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Companies Benefiting from Strong Chinese Consumer Demand

Chinese consumers account for a third of all spending in the luxury category alone, tariffs be damned.

Portfolio Manager

Eric Clark is the portfolio manager of the Rational Dynamic Brands Fund (HSUTX).
Eric Clark is the portfolio manager of the Rational Dynamic Brands Fund (HSUTX).

Image: Lululemon Athletica

China continues to dominate market headlines, with an overwhelming emphasis on tariffs. With so many looming questions, when will a deal be made? How are company revenues impacted? It’s a narrative that has given pause to investors.

But this saga overshadows a strength in the region that has propelled a number of consumer-facing brands in the last few quarters. As we approach another earnings season, we’ll likely see continued growth from these companies, particularly luxury goods that have a strong e-commerce presence, as Chinese consumers continue to spend in droves.

Chinese consumer strength has grown steadily over the past two decades, buoyed by an emergence of a blossoming middle class. Recent reports show that Chinese consumers account for a third of all spending in the luxury category alone. Despite worries about the impacts of tariffs, Chinese consumers are resilient. The future of this middle class is growing, which means a growing number of consumers with disposable income.

This growth is reflected in both China and the greater Asian region. There are more consumers that fall into the millennial or Gen-Z categories in China than the entire population of the U.S.! This is even more magnified across Asia, creating a wonderful tailwind for brands across the globe that resonate with these consumers.

In China, Alibaba BABA remains a clear winner. Despite higher than average short interest, the stock continues to rise and serve consumers across Asia. Alibaba is slowly but surely gaining brand recognition in the U.S., as well opening an entirely new and very large consumption economy. Likewise, Tencent TCEHY remains in strong favor with the Chinese consumer. Most notably as the company behind WeChat, Tencent continues to expand its business portfolio, diversifying away from its dependence on video gaming. Both Alibaba and Tencent hold significant stakes in many of China’s leading consumer brands, offering investors access to attractive venture-backed deals that will eventually be monetized by these companies. For example, Tencent Music TME spun-out as a very successful IPO on December 18, 2018, to the benefit of Tencent investors.

Baidu BIDU is another strong Chinese company bolstered by the domestic consumer that seems to have been overlooked by investors. BIDU currently offers a unique opportunity because the stock has declined over the past year on concerns over Internet competition and a slowing Chinese economy. Think of BIDU like the Google and PayPal of China. They control 80% of the Chinese Internet search market and through their platform offer consumers an easy way to transact online for all of their favorite items. BIDU also has a successful venture arm, with part-ownership in China’s “Expedia” via as well as holding a large stake in the Netflix of China, iQiyi IQ.

European companies are also benefiting from growing Chinese demand. Specifically, these new middle-class consumers are driving luxury brands with great strength. It’s a trend reversal after years of lagging results, for which the Chinese consumer has played a big role. LVMH LVMUY, parent company to a number of luxury brands ranging from Louis Vuitton and Celine to Moët & Chandon, also remains a favorite within younger Chinese consumers. This is also true for their e-commerce, with brands like Sephora being wildly popular. LVMH recently reported a very strong quarter with strong momentum across most of its business segments. Operating margins expanded at all five of its business segments as well. Global consumers continue to be willing to pay up for aspirational brands that resonate with them.

Ferrari RACE, the Italian luxury sports car manufacturer, has also benefited. In 2018, the automaker’s profit rose nearly 50%, and has an aggressive revenue growth plan for the year ahead. Ferrari has invested in technology-forward sales initiatives, such as VR showrooms, which has been a hit with Chinese consumers. RACE isn’t just a luxury car company, it’s a luxury goods company and is one of the most recognized brands around the world. No brand has benefitted more from the scarcity-value concept than Ferrari. Millions of ultra-wealthy consumers jockeying for position to spend $250,000 to over $1million to be part of an elite group of loyalists for the brand. That makes for very high margins and strong returns on capital.

U.S.-based companies in this sector continue to benefit from Chinese spending, despite the current tariffs. Retail brands such as Nike NKE, Lululemon LULU and Tapestry TPR (formerly Coach, but now parent company to Coach and Kate Spade) remain favorites, as does Estée Lauder EL. Chinese demand has pushed Lululemon, for example, to higher profits in years’ past. Growth for the company shows no signs of slowing down, with strong earnings during the last announcement period. The growth story at LULU in Asia is in the early innings, making this great athleisure brand a truly global opportunity.

Apple AAPL has a tenuous relationship with the Chinese market. The company has focused enormous efforts on growing its market share in the country, competing in a crowded landscape where other brands reign supreme. Tariffs certainly haven’t helped Apple in this area, but the company may have turned a new page in the region. Recent price cuts to its iPhone has stoked interest from the market. Yes, the smart-phone market is highly competitive but make no mistake, Apple is also a luxury goods brand and with >1 billion phones in its installed base. There are plenty of ways for Apple to continue winning with global consumers.

As earnings season kicks off, and these companies divulge their success for the first quarter of 2019, we can expect that these companies across the globe will benefit from the Chinese consumer, and the greater spending power coming out of Asia. There will always be short-term hiccups, but investors would do well to take advantage of any earnings weakness to begin building or adding to the global consumerism theme through many of these brands.

Eric Clark is the portfolio manager of the Rational Dynamic Brands Fund (HSUTX).

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