China’s rapid retreat from its zero-Covid policy in a bid to boost economic growth is one of the big investment themes of 2023 and is sure to provide a major boon for consumption in the so-called Middle Kingdom. Since November 2022, the government has dramatically reopened the Chinese economy and rolled back pandemic-induced restrictions that had been in place for three years.

While the end of zero-Covid has created challenges for the healthcare system – major cities such as Beijing and Shanghai have seen surging Covid infections – Chinese people are travelling once again and there are signs of recovery in consumer spending as well as in travel and tourism and on leisure activities, while the reopening should also benefit oil exporters as demand for energy increases.

Admittedly, new Chinese guidance for GDP (gross domestic product) growth has checked some of the optimism over any boost from the reopening, with the new growth target announced at the National People’s Congress set at just 5% for 2023, at the bottom end of market expectations.

Nevertheless, three years of pent-up demand from 1.4 billion people is being released and the reopening, which is still in its early stages, should act as a positive catalyst for consumer-facing companies generating significant revenues in China.

Indeed, retail sales rebounded in January and February after Beijing abandoned its suffocating zero-Covid policy, reopening borders and ending mandatory quarantine. Growth of 3.5%, released by the National Bureau of Statistics, was much better than the 1.8% retail sales drop witnessed in December, demonstrating that the world’s number two economy is picking up.

‘REVENGE SPENDING’ EXCITES

Rising affluence in China is generating fast growth in premium sectors within food, travel and cosmetics and the country’s burgeoning middle class has increasing wealth and an appetite for top tier brands. Therefore, luxury goods purveyors are pinning their hopes on Chinese ‘revenge spending’ to boost demand, driven by domestic consumption and the fanning out of well-heeled Chinese tourists to cities such as London, New York, Paris and Milan.

Stocks to watch include luxury conglomerate LVMH (LVMH:BIT), the sector goliath behind brands ranging from Dior, Tiffany and Louis Vuitton, as well as Gucci-to-Yves Saint Laurent owner Kering (KER:EPA), Swiss luxury goods group Compagnie Financière Richemont (CFR: SWX), behind the Cartier and Montblanc brands and Hermes (RMS:EPA), the French design house famed for the iconic Birkin handbag.

The reopening is also helpful for Burberry (BRBY), the trench coats-to-cashmere scarves seller which generated almost £1.28 billion of its revenues from the Asia Pacific region in the year ended 2 April 2022. That’s comfortably ahead of the £696 million of sales seen in the Americas and the £813 million delivered in the Europe, Middle East, India and Africa (EMEIA) region.

And don’t forget other beneficiaries such as high-end spirits giants Diageo (DGE) and Pernod Ricard (RI:EPA) and global cosmetics leaders L’Oreal (OR:EPA) and Estee Lauder (EL:NYSE).

As Swetha Ramachandran, investment director, GAM Luxury Equities, argues, the near-term impact of the recovery of the Chinese consumer is underappreciated. ‘In 2019, the Chinese consumer drove a third of the (luxury) sector’s demand and 90% of its growth,’ notes Ramachandran.

‘The Chinese traveller has been virtually absent from the world stage for the last three years due to the Covid-19 pandemic. The decreased contribution of the Chinese consumer amounts to approximately €33 billion in absolute terms, thereby creating huge scope for catch up.’

Ramachandran adds: ‘This is not a catch up which we think will take a long time. Rather, it is happening already, with queues forming at stores domestically and consumers beginning to spend their substantial accumulated excess savings. This is set to receive a further boost with the eventual resumption of outbound Chinese tourism.’

FUND MANAGERS’ FAVOURITES

Zehrid Osmani, manager of Martin Currie Global Portfolio Trust (MNP), points out that China accounts for around 50% of global luxury consumption. Yet despite zero-Covid limiting spending, the sector has remained resilient and top 10 holding Ferrari (RACE:NYSE) is ‘positioned to benefit from pent-up demand as it reopens’.

Osmani notes Q4 2022 results from the iconic sports car maker ‘exceeded expectations, with orders at an all-time high and revenue and EBITDA growth of 12% and 8% respectively. This was the first quarter featuring meaningful contributions from deliveries of the Purosangue SUV and the SP3 Daytona (Icona model). Both models are priced above the group average selling price and therefore accretive to margin.’

He adds: ‘This ability to sell at high margins, even by luxury standards, sets Ferrari apart, as it prices its products at a 25% to 75% premium to its nearest competitors. Its focus on ultra-premium limited releases, investment in electric vehicles, and its first SUV in the Purosangue represents encouragement for growth in China, which already accounts for 9% of revenue.’

Also weighing in is Nicholas Price, manager of Fidelity Japan Trust (FJV), who says ‘Japanese retailers and consumer product companies that have a high earnings contribution from China stand to benefit’ from the reopening and ‘an accompanying recovery in consumption’.

Price sees ‘significant growth potential’ for a range of portfolio holdings ‘that can capitalise on their competitive strengths and product appeal. Fast Retailing (9983:TYO) and Ryohin Keikaku (7453:TYO), operators of the UNIQLO and MUJI brands respectively, and sportswear company Descente (8114:TYO) are key examples,’ he enthuses.

In the manufacturing sector, he sees economic recovery in China and an ‘attendant pickup in capacity utilisation’ as positive for companies such as Harmonic Drive Systems (6324:TYO) and MISUMI Group (9962:TYO). Finally, Price flags the prospect of ‘a recovery in inbound demand with the eventual return of Chinese tourists to Japan, which would benefit urban retailers and various hospitality industries.’

Fidelity colleague Marcel Stotzel, manager of the Fidelity European Trust (FEV) and the Fidelity European Fund (BFRT350), estimates that as China reopens there will be ‘roughly 150 million outbound Chinese consumers returning, with many planning to visit Europe. Holdings in our portfolio that could benefit are luxury conglomerate LVMH, and Amadeus (AMS:BME), a Spanish business that provides technology solutions for the travel industry’.

Stotzel says Amadeus ‘uses its web across the travel industry to aggregate data and ensure things operate smoothly. The data analytics used to optimise the procedure of booking a flight, travelling to the airport, flying and staying in a hotel is very powerful. The company suffered through Covid, but it left the two biggest competitors in weaker positions and Amadeus is gaining material market share’.

OPPORTUNITIES IN SNEAKERS & CAPPUCCINOS

Also geared into the China reopening story are two of corporate America’s best-known brands, Nike (NKE:NYSE), the world’s largest sportswear company, and Seattle-based coffee roaster and retailer Starbucks (SBUX:NASDAQ).

China is Nike’s third biggest market by sales, where the sneakers-to-soccer balls behemoth does face competition in China from homegrown competitors including Anta (2020:HKG) and Li Ning (2331:HKG), the latter founded by the eponymous former Olympic gymnast Li Ning.

But neither brand has the international cache of Nike, which offers investors a great way to play trends towards health and fitness, the casualisation of fashion and the growth in athleisure.

Based on Stockopedia data, Nike is expensive, shares swapping hands for 37.1 times forecast 2023 earnings falling to 29.3 times on 2024’s estimates, but we believe Nike merits this premium as it will remain the world’s preferred sportswear brand for years to come given its strong brand, scale and digital savvy.

Second quarter (20 December) sales and earnings smashed analysts’ estimates as sales in largest market North America surged 30% higher, offsetting weakness in China, where quarterly sales dropped by 3% year-on-year. Nike was set to post third quarter results as Shares went to press on 21 March.

Behind the US, China is the second biggest market for coffeehouse colossus Starbucks, whose sales and earnings in the first quarter ended 1 January 23 fell short of analysts’ estimates as Covid-related disruption in China impacted international sales.

While Starbucks generated impressive same-store sales growth in the US, its biggest market, comparable sales slumped 29% in China, the Flat White-to-Peppermint Mocha seller’s second biggest market, where it has over 6,000 stores and counting.

Starbucks’ shares aren’t cheap, trading on 29.2 times forecast 2023 earnings according to Stockopedia, but that rating drops to 24.3 times estimated 2024 earnings and there is scope for positive earnings surprises as the progressive dividend payer laps easy China comparatives.

Starbucks’ founder and interim CEO Howard Schultz handed over the reins to well-regarded former Reckitt Benckiser (RKT) boss Laxman Narasimhan in March.

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