Consumer Spending in China: “China Play” Again
Editor’s Note: The following insight comes from Korea Investment Management – a leading asset manager in South Korea – and continues a series of posts intended to introduce South Korea as an investment destination.
Once the “world’s factory,” China is no longer the leader in global manufacturing as the services sector has emerged as a dominant engine since manufacturing-centered growth has wound down. Since 2012, the weighting of tertiary industry to GDP exceeded secondary industries, and the gap has widened rapidly.
Until recently, market interest in China plays in global equity markets was mostly limited to materials and industrial-orientated heavy industries. With the eroding growth potential of the Chinese economy and massive industrial restructuring underway, we recommend closely monitoring “New China Play” stocks focused on IT and consumer goods.
While valuations of traditional China plays, such as chemicals, steel, machinery and shipbuilding, remain at historically low levels, new China plays, including IT, food & beverage, cosmetics, fashion and leisure, are trading at burdensomely high levels.
However, 1) deteriorating Chinese macro momentum has widened the valuation gap between new and old China plays, 2) old China plays may still be exposed to risks given the government’s long-term industrial restructuring plans, and 3) the value chain of old China plays may no longer serve as core economic growth drivers, even if the Chinese economy recovers on firming DM demand.
Meanwhile, the valuation premium for new China plays is being further justified as Chinese GDP per capita nears USD10,000 and the government begins focusing on domestic consumer demand via urbanization, the easing one-child policy, household registration reforms, higher minimum wages and tighter environmental regulations.
One of the key factors driving the Chinese consumer market is the country’s post-‘80s buyers, born between 1980 to 1989. This generation plays a key role in spending and changes in the structure of China’s tertiary industry. Consumers are being increasingly picky, favoring quality over quantity. This trend should continue to fuel a rapid growth in consumer spending, including education and culture.
Over the long term, cosmetics and related sectors have been one of the biggest beneficiaries of this trend. In 2011, China’s cosmetics/household goods market overtook Japan as the second-largest market in the world. With a 10.3% global share in 2014, China is forecast to overtake the US as the leading market by 2020. Considering Chinese consumers spend only USD37 per capita on cosmetics, versus USD253.5 in Japan and USD230 in Korea, Chinese spending is still at a very low level compared to other markets, suggesting substantial growth potential.
Korean beauty brands are positioned to benefit from the potential growth of the Chinese cosmetics market. Korean cosmetics accounted for less than 4% of the market in 2011, but this has risen to 6.7% in 2013, 7.4% in 2014 and 16.8% in 2015, exceeding Japan and the US’ market presence.
The success of Korean cosmetics brands is being fueled by product differentiation and positioning. Major Asian cosmetics brands have advantages over western competitors in terms of key R&D factors, namely racial and environmental conditions. Furthermore, Korean beauty products are sold across multiple distribution channels as the Chinese cosmetics market is growing from low- to high-end product segments.
AmorePacific, Korea’s largest cosmetics maker, is not only positioned in department stores, but also utilizing one-brand road shops and online shops to offer low- and mid-priced products. This marketing strategy is significantly different from western counterparts, which distribute high-end products mostly in department stores. Another competitive advantage is that AmorePacific and other Korean cosmetics brands have been recognized for high quality compared to local brands in the rapidly growing online channel.
With a strong inflow of tourists to Korea backed by the Korean wave, Chinese demand for Korean beauty products is increasing rapidly. After being sparked by K-drama and K-pop, the Korean wave has expanded into K-beauty products, generating synergies by bolstering the brand image of Korean cosmetics. Overall, the Korean cosmetics market should continue to grow backed by solid product quality and high brand recognition backed by the steady growth of the China market.
Currently, there is a wide range of cosmetics-related companies from raw material suppliers to container makers are listed in Korea. Companies with solid brand recognition in China are diversifying into household goods, including toothpaste, soap and shampoo that are customized for China.
As the popularity of K-beauty spreads, the brand image of overall Korean consumer goods is improving. In particular, sales of Korean female-related consumer goods, such as baby formula, diapers and women’s apparel, are growing rapidly in China. Overall, the increased spending on consumer goods, including cosmetics, suggests there are attractive investment opportunities regardless of the macro business cycle in China.