CLSA comes to Chengdu

Chengdu is the land of the panda.  In case you had forgotten there is a display of some rather moth eaten specimens in the arrival hall at the airport.  That was as close as I got on this trip.  The airport is new, but already expanding and still on the small side for a growing city which when including its catchment area numbers around 14 million.  I would compare the airport to Birmingham, yet Chengdu’s population broadly defined is roughly 11x larger than that of Birmingham.

The CLSA China Conference is a serious event while their annual Hong Kong jamboree is more of a party.  Sadly I had to miss the sublime Chris Wood due to an appointment with Hong listed CC Land that owns a huge development close to a massive Flower and Horticultural Centre.  Nothing is small in China.  Chris is arguably the most respected regional strategist.  His Greed and Fear publication is widely followed.  Old Etonians seem to be doing well everywhere at the moment.  He is also an outstanding speaker and if you are ever invited to one of his appearances, it is worth blocking off the time.

Turning to the formal presentations, I was disappointed with Professor Mao Zhenhua of CCX Group, a Chinese credit rating agency.  He seemed to wander round issues rather than say anything concrete, though possibly the simultaneous translation let him down.  Still he did say one thing that caught my attention.  He said the government owns R100 trillion of assets that could be privatised – or presumably used in debt to equity swaps?  If that is true why are we worrying about the R4 trillion debt in local government SPVs?  Indeed it was not obvious from his talk why you needed to bother with a credit rating service in China – except of course things are different over in the private sector as holders of Kaisa and Winsway now understand.    

The new normal got a lot of attention, but was of greatest relevance in a session led by Ben Simpfendorfer of Silk Road Associates.  He made a point many people tend to forget.  If you are sourcing some item in size, especially if you are a large Western retailer, there really is only one place to go : China.  And if you are a leading MNC wanting a global footprint there is one market you have to be in like it or not, and that is China.  You cannot ignore a country with a GDP greater than all the other BRICS put together, a country whose incremental GDP growth for the two years of 2013 and 2014, exceeded the total GDP of Nigeria, South Africa and Sweden combined.  You just have to be there.  That goes for investors and global asset allocators as well. 

As a shortage of labour starts to bite, there are plenty of productivity gains to be had especially from automation.  Serious sourcing companies think a 50% improvement is not out of reach – in 2 to 3 years!  Some shift.  Our own experience with holdings such as Skyworth, the largest TV manufacturer in China and Welling, the world leader in micro motors would be not inconsistent with that sort of leap, but I might want to be more conservative about the time it will take to achieve such a step change.  I do agree with the speaker that it is happening and it will be fast.

As for other options, Cambodia and Laos are tiny and would be nowhere without tax preferences.  Bangladesh is cheap but has some of the world’s worst infrastructure.  India and Indonesia come with a lot of baggage so it is hard to know where to start.  Vietnam and the Philippines can cope with a degree of migration, but truthfully how much?  China has the scale and the supply chain clusters.  As my friend, the world’s largest button manufacturer, points out - it is all there.  The cost of moving and multiple potential problems at the other end negate any advantages.  Even if wages go up 10% so what.  Figure out a way to cut 20% from the workforce; and that is what is going on : or if you are an SOE, spin off a unit and leave them to it.

The Conference contained a nice mix of formal presentations, sessions with CLSA’s excellent team of sector specialists and meetings with a large range of China corporates.  There was a wide spectrum of sectors represented from utilities both traditional and renewable to internet verticals.  On the corporate side the encounter that registered most with me was Autohome, one of two leaders in the auto space and according to the CLSA research the one with by far the most comprehensive database and most consumer usage.  What caught my attention was the range of monetisation possibilities waiting in the wings, so plenty of revenue upside.  One challenge in China is getting people to pay for internet services.  B to B can work but consumers prefer things to be free, so B to C only works when some business in the chain can see a clear benefit for which they will pay.  Leads on people who might buy a car are worth something to a dealer.  A potential purchaser looking for a quote is more valuable, and someone ready to buy today is best of all, especially if they also want a loan and insurance package. 

Soufun, one of the online leaders in real estate faces a tougher task.  Correctly they recognised that their traditional business model has a limited shelf life so are moving to transaction based revenue; but in doing so of course they are alienating their legacy customer base.  While their plan is potentially disruptive to the entire industry much higher costs will come before higher revenues.  It is no mean feat to capture 30% of the Shanghai rental market in a few months, but what does it mean if you do this only by not charging either tenant or landlord?  What will happen when you start to charge?  Equally if your strategy to go after a big slice of the second hand volume in Beijing is by accepting 50 bps when the standard fee is 200 bps you will get listings, but will anyone make any money?  They are on the right track, but it will be a bumpy ride : one to watch from the sidelines. 

Most other meetings were less interesting, but Qingdao Port is making several sensible changes expanding the role of grain and reducing coal and iron ore, reflecting the likely change in traffic mix into China.  They are also investing in a significant expansion of refrigerated capacity that is in tune with an economy repositioning from production to consumption.  Management seem to understand their business and anticipate market demand.  Other port operators seem reactive by comparison.                  

One thing Chengdu is not short of is land.  There is lots of it : in every direction; so not likely to be any shortage nor much price appreciation if any.  Only downtown could there be any pressure, and even there, there appears to be plenty of space.  Several satellite areas are developing.  I have neither the vision nor local knowledge to predict which will succeed and which will end up as white elephants.  Suspect there will be both.  Hard therefore to say which developers to back.

There is quite a lot of construction visible, but the quantum does not suggest massive overbuilding (unlike Changsha).  As usual there are too many hotels and more on the way.  Not sure how any of them can earn a reasonable return on either capital or equity.  I do not understand the fascination of local planners for hotels.  They do not employ many people.  One point of difference : I noted a number of hospitals, dental centres, and related university departments.  Chengdu is trying to be a regional centre for healthcare.

On the one hand, the city centre could be said to have been completed with all available space taken.  On the other while certain parts are modern in every sense of the word, plenty of plots contain legacy buildings, by which I mean structures that may only be 8-10 years old, but look double that or older.  These need to be and will be replaced or at the least upgraded.  I could see some of exactly this sort of activity going on out of my 33^rd floor hotel room.  Upgrading means appearance and quality of material, as well as home buyers wanting larger space with better aircon. 

I had a wander around downtown Chengdu during a break.  A couple of things struck me.  The pace of life appears slower than in almost every other city I have visited in China.  Of course a warm day could have had something to do with that as the temperature was close to what it was when I left Singapore.  The second was the composition of the traffic.  There were plenty of cars but a lot more motorcycles and not a few pedicabs and cyclists.  I struggled to understand the etiquette for crossing a road, particularly when there were four intersections connecting to a circle.  After some study I concluded that pray and go appeared to be the best if not the only approach, along with staying alert; though that did not always work as I witnessed a city bus rear end a motorcycle.  The bus got a dent; the motorcycle came off worse, and the rider did not look so great either.  Impressively an ambulance arrived in minutes.  

I walked through a couple of department stores.  The ground floors contained some of the usual international offerings that are getting overexposed and an annoying number of cosmetic counters.  Ladies in Shanghai do not want to be seen with the same bag as ladies in Chengdu; and certainly not at the same time.  So is the massive new Miu Miu outlet such a good idea? 

Ascending you find a dizzying assortment of local offerings with Western names, several carefully pitched to be as close as possible to well-known global brands.  Miyu, Miyu for example.  The building operated by Renhe was almost devoid of traffic.  On the men’s floor (4^th) I was the only customer, except I was merely window shopping.  The salespeople, almost all women, seemed desperate or perhaps just bored.  Based on this admittedly limited sample I would not be a long term bull of Renhe.  Hopefully if you are a bond or equity holder here the other operations are doing better.  They must be based on the recent run- up in Renhe’s share price.  I do not know who operated the second one but at least there I was not alone.  Even so salespeople in menswear must have outnumbered potential buyers by 20 to 1.  The busiest place was Starbucks on the ground floor, though the jewellery section had customers and in the shoe department I did witness someone making a purchase.

There were more shopping bags in the street so my experience may not have been typical.  As another indicator of economic activity, I mention the monthly sales volume of the large property project I visited in a suburb where unit prices for apartments ranged from below US$50,000 to around US$90,000.  When the first phase was launched in the second half of 2013 the manager told me they were selling 100 units a month.  During 2014, that tailed off until by early 2015, the monthly tally was down to 30.  But post the latest set of QE China style activity shot up along with looser bank requirements.  April was back above 100.

Let me close with a comment on the famed Local cruise : famous that is for its spice.  I used to think I liked Sichuan style cooking, but that was before I went to Chengdu.  Prior to that I had clearly only experienced watered down imitations of the fiery food.  Unfortunately as is too often the case in Chinese restaurants the hottest food comes out first.  If you have ordered a steamed fish, this delicate dish invariably arrives just after whatever contains the most chillies.  Tofu with minced pork, beef noodles and vegetables may all have been delicious but following some sort of fried chicken submerged in chillies, and covered in peppercorns I could not taste a thing until breakfast the next day.  Even an extra bowl of steamed rice did not do the trick, nor did two pots of Jasmine tea, as at least I suppose it was Jasmine.  After the chillied, peppered chicken it was impossible to be sure.  Order carefully in Chengdu, or better yet get your dining companion to go first!  If they are still smiling it is probably safe to follow, unless they are smiling because they know you are about to suffer.