China's reforms prompt fresh look at European, U.S. consumer stocks

Wed Dec 4, 2013 10:31am EST

* Europe's consumer firms with revenue exposure to win

* U.S. technology companies also seen gaining

* Relaxed 'one child' policy immediate boon for baby food

* Staples, autos, pharmas to gain when rally broadens

By Tricia Wright

LONDON, Dec 4 (Reuters) - Beijing's plans for big economic reforms have put companies with exposure to China back in vogue, with Europe's consumer goods makers and U.S. technology firms set to benefit from a shift to consumption-led Chinese growth.

China announced wide-ranging plans last month for changes including a relaxation of its one-child policy and a shift to a more market-driven economy, policies that will turn more of its people into avid consumers.

For investors frustrated by Europe's subdued economy but worried about Chinese corporate governance, one route to that market is through European firms that sell to China.

China aspires to develop from a low unit-cost production centre to one that creates more products and services with greater sophistication.

That could turn some European firms, rich in intellectual property with hard-to-replicate franchises, into targets for joint ventures with Chinese firms.

For those keen to jump on the bandwagon, Morgan Stanley has launched a "China reform" basket of 50 European stocks which are exposed to the Chinese consumer and which make a significant chunk of their revenues there.

Gains will be felt first by the likes of French baby food maker Danone, as China's birth rate rises, before the rally spreads to sectors such as autos, staples, and healthcare, analysts say.

The Chinese economy - which is expected to grow 7.6 percent in 2013 against 1.7 percent growth in the United States and a 0.4 percent contraction in the euro zone - has long been a target for overseas companies and their investors, but until now much of the focus had been on the basic resources sector.

Share prices of miners, which feed China's factories, have fallen this year on worry over slowing demand and rising production costs and the reforms' focus on consumers means other sectors are likely to be more popular China plays in the future.

"Consumer staples, carmakers, and drugmakers may be better plays on China than the miners (since they) ... are akin to supertankers which take a long time to turn around," said Neil Veitch, investment director at SVM Asset Management.

Veitch backs Asia-focused fund manager Aberdeen Asset Management and bank Standard Chartered, with a healthy China likely to lift its regional neighbours.

He also holds BMW, which draws 19 percent of its revenue from China. BMW, Audi and Daimler, which all feature in Morgan Stanley's basket, should in the long term benefit from higher demand, especially for large sedans and SUVs.

"A more consumer-led economy... means that people will find it easier to finance cars, (and) it will probably mean that the whole leasing business can get developed in the mid-term," Jochen Gehrke, auto analyst at Deutsche Bank, said.

EARNINGS PINCH

Reform of the household registration system, or hukou, could prove a longer-term boon to companies such as Danone and Unilever which have felt a pinch on earnings as Chinese growth slows.

Under existing rules, migrants forfeit social services when they leave their villages.

"Rural citizens would not have to save quite as much to cover healthcare costs and the like," Dean Cook, investment research analyst at Duncan Lawrie Private Bank, said. "That could be a significant boost for consumer staples companies."

Leisure firms are expected to cash in on more travel. InterContinental Hotels Group already derives some 10 percent of its earnings before interest and taxes (EBIT) from China. It plans to double the number of hotels it has in China over the next three to five years.

Any influx of Chinese tourists into Asia could also help fellow UK-listed hotelier Millennium & Copthorne, Panmure Gordon analyst Karl Burns said, with Asia accounting for about 40 percent of its profits.

U.S. companies also stand to benefit.

Besides commodities, "Chinese demand ... can affect quite a few technology/communications companies in the United States - a good example and an obvious one might be Apple," Bryant Evans, portfolio manager at Cozad Asset Management in Champaign, Illinois, said.

Wynn Resorts, Advanced Micro Devices, Yum Brands, Qualcomm and Micron Technology lead the list of S&P 500 companies with the highest exposure to China, according to Thomson Reuters data.

Ambitious Chinese firms may also look for expertise.

"We might be surprised at the extent to which Chinese companies may actually seek to do more in terms of corporate tie-ups with European companies," Paras Anand, head of European equities at Fidelity Worldwide Investment, said.

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