Cheng Wai Lin of China Universal Asset Management: Comparison between Chinese and overseas consumer stocks

I have been investing in overseas consumer stocks such as U.S. stocks for some years, and this article wants to make some comparisons between Chinese and overseas consumer stocks.

There is a wide variety of consumer companies, and there are many different dimensions of categorization. If a more popular classification method is chosen, it can be divided into mandatory consumption and optional consumption, and further can be divided into mandatory physical consumption, mandatory service consumption, optional physical consumption, and optional service consumption.

We select a leading company in China and overseas in each sub-field of required consumption and optional consumption, and compare financial indicators such as operating income, net profit, ROIC, and PE. The sub-sectors of essential consumption include daily personal care, functional drinks, cosmetics, food, and beer, while optional consumption covers sportswear, luxury goods, supermarkets, automobiles, home improvement channels, professional channels, hotels, restaurants, and e-commerce. Here are a few points:

First, in the "luxury company", overseas are mainly leather goods, jewelry and other companies, and we have no corresponding company in China, so we choose China's high-end liquor company, which belongs to the category of luxury goods with Chinese characteristics, in fact, it is not completely analogous with overseas luxury companies.

Second, in the "professional channel", discount stores, cosmetics franchise stores, outdoor franchise stores, sports franchise stores, etc. are all overseas companies, and we have not found any listed companies with corresponding formats in China.

Through comparison, we found that from the perspective of financial indicators and company quality, many leading companies in China are actually very good. However, because Chinese companies are still in the middle and early stages of development, there is still a lot of room for improvement in many aspects. It is mainly reflected in the following five areas:

(1) The ability of systematic system construction needs to be strengthened. In fact, we can see that one of the shortcomings of China's leading companies is that the degree of internationalization is not high, and the deep-seated reason behind it may be the lack of systematic system construction capabilities. After the scale of many leading companies in China reaches a certain level, they must break through the cognition and realize the platform-based and systematic operation in order to open the ceiling of the company's growth and finally realize the smooth expansion of cross-product lines and cross-regions. This may be a top priority for many of China's leading companies.

(2), brand accumulation still takes time. At present, many leading companies in China still prefer to be "product-driven" and "channel-driven", while many leading overseas companies are biased towards "brand-driven".

The difference between "product-driven", "channel-driven" and "brand-driven" is the sustainability of growth and the ability to navigate through cycles. We found that the sustainability and stability of the medium- and long-term growth of many leading overseas companies are relatively good, and they have been tested by many cycles. On average, in the past 20-30 years, leading overseas consumer goods companies have achieved a compound growth rate of about 10% (including the performance increase brought about by equity buybacks). Most of the Chinese companies are relatively young and have not yet proven their ability to survive multiple cycles and the stability of long-term operations. Therefore, in the larger consumption tracks such as daily personal care, cosmetics, food, beer, sportswear, etc., the scale of China's leading companies is often smaller than that of overseas leading companies.

Overall, overseas leading companies are more likely to provide medium and long-term compound interest, which is relatively weak in China's leading companies. Therefore, the valuation premium of overseas companies comes from the stability of the medium and long term, while the valuation premium of Chinese companies often comes from the growth premium given during the period of rapid growth, and once the growth rate slows down, the valuation will be more killed, which also leads to the volatility of the stock price of Chinese companies will be significantly higher than that of overseas companies, even if it is a leading company.

(3) Strategic choice and determination need to be strengthened. Some consumer sectors in China are relatively "volatile", resulting in a potential industry may soon become a red ocean, and some fields may be subject to cross-border competition and permanent disruption. Behind the "volume" is the ambiguity of the strategic choice of the enterprise and the lack of determination. Many companies, once they see that there are new growth areas, want to do it, and because there are many new entrants, existing players also have to speed up their development and seize the market, resulting in "volume". In addition, the consumption habits and interests of Chinese consumers are also changing rapidly, which has exacerbated the "volume" of the supply side. As a result, some ecosystems are prone to ups and downs.

The domestic consumption channel field is a typical example of permanent changes in business formats, including supermarkets, department stores, home improvement channels and franchise channels in various vertical industries. The pace of change in the purchasing channels of Chinese consumers is the fastest in the world. In recent years, with the world's highest operational efficiency and fastest development speed, Chinese e-commerce companies have made many offline channels unsustainable, even the former leading companies have not been spared. This also leads to the fact that the richness of China's channel formats is far less than that of overseas, and overseas companies have a higher degree of specialization and a sense of order, while China inevitably has a feeling of "one whale rises and everything falls".

In addition, some subdivisions of products such as small foods and small household appliances are also easy to be short-lived, and the "Internet celebrity effect" or "trend attribute" is strong.

(4) The concept of high-quality growth needs to be strengthened. Chinese companies are more eager to grow, while many leading overseas companies will actively control the pace of growth. The former focuses on short-term high-speed growth, while the latter is more inclined to medium- to long-term sustained growth.

Controlling the pace of growth can help leading consumer goods companies truly capture a brand premium. Because the brand premium comes from the relative scarcity of supply and from the fact that consumers have always maintained a desire to buy, which is called desirability in English, which is the most important competitiveness that many companies strive to maintain and improve. It describes a state in which consumers have a strong need to buy, but the needs cannot be fully satisfied from time to time and easily. Luxury companies are a prime example of creating a brand premium. When comparing luxury companies, it is almost impossible to find a domestic benchmark. This is because China's high-end brands have not been around long enough, and management often focuses more on the company's growth rate than on controlling the growth rate in pursuit of medium- to long-term brand viability. Of course, we see that more and more entrepreneurs and management have realized the importance of medium and long-term brand vitality, and many leading Chinese companies are working in this direction.

In fact, the growth anxiety of Chinese enterprises also comes from the pressure of competition, if you don't grow, the space will be snatched away. Overseas, we often see that even if there is several times the growth space in a certain consumer field, there are only 2-3 players, and almost no new players enter, while the existing players are growing at a rate of about 10% every year. Because these companies control the pace of growth and are constantly working to improve the quality of growth, they can achieve high valuations. This kind of high valuation pricing is actually an investor recognition of the certainty and space for medium- and long-term growth. Investors can price long-term assets, and the valuation center is not linked to short-term growth, but to medium- to long-term development potential and development quality. We believe that this long-term valuation approach may be seen in China's best leading companies in the future.

(5) There is still great potential for development in many segments of China's consumer industry. There are many sub-sectors of overseas consumer stocks, and the targets are rich and extensive. Therefore, overseas consumer stocks have different subdivision betas, and in different macro backgrounds, we can find different targets to do portfolio allocation. Chinese consumer goods companies tend to be more affected by the same beta because they are still doing more popular fields. In the future, we look forward to seeing more colorful consumer companies, committed to making good products and services in different segments, and allowing Chinese consumers to have more consumption choices.

The chart below illustrates the relationship between the MSCI Discretionary Consumption Index, the MSCI Discretionary Consumption Index, and U.S. GDP. We can see that consumer discretionary companies fluctuate significantly more with the economic cycle than consumer discretionary companies. But in the long run, consumer discretionary companies are constantly growing in fluctuations, similar to the "snowball" effect that Warren Buffett talked about, with long slopes and thick snow and continuous accumulation. Must-choose consumer companies, on the other hand, have low volatility and low growth, and can achieve "stable happiness". We believe that in the future, whether in the field of optional consumption or compulsory consumption, China will also have more and more abundant and competitive enterprises to come out.

Figure 1.

Source: Bloomberg, as of 18/04/2024.

All in all, Chinese and overseas consumer stocks have their own characteristics, China has unparalleled consumer demand and market space, while overseas has long-lasting consumer brands and professional segments of the consumer sector. At present, Chinese consumer companies are still in the early stage of development, and there is still a lot of room for improvement in the construction of market systems, brand duration, and sustainability of growth. We believe that in the medium and long term, China's consumer industry will continue to benefit from the trend of consumption upgrading, and continue to move closer to mature markets, and more and more excellent consumer companies will stand out.

Risk Warning: Funds are risky, and investment should be cautious. The views and judgments involved in the article only represent our views at the current point in time, and the views and judgments involved may be adjusted or changed subsequently due to the uncertainty and volatility of the market environment. This material is only promotional material, not as any legal document, this article is only for communication purposes and does not constitute any investment advice. The fund manager undertakes to manage and use the fund assets in good faith, diligence and due diligence, but does not guarantee that the fund will be profitable, nor does it guarantee the minimum return. Past performance of the fund is not indicative of future performance, and the performance of other funds managed by the fund manager does not constitute a guarantee of the performance of the fund. In addition to the general investment risks such as market fluctuation risks similar to those of domestic securities investment funds, funds that can invest in overseas securities are also subject to special investment risks faced by overseas securities market investments, such as exchange rate risks.