classification System (GICS).