China is a key economic partner for Australia, being our largest trading partner for both imports and exports. Whilst our commodity exports to China make up the largest amount by value, our agricultural and consumer-related exports are experiencing greater growth. This presents some interesting investment opportunities for Australian listed companies with exposure to this thematic.
When investing in companies whose growth depends on demand from the Chinese market, it is important to try to gain an understanding of the opportunities and challenges these companies may face. With two of our portfolio holdings being exposed to this market, namely Wingara Ag Limited (ASX: WNR) and Costa Group Limited (ASX: CGC), we took the opportunity to gain insights into each company’s operations and end markets on the ground in China.
Our recent visit to China included a site tour to Costa’s berry farm operations in Yunnan province, which provided the opportunity to meet key management within the businesses, understand the culture, and assess the key environmental, social and governance (ESG) risks at play and how they are managed. In this short note, I describe some key themes and learnings from a fascinating trip.
The Rising Chinese Consumer
With rising incomes and the emergence of the Chinese middle class driving the next period of consumption-led economic growth, companies with exposure to the Chinese consumer are set to benefit from strong demand tailwinds over the coming years. For some perspective, 76% of China’s GDP growth was driven by domestic consumption in 2018, up from 59% in 2017.
We often think of the Chinese consumer’s spending power being focused in wealthier, larger tier one cities, such as Beijing and Shanghai, but those cities only make up about 5% of China’s population on the whole. Consumers in lower tier cities (basically, smaller, less wealthy cities) also have much lower costs of living, meaning disposable incomes are generally higher. On average, disposable incomes in second-tier cities are 27% higher than those in first-tier cities. While these cities present a larger, untapped opportunity, they are less accessible and require a greater understanding of who the consumer is, and more targeted consumer education on new products. Having the right infrastructure and logistics partners is also key, particularly with fresh products such as Costa’s berries.
As incomes rise, tastes are also changing, and consumers are using their increased wealth to demand fresher, more premium products. While more Australians are donning their activewear and sipping green smoothies, Chinese consumers are hopping on the health and wellness trend too. This is based on the belief in Chinese culture that your health is primarily driven by what you eat. Origin of product is also a key concern alongside food safety, which makes Australian products favourable to Chinese consumers. As a result, consumers demand brands produced in “clean and green” geographies which are trusted in terms of quality. It is therefore vital for companies to maintain a positive brand image to capture this trend.
With great opportunities come challenges. Political risks come to the forefront both for exporters to the country and companies operating within its borders. The relationship between Beijing and Canberra poses a key risk for exporters. If tensions erupted, it could mean unfavourable consequences as has happened in the past – one recent example being the speculation around the restriction of canola imports from Canada subsequent to the arrest of Huawei’s CFO, although any link between the two events has not been confirmed. Regardless, it shows that exporters are very reliant on the political environment and decision making of Chinese officials – one day the export channel might be open and the next day it might not be. Businesses need to be cautious of this risk and ensure there is a plan B. What is in a company’s control is their own relationship with the government, their impact on the local community in which they operate, and their adherence to policy. For Australian companies operating within China it is vital they uphold these relationships.
Costa Group in China
When looking to our investments, the first consideration from the above points relates to Costa Group. Through its 70% owned JV with Driscoll’s the company grows and markets berries in China. The addressable market is estimated to be about 150m people, but could be as large as 400m as incomes rise and more people are able to afford products with perceived health benefits, such as blueberries. The Driscoll’s brand, whilst not yet mainstream, is recognised as a quality international brand in China, and Yunnan province where their farms are located is viewed as a good agricultural region (and is also a holiday destination for locals). Costa’s premium varieties which are larger, tastier and arrive fresher to store versus other brands make them highly demanded by the consumer and therefore commands a significant price premium. Costa has also been successful in developing a positive relationship with the government and local community which is crucial for managing political risk and conducting business sustainably. They employ many people from the local area and give back to the community by providing scholarships to train promising upcomers within the business, for example. Costa’s farms can yield over 4 times the tonnes per hectare of the local growers, which is evidence of their superior growing techniques, leading-edge genetics and variety breeding programs. Overall, we have come away with the understanding that there are clear barriers to entry in the market, and an increased conviction that Costa have a sustainable competitive advantage which will allow them to grow their business in China for years to come; and that their Chinese operations will become a much larger contributor to earnings over time.
Wingara and China
Wingara is also set to continue to benefit from growing Chinese demand. Wingara exports oaten hay to China to supply the dairy industry with high-quality Australian feed where local production doesn’t consistently meet the demand or required quality standards. Within the dairy category, yoghurt is a key product which is currently experiencing good growth and popularity amongst the consumer – Austrade forecasts Chinese yoghurt sales to double from 2018 to 2022. Wingara also runs a cold storage and export business which benefits from the increasing demand for quality Australian red meat. A key challenge for Wingara is the political environment and reliance on the export channel being maintained, however, Wingara has reduced this risk through diversifying export markets to South Korea, Japan and Taiwan for hay, and more globally for red meat. The Chinese government has approved their Raywood site for export faster than the originally anticipated timeframe, indicating a positive relationship exists. Whilst Wingara does not supply the end consumer directly, their products and services are a key link in the supply chain which is ultimately being driven by the consumer, and for this reason, we believe Wingara is set to benefit through growth over the longer term.
We believe these two positions provide quality exposure to the China consumer growth thematic without taking on unnecessary risks – such as single-product exposure or concentration of business operations in the region. Through discussions on the ground, we learnt that relationships are particularly important in doing business in China and in our view, both of these companies have developed positive relationships in the market that has put them in good stead to continue their growth.
Important Information: This material has been prepared by NAOS Asset Management Limited (ABN 23 107 624 126, AFSL 273529 and is provided for general information purposes only and must not be construed as investment advice. It does not take into account the investment objectives, financial situation or needs of any particular investor. Before making an investment decision, investors should consider obtaining professional investment advice that is tailored to their specific circumstances.