Chinese Pharmaceuticals, Industrials Stand to Gain from Reform

Good news for investors in China stocks: Beijing authorities recently decided to dismantle the Ministry of Railways. No, seriously, it’s a very positive sign China’s new leaders tackled fundamental economic reforms by restructuring a last major relic of the state-run economy. While benefits from deep-seated reforms will play out over a number of years, two sectors poised in coming months to cash in on a commitment to reform are healthcare stocks and industrials.

Tackling the giant Ministry of Railways is “a promising start” by the new administration of President Xi Jinping, according to Jing Ning, Asian Equities Portfolio Manager at Blackrock. “This was accompanied by the consolidation of a number of agencies, indicating the new government has the willpower to make the necessary changes,” Ning told Equities in an email, noting the movement is still at an early stage. Success in reform is crucial for the future well-being of the Chinese economy and stock market as growth slows, inflation persists and waste proliferates under the cheap-labor, high-investment economic model that worked so well for decades.. Future prosperity depends to a major extent on shifting to a more streamlined consumption-led economy.

Healthcare is one sector that needs to make more progress to facilitate long-term growth in the new economy, Ning said. And in addition to promising long-term demand due to an ageing population, she said, in the short term “the overall valuation for the sector is relatively cheaper than some of the more cyclical choices in the Chinese market at the moment.” BlackRock is buying pharmaceutical distribution, medical equipment and medical research companies.

BlackRock doesn’t publicly reveal the names of the companies it invests in, but KGI Asia likes Shineway (CSWYY) and Sinopharm (SHTDY) in the pharmaceutical area. Shinaway is a “strong turnaround story” as profits rebound from slowing growth in 2012, said KGI Chief Operating Officer Ben Kwong. He said Sinopharm, China’s biggest pharmaceutical distributor, will gain from mergers and acquisitions. Kwong is a fan of the sector as a whole, asserting to Equities that better basic drug prices and more government investment, on top of strong organic growth, will lead to more profits in 2013.

Another sector that stands to benefit from China’s budding commitment to reforms is industrials. In fact the consolidation expected to come from reforms is desperately needed by struggling manufacturers. Oversupply coming from myriad inefficient factories results in “profit margins (that are) at near zero if not negative along the value chain,” according to an email to Equities from Jackson Wong, vice president for sales at Tanrich Securities.

BlackRock’s Ning said the government can help. “In our view, industry leaders will benefit from the government’s focus to tackle environmental issues and potentially close down older, inefficient factories, which should lead to returns expansion,” she said. Some segment leaders have strong balance sheets and cost advantages that will allow them to take advantage of consolidation, according to Ning.

Again, BlackRock doesn’t announce names of companies it recommends. But Wong of Tanrich said, “(The) solar industry is probably one of the worst and will benefit from the consolidation. Leaders such as GCL-Poly (GCLPY) and Comtec (712, HK) will probably come out of this as winners.” Sportswear has similar woes and consolidation should winnow out numerous weak brands to shape a business model like the one in the U.S. with a few big names, he said, predicting likely survivors will be Anta (ANPDY) and Li Ning (LNNGY).