TET Around the Corner

The decorations are up in Ho Chi Minh City as the party convenes to ratify the new leadership.  This time round the process is not predetermined.  The situation is fluid as we sit in the bar of the Hyatt Hotel.  For once no-one knows what will be announced next week (In the end it was an anti-climax as the head honcho stays in place and the progressive Prime Minister got the chop.).  There is even a sense that public opinion might be taken into account (it wasn’t).  One delegate hosted a page on Facebook featuring the main candidates where visitors could comment; and this site was not shut down by the authorities.  Evidence of a little more openness but French philosophy still seems to apply to politics in Vietnam in the sense that the more it changes the more it stay the same.

Yet there has been plenty of change here over the past two years.  The Hyatt remains the most pleasant place to stay, but its room rate is up about 25%, and breakfast is expensive if excellent.  One thing is still the same.  Coffee and tea shops are proliferating including one across the street.  That venue looked a lot more tempting when I got the chit to sign and saw what the Hyatt was charging for a croissant.  Breakfast is not included when you are on a corporate rate. 

I am here for a conference hosted by Ho Chi Minh Securities (HCS).  Vietnam has a good work ethic and HCS demonstrates that as we start each day at 7.40 am and cram in 13 company meetings over two days plus an overview on real estate from local expert CBRE.  Amazingly while the schedule changes several times in the days leading up to the conference all the companies that commit do turn up and only a few are late, victims of HCM City’s terrible traffic.  Full marks to HCS for an impressive line-up that covered almost every area of economic activity of importance in this country.  If you do decide to trade on the local exchange, you should consider them.  The other broker we work with is Maybank.

Congestion has become so bad that during peak periods the centre of the city becomes gridlocked, a pedestrian precinct full of cars.  No wonder a city of 8 million contains 6 million motor bikes.  A bike really is the only sensible way to get around.  The first line of MRT should be in service next year, but one line is not going to make much of a difference.  HCM City needs a proper network but that could take another twenty years.

Back to the Stock Market.  Vietnam has a lot going for it.  The Trans Pacific Partnership, if passed by the US congress will give the economy another boost.  Vietnam is expected to be the biggest winner.  FDI is booming as Chinese and Taiwanese firms in particular are ramping up capacity across a whole range of light industries.  On my flight in from Singapore, I sat next to an executive from a thread company who was coming to review sites in industrial parks for a new factory.

For a foreign equity investor, however, the situation is one of slim pickings owing to the 49% foreign ownership restriction.  Where we as potential purchasers of shares stand can be summed up all too simply.  If you want it you can’t buy it; and if you can buy it you don’t want it.

Not entirely accurate, but more or less correct.  Occasionally the good stuff becomes available; but you may have to wait a while.  If in a hurry, you can buy anything you like but only by paying a premium for foreign quota.  Premium can run as little as 5% to 20% or even more.  Stock market favourite Vinamilk has been above 30% : not a realistic way to trade when you have to mark to market.

Ah ha I hear you say : didn’t Vietnam pass a law to allow 100% foreign ownership only last year?  Well yes and no.  They did and in theory you can, but the first one out of the block to go the whole hog, Saigon Securities, got into a lot of trouble.  Now everyone else is nervous.  There are lots of things foreign controlled companies in Vietnam cannot do; and it would be easy for many businesses to fall foul of some restriction.  Of the thirteen companies we met over half wanted to open up, but not one had a plan to do so, nor did any of them intend to change without a clear endorsement from the government.

Reading between the lines and in other conversations with local experts, it is clear that the government is still in two or possibly three minds on this subject.  Having announced an intention to open up foreign quota some four years ago they probably felt they looked stupid after so much time had gone by and nothing had happened (they did look stupid).  So eventually a law was passed but the draft contains so much ambiguity and exceptions that everyone is scared to act for fear of contravening something else that would put their business at risk.  So in theory the government allows 100% foreign ownership.  In practice the law that is supposed to allow it effectively makes sure nothing changes, handicapping capital markets in a country where capital is still in short supply.

This ensures that would-be foreign equity investors are largely frustrated.  One would like to do more in Vietnam, but until the foreign ownership issue is resolved there is little opportunity for direct investment into the most interesting listed companies.  The most viable route is to sign up for one of the better managed single country funds.  Here I disclose that I am personally invested in Kevin Snowball’s PXP.  If you go to HCM City he is someone you should seek to meet as he understands corporate Vietnam as well as anyone, and is suitably cynical.

So where does that leave anyone who wants to invest in the country?  The answer look is look at property.  In the past there have been multiple restrictions on foreigners owning property in Vietnam.  You could only own one.  You were not allowed to rent it out and so on.  There still are restrictions, but in 2015 some of the biggest barriers were relaxed.  Importantly you can now rent, and also own more than one property, though still not land.  One disadvantage is that while in theory you can also get a mortgage, again in practice, you cannot.  That means foreigners are exposed to dong risk.  While the dong has been behaving a lot better of late it is more likely to be going lower than higher especially against the US$.  The only question is how much lower.  FX aside, all the ingredients – inward migration, family formation, and lower borrowing costs - are in place for an extended property run this time round.

Unlike most of the rest of Asia, Vietnam has not experienced a recent property bubble.  They overbuilt between 2007 and 2010; and that boom was followed by a major bust.  Come 2012/2013, and the market was close to comatose; but in 2014 it began a slow resurrection.  Some commentators are concerned that the explosion of projects expected in 2015/16 heralds another boom/bust cycle; but demographics, the supply demand imbalance, and improving affordability all suggest otherwise.

The next bust will start from a much higher level and in my opinion the peak is several years away.  Quality is improving.  The new condo towers are in a different league from those put up five years ago.  Still the path to purchase is not a straight line and it pays to have reliable local help.  I just took possession of my first unit in Novaland’s Icon 56 project located near the river and facing the Stock Exchange building.  The end product is decent and the river view is a big plus.  The rental market for the right location is lively.  I am adding to my portfolio in HCM City, but could not do it without the help of Chris Piro of Indochina.  If you are interested, consider giving him a call.  Mistakes can be expensive and Chris knows his way around.

Silent Nights in Panzano

Sorry for the silence but voyaging has been at a somewhat slower pace over the holidays.  We try and usually succeed to spend some of that period in Panzano in Chianti, a village that captures the Christmas spirit.  On Christmas Eve our resident celebrity Dario Cecchini, “The World’s most famous butcher” according to Google, holds his annual street party.  Usually over 20% of the village attends.  The turnout in 2015 was up to the mark.

Talk this year was of a wonderful harvest; both for grapes and olives, a 180° reversal of the disastrous 2014.  Everyone is upbeat and looking forward to the wine release in 2-3 years’ time.  In the meantime the olive oil is green, thick, spicy and luscious : a product you will never see in shops.    

The economics is something else.  You can make money with wine.  Olive oil is another matter.  Growers who use traditional methods lose money on every bottle they sell : so more is less, at least less money in their pockets.  Some have given up.  The groves next to our house containing over 1,000 trees went unpicked the last two years.  At the top of the road one grower ripped up all his trees over the holidays.  Our harvest this year was 550 bottles of exceptional quality.  We could have had more.  Fully costed but pre-shipping I estimate our cash cost at around Euro 18.50 per bottle.  At wholesale we could expect around Euro 7.50 if lucky.  Luckily we are our own best customers.

Still it does strike me as strange that a merely decent bottle of can wine retail for around Euro 40, while the very best olive oil struggles to sell at Euro 20.  That bottle of wine tends to disappear at one sitting, often along with another in our house.  Olive oil often survives to grace    vegetables and salads for a couple of weeks.  The quality gap between top end, handpicked, biodynamic extra virgin olive oil from old trees compared to the commercial mass produced product is every bit as great as that between a premier cru and village plonk.  Yet the price multiple     is only about 3x for the olive oil versus 50x or even more for wine.  Markets are not efficient whatever Professor Sharpe and the Nobel Committee claim.    

Even so grumbling about olive oil was more than submerged by enthusiasm for the latest wine vintage.  Indeed there is generally a much more positive attitude in the main square.  Tourism is on the up.  There is investment all around in agritourismos, new hotels, new vineyards, and improved wine production.  Hopes in this part of Italy are for a better 2016.  The lower Euro makes a difference.  The only worry related to the migrant invasion.  Italy cannot cope.  Chancellor Merkel and Prime Minister Renzi have very different views on how this problem should be addressed; and as importantly who should pay.  Local opinion is largely that Italy already has done more than its fair share, a sentiment supported by polling data, though this is a debate where accurate data does not often get a look in.

As to other matters of note at this sleepy time of the year, the biggest curse in our valley are the not so wild animals, both deer and boar.  They can be extremely destructive.  Yet the powers that be in Greve do not allow landowners to cull them.  That is why a valley that did not contain a single fence ten years ago affording a pristine view for locals and tourists alike now is interrupted by a series of wire fences separating vines and olive groves.  Both walkers and the scenery suffer due to bureaucratic stupidity.  The crazy system means a mandatory prison sentence for killing a pest, but if you kill a person you could avoid jail with a good lawyer.

The local ‘approved’ shoot has been enjoying this juxtaposition.  Two Saturdays ago they shot 21 boar in our wood, three just outside the garden gate.  Last Saturday they shot 15.  Our wood is not big.  The ratio works out to more than one boar per acre!  Sadly there are still plenty more where those 36 came from.  While nearly everyone views them as a menace we heard stories of hunters leaving food out to encourage larger families for next season.  It has even been suggested that people from other parts of Italy are paying to hunt here though I am sure such rumours cannot be true; and if by some small chance they are true, no-one in authority could possibly know anything about it. 

There is one small positive out of this.  We get given part of the ‘bag’.  So periodically a hairy haunch or two of boar turns up on the doorstep.  Skinning and softening a piece of wild pig is hard work and very time consuming even if the result is a rare treat.  We ended up enjoying some of our very own boar as Cinghiale Pappardelle at the local wine bar : Enoteca Baldi.  That was definitely a better way to benefit : get someone else to do the heavy lifting.

Mimmo Baldi of Enoteca Baldi

Still the valley needs to cull more.  There are so many animals Panzano is in danger of becoming a petting zoo.  Spent a good part of the last day of our Christmas break chasing three very fast and lively young deer that had found a way into our garden, but did not seem to be able to find their way out.  We had to call for reinforcements from Enoteca Baldi to make sure we had enough people to herd them to an exit.  When your garden is on several levels the deer have a definite advantage, but we got rid of the last one just before local restaurants stopped serving lunch!  Having run up and down steep hills for a couple of hours a Bistecca Fiorentina was badly needed, and well deserved.     

Salute to all my followers and the very best for 2016.       

To Get From A to B You Sometimes Have To Go Through Z

Has this Conversation already Happened?  Will it Happen Soon?

Clare Bonito came top of her class.  She was used to being a winner.  That was why she sat straight in her chair.  She was calm and in control.  

The Prime Minister in contrast sprawled in his seat, looking ill at ease and uncomfortable.

“That the President of the EU is a liar and a drunk says it all really.  It’s all you need to know.” 

He spoke so softly she had to lean forward to make sure she heard every word.  It was important not to miss one.

He glanced up and then away, apparently unable to look her in the eye.  More like sparrow hawk than sparrow he thought but kept that thought to himself.

“So?”  Better to make the other person do most of the talking.  That way she gave away little and learnt more.  Clare was good at that.  She was good at silence.  She was good with words.  She was good with many things which is she was now in control of the third largest political party in the UK, coming from next to nowhere only two elections back.

The pause that followed allowed her to control the pace of the conversation.  She was good with pauses.  She liked the wait.  Silence made most people, especially most politicians uncomfortable.  Silence tempted them into talking.  Often that way they would say something that exposed an opening.

“I do not want to be remembered as the man who led Britain out of the EU.”  That statement seemed to drain the last of his reserves.

Nor the man to let Scotland go thought Clare but kept the thought to herself.  She kept most of her thoughts to herself.  That was another great strength : another lesson of a painful childhood watching other children get all the cake.  Children like William Motion, the privileged Prime Minister, with his fake call me Bill and easy charm.

“So you will campaign to stay in the EU.”

His hand waved weakly through the air as he shifted in his seat.  “No choice.  Of course …….” Here his tone did change as some measure of strength returned.  “I will do what I can to get the best deal for Britain, …… and only decide then.  But ………”.  He trailed off again leaving her in no doubt which way the decision would go however little he brought home : one rasher  of bacon or twenty.  The way things were going he would be lucky to get one.  Somehow he would spin that into at least five.  

More or less exactly the same thoughts were going through the PM’s head except he was far from  confident about emerging with something sufficiently compelling to spin : especially as he already had a good idea of what would be coming out of the negotiations however long they went on.  To be precise he was likely to have next to nothing to show for his efforts.  

He could imagine all too well how the No campaign could exploit that making him out as wet and unreliable; and all down to the dreadful Herr Meckel and her pet poodle the President of the EU Madame Junker, nicknamed by his good friend the Chancellor as that wanker.  He could imagine all too easily that the dreadfully vulgar leader of UKIP would label him a plonker.

Plonker and Wanker : what a pair!  Not what he wanted to read in the history books.

But now he had a cunning plan, or at least the makings of one.  Yet his plan had holes, some huge, and the biggest of all was sitting across from him.  Someone he had never bested before.  Prickly as a thistle she was, and not susceptible in the least to flattery.  Self-interest though that was another thing.

Banishing thoughts of failure he managed a smile that bordered on the sincere, an expression increasingly rare as they clashed on almost every imaginable issue.  “Under those circumstances we would be sharing the same platform.  The Conservatives and the Scottish Nationalists : something we could agree on after all.”

Clare stiffened.  The idea of being on the same side as the Prime Minister on anything was uncomfortable.  Yet she had boxed herself in on this issue : so unlike her.  Normally she dealt herself a get out card just in case she needed to change her mind later.

“Assuming of course you will still be campaigning for Britain to stay in ……..”.  Clare just managed to check a frown that was forming instinctively in reaction to seeing William Motion smile.  Did she detect a hint of mockery behind the Prime Minister’s expression?

“That has always been our position.” she could acknowledge that at least without giving anything away.

“It has.”  He seemed keen to secure her confirmation.  Too keen.  Why Clare wondered.  “And the Scottish Nationalists are nothing if not consistent.”

Now she was sure she was being patronised.  

 “Of course if Britain were to vote to leave that could leave us in an interesting constitutional quagmire.”

Ah thought Clare.  Now we come to the point.  She waited to see what more he would say.  When he slumped back in his seat she concluded a prompt of some sort was called for.

“Such as …………..”

Call me Bill leaned forward rubbing his hands as if he had just been passed a very large towel.  “If England wanted to leave yet Scotland wanted to stay it would make it very difficult to refuse another referendum.”  

Yes.  She had already reached that conclusion some time ago, but never had anyone senior in the Conservative Party admitted the blindingly obvious, let alone the leader of the Party.

“Not sure how Andrew would feel about that.” Bill moved on before she could decide what to say.  Few things in life surprised Clare.  This was one of those rare occasions.  She did not like being surprised even when the surprise was one she rather liked.

“We would feel obliged to allow Scotland to consider its position ….. if you were to ask.”  Bill dropped temptation into the conversation with all the sweetness of a chocolate truffle.

And ask she would.  Commitments made after losing the last referendum were a source of lasting regret to Clare.  The promise not to raise the independence question again for a generation was one that had to be broken; but how and when to break it without seeming too much like yet another dishonest politician was the difficulty.  A vote to leave the EU would provide the perfect excuse.  She knew that; but that of course was another problem.  It left her in a position of having promised she and her party would campaign for an outcome that would deprive her of the perfect excuse she so badly wanted.

“Andrew may not see it the same way of course.”

As leader of the Labour Party, Andrew Dicks would not and the Prime Minister knew it.  Having lost almost all its seats in Scotland, Labour’s best chance of returning to government was in coalition with the Scottish Nationalists.  And Andrew Dicks would be politically and ideologically more at home in the SNP than he was in the party where he was now the leader.  So cohabitation would come easily.  Yet if Scotland went its own way, the chance of Labour regaining power, especially under his leadership, would be next to nothing.  Departure of the Scottish voters would renew calls for his early retirement.

“Yes I cannot see Andrew supporting this position.”  Bill reiterated.  Clare also knew this, but it did not hurt to rub it in.  And he did enjoy the sight of her wrestling with the contradiction that came with this dilemma.  What would she do?  Ditch her friends or her principles?  Really it had to be one or the other.  The inconsistency and incompatibility was too big a chasm to bridge with fine words; and it was all the more difficult to recast history as every word you said and any article you wrote lingered overhead up in the cloud just waiting for the Twittersphere and internet trolls to pull proof of inconsistency back to page one prominence.   

Amazing really how incredibly stupid most Scot voters were.  They wanted freedom from Britain only to surrender it all the next day to the more demanding and intrusive rule of the EU.  The bureaucrats in Brussels would have a field day with another small, unimportant country they could boss around and ignore.  The only winners would be Clare and her closest confidantes, elevated to the top table of the Euro elite, with no need to make a reservation for the best tables at Michelin three-star restaurants : not that Bill thought Clare would fit in there.  Still the Kinnocks had shown just how fast a conversion could happen and how far it could go.  The price of principle was not so high counted in Euros. 

Join the club Clare was what he wanted to say, except she did not join clubs, and they would not let her in his.

Finally Clare felt obliged to break the silence.  Bill had outlasted her.

“We could not appear at the same events.”

Bill nodded his agreement.

“Or give the same reasons.”

Bill shrugged his shoulders.  There were always plenty of reasons, some better than others for taking my position, and more than enough to go round.

“And I do not want you to campaign in Scotland.”

Bill tried hard not to appear pleased and more or less succeeded.  He grimaced his acceptance of that condition.

“Won’t be long now” he said stretching and standing to show they had arrived at the end of meeting.

Clare did not shake his hand.  There are some things she could not bring herself to do even in private; especially in private. 

The characters in this vignette are thinly disguised so you can easily recognise them.  

WHAT IS GOING ON IN GUANGDONG?

This month I want to share with you some highlights from my latest trip to China.

I visited ten factories, one real estate project and met with management from three other companies.  The meetings in aggregate provide a representative cross section of economic life in arguably China’s most important province, even if somewhat skewed towards traditional manufacturing industries.  I also encountered a diverse group of corporate personnel from CFOs to shop floor supervisors.

The majority of companies were located in or around Dongguan and Shenzhen, but visits included Foshan, Qing Yuan City, Panyu, Shunde, and Zhuhai.  There was also time to walk around a couple of shopping centres.  We stayed in a hotel owned by a company where some of our clients are invested.  On that note I can confirm that the Ritz Carlton in downtown Guangzhou has an outstanding Chinese restaurant : for food, ambience and service. 

Ritz Carlton Guangdong

Guangdong has been among the most progressive parts of China.  Of course its proximity to Hong Kong has been more than helpful.  Some thirty years back early entrepreneurs began to build businesses across the border.  Thus the main metropolitan areas are mostly mature.  That said there is still modest inward migration into key cities such as Guangzhou and Shenzhen.  Yet as of 2015 most residential real estate activity is driven by upgraders.  Anything built before 2000 looks shabby and second rate.  Interiors too have come a long way as have buyer expectations.  Bare shell still predominates, but fully fitted is the future.

There is plenty of money.  We saw no old cars on the road only in the wrecker yards.  At all levels wages in real terms are still rising as they have done since the 1990s.  One company talked about the days – not so long ago – when it paid R400 per month fully loaded to shop floor workers, whereas the better ones now take over R4,000 back to their dormitory.  R2,000 is the starting point.  Not a lot to live on, but move up the productivity ranks and your net can support a lifestyle that goes beyond the bare necessities.  Expectations are that real wage rates will go up again next year by 3-5%.

This may explain in part comments on several occasions about a shift in priorities and spending patterns.  Maslow’s needs hierarchy is not just a neat theory.  It plays out in practice.  Food first : then shelter.  Something basic to begin with : then the better things.  After that comes appearance; what other people see.  Clothes of course and accessories especially bags.  You can of course have too much of a good thing.

The Daphne store – a mid-end national shoe chain - was tired.  Everything appeared to be on sale.  Our interpreter remarked that the quality of the shoes are not good enough for R299.  Next door Belle – a higher end retailer - looked a lot more appealing.  There were no customers when we were there but the saleswomen seemed happy enough claiming some of the styles in the new collection were selling well at R1,200.  The jewellery area of one mall was deserted.  No one stopped even to browse at Chow Tai Fook or Luk Fook.  Jewellery results may not get better for a while.  Interestingly the following week both companies duly delivered profit warnings for 2015.  We knew things were bad in Hong Kong, but China is not going to bail these businesses out, not based on our sample at least.

Having met basic needs, the question turns to where Chinese consumption will flow.  The anti-corruption campaign does seem to have altered behaviour reigning in   conspicuous spending.  Wine, high end spirit sales and even restaurants are all suffering.  It is not back to noodles, but suckling pigs are a little safer.  One theory is that more money will now go into making homes nicer.  Smart appliances is a possible destination, especially as product upgrades embrace the Internet of Things.  Model cycles seem to be getting shorter if nowhere near the turnover of mobile phones.  Furniture could also see more money.  Decoration is another possibility, such as better floor tiles and lamps.    

In the manufacturing world a strong currency does hurt, though there is a not insubstantial cost offset due to overseas sourcing of raw materials and components.  The TPP was a subject that came up several times.  Some companies have already positioned for this expanding in Cambodia, Indonesia, the Philippines and Vietnam.  Others claim to be less concerned claiming worker productivity, supply chain clusters and lower logistics costs will outweigh duty benefits.  These points have merit.  Yet it was noteworthy that Coach had stopped sending bag orders to one supplier for just this reason, while another claimed it had been wining new business for their plants in countries that stand to benefit; and higher end capacity in those countries is for now so limited that they were able to require customers to allocate part of any order to China if they wanted to secure space in duty friendly locations.

One common trend was moving up the quality curve.  We saw this everywhere if manifested in different ways.  The shift included new products with more features, or better appearance, more emphasis on the QC role, and increased investment in R&D.  Cost is still under the microscope but the cost/quality trade-off is more nuanced as companies reassess customer priorities.   In that hierarchy there appear to be regional variations.  The Japanese are quality fanatics.  Many American companies maintain a focus on cost first and foremost – one supervisor commented that Gap is crap – while Europeans appear to lie somewhere in the middle.  An American brand that will remain unnamed was buying all the leather rejected by Prada.

Still cost was not neglected, but the emphasis was not on cheaper and cheerful, or even plain cheap as used to be the case.  Automation featured everywhere even though the economic advantages varied.  It made an impact in a variety of ways notably through declining defect rates, as well as reduction in the number of workers on the factory floor.  Welling, the world’s largest manufacturer of micro motors, had installed Yaskawa robots since my last visit 2½ years ago.  Among other improvements that investment had contributed to a workforce decline of over 50% during the period. 

Interestingly Sitoy, China’s largest manufacturer of handbags, had such a poor experience with specialised machinery that was supposed to spot defects in leather that they were barely using the semi-automated process.  Experienced people were apparently more cost effective, and getting the most out of such expensive raw material was one of the keys to better margins.  So not all one way – but the trend is more machines and less people.  This trend is only going to accelerate as good workers get harder to find and retain in Guangdong; and of course they cost more each year, bringing down the breakeven point for capital/labour substitution and accelerating the payback period. 

I have pulled out a couple of key points from each company visit to illustrate what is going on at the businesses.

Luen Thai (garment cut and sew plant and separate handbag plant)

Uniqlo growth in China a key driver.  Uniqlo employees sit on the sewing line. Quality similar to shirts that sell at twice the price.

Ballooning business at Batam facility, yet excess capacity in China.  Balance will be a challenge.

Expects to be a big beneficiary of TPP

Skyworth (TV production and set top box assembly : market leader in both products in China)

Is OLED the next new wave?  OLED panel availability a possible bottleneck

Game playing over large panel smart TVs should be a key driver for model upgrades at higher margins

QC area has seen significant automation advances since my last visit 2½ years ago.

Packaging going through automation conversion : will cut the number of workers on that part of the line by over 70%.

Expansion of set top box capacity in purpose built plant will introduce more efficiency and significantly reduce subcontracting.  In-house production should mean better gross margins in 2016/17.

Expanding  commercial real estate portfolio and growing rental roll : 2017 fiscal impact could be material.

Hopefluent (largest real estate broker in Guangdong) 

Market back into positive unit growth and ASPs rising once again though still some patches of weakness.  Shenzhen exceptionally strong.  Shortage of new projects in some places

Banks making life much easier for borrowers both in lending terms and speed of processing mortgage applications.  Sales are easier to close than at start of year.

Disruptive models like Soufun only work in the secondary market and have Kamikaze elements.  Soufun hiring mostly poor producers.

Sitoy (China’s largest manufacturer of handbags) 

An experienced workforce is key to productivity and margin.  3+year cutter can achieve up to 50% less material waste than one with just six months on the job.

Have implemented multi-faceted employee compensation structure.

Developing own brand to capture full channel margin.  Base OEM price gets marked up roughly 6x to retail on Madison Avenue (sometimes more!)

Dramatic variation in leather quality across brands.

Very impressive design studio/capability

Samson (Largest manufacturer of case goods in China)

Sees furniture market picking up in the US after long hiatus.

Now able to justify major upgrade of plant and machinery : first serious cap x since 2008.  Upgrading both for productivity and to reduce pollution.

Veneer application a key element of product quality and cost driver.  Expertise in this area a critical competitive competence.

Hotel industry also in positive refurbishment cycle after long weak period post GFC.

Dongpeng Holdings (one of three major tile manufacturers, probably the market leader) 

Main tile plant impressive with high degree of automation especially in polishing and painting, plus driverless fork lifts on the shop floor and in the warehouse.

Low cost producer when at full throttle (it was when we were there)

Moving product mix up market with major investment in design and product range expansion

Sales channels shifting as more developers go for fully fitted units, a trend that is likely to continue.  Makes marketing easier.

MIS a key priority with company connecting distributors to SAP system for better information flow and control (and significant personnel savings).

Material value to be unlocked when company moves from Foshan downtown site, but timing unknown.

Goldpac (#4 worldwide and #1 in China for credit cards) 

Amazing that largest centre for card personalisation in the world (900 million cards p.a.) is so small.

Linked in to Union Pay, so benefits from their strategy to go global.

Interesting extension of full service hardware and software card issuance to standalone remote locations.  Is this a major new business?

Conversion to local Chinese chip manufacturers going slowly.  Infineon gaining    share from dominant niche provider NXP.

Healthcare card will be a massive new sector, but who is going to pay?

Welling (World’s largest manufacturer of micro motors for air conditioners and washing machines)

Significant reconfiguration of assembly process with meaningful increase in average employee productivity.

Development of dedicated customer lines for global leaders.

New motor line comes from a Chinese equipment supplier replacing traditional supplier, an Italian machine builder : same efficiency but less than half the capital cost for similar throughput.

Material inventory managed down to 3 days.  JIT in action.

Further workforce shrinkage expected over next three years.

China is changing.  The factory of the world is yesterday’s business model.  Yet industrial public companies can still provide investors with attractive opportunities even as the service sector becomes the main driver for growth.  Some of these HK listed names should deliver solid earnings improvement while available now on single digit P/Es.

All these companies recognise the growing importance of quality of employee versus basic payroll.  Automation was not just a factory floor issue : it is starting to affect the office as well.  Still it seems like there is still a lot of low hanging fruit to pluck, and we were seeing the better companies.  ROCE could and should improve.  Innovation and efficiency gains suggest price deflation (even excluding raw materials) has further to go.  This implies anything beyond single digit sales growth is going to be a challenge, but profitability will be more in focus and therefore profit growth could be relatively easier.  Companies that do not participate in these changes will disappear.  If the management of companies you own do not embrace these trends, consider transferring investment allegiance to those that do.  There are plenty to choose from.

2003-2013 was all about the top line and getting bigger fast.  2015-2025 could be about getting more profitable and making more careful use of capital.  Too early to be sure but some encouraging signs are there.

Please feel free to give me your feedback if you have seen similar trends or disagree.  Thank you.