“If the lips are gone, the teeth will be cold”: China’s New Normal policies require companies to undertake radical strategy reviews

China elec Aug15Wishful thinking can be terribly dangerous for company profits.  Taken to extremes, it can lead them into bankruptcy.

Recent developments in China thus make it essential for every company to immediately review its strategy for doing business in/with the country, against a realistic outlook for 2016-2018

  • GDP growth will likely be zero, and could well go negative
  • New auto sales will also remain slow, as growth is cannibalised by the used car market
  • Lending cutbacks will mean property and construction markets will remain under pressure
  • Major growth will be seen in the supply of basic goods such as $50 refrigerators in rural areas
  • The need to clean up today’s pollution means growth in environmental clean-up markets will be turbo-charged

None of this will be a surprise to anyone who has followed the recent development of China’s economy.  But it will come as a tremendous shock to those company boards and investors who have believed the myth that somehow China was about to become middle class by Western standards.

Key to this strategy review process will be to ignore published data for China’s GDP.  As the world’s media are beginning to recognise, this is completely fictitious.  How, after all, could any country possibly present accurate GDP data within 2 weeks of the end of a quarter – and never need to revise it?

Equally, how could its GDP really be growing at 7%, when such critical areas as electricity consumption are now seeing growth of less than 1%, as the chart above confirms. Consumption in January – July rose just 0.8%, and it actually fell by 1.3% in July.  As the National Bureau of Statistics highlighted, the data:

“Shows the structural adjustment of China’s economy and power consumption.  Sluggish external demand and a slowdown in exports, which dragged down industrial production, as well as the high base data registered last July, all resulted in July’s power consumption shrinkage.”

The slowdown underway in new car sales confirms that this is a long-term structural issue.  Passenger car sales fell 6.6% in July, after a 3.4% fall in June, despite price cuts of 30% or more on hundreds of popular models.  And worse is to come, with inventories still at 1.7 months.  In addition, we can expect Chinese companies to react to the downturn by:

  • Producing more “lookalike” models of Western cars – a lookalike LandRover Evoque is now on sale at one-third of the Western price
  • Boosting exports by using the currency devaluation to compete with foreign manufacturers

Similar developments are taking place in the property sector, as the government slowly brings shadow lending under control.  This means the end of the property bubble which allowed people to buy new cars that they couldn’t afford out of their normal income.   Instead, the profitable companies in the future will be those who focus on the used car sector.  This is likely to grow four-fold between 2014-2010, from 6m sales to 25m.

Smart investors such as Tencent are now focusing on this sector – aware of the potential profits to be made from used car sales and service, when offered through an integrated online and physical presence.  As the China Europe International Business School’s Center for Automotive Research has commented:

Dealers’ margins are reducing. They are not what they were years ago. Now dealers are not making money by selling new cars, and in fact, dealers in the United States are making more money in after-sales services than selling cars.

The good news is that the new growth areas for China’s economy are becoming increasingly obvious, as the lending bubble disappears.

The key for those focused on consumer markets is to produce products that are affordable for people on average earnings.  This means urban residents with incomes less than $4k, and rural residents with incomes less than $1300. One company I know is seeing excellent growth in affordable bedding sales; everybody values a good night’s sleep.

Another profitable market for the future will be in providing products and services to help clean-up the pollution created by China’s ‘dash for growth’.  Even before the Tianjin disaster took place last week, the government was already accelerating its Rmb 9.4tn ($1.4tn) programme for environmental protection, as Securities Daily reported:

In the next five years, the market for energy efficient, environmentally friendly products will have huge potential. With the government focusing on controlling pollution, the energy-saving and eco-friendly industries will become fast-growing sunrise industries in China.”

Many companies and investors have preferred to believe that President Xi was only paying lip-service to his concept of the New Normal.  But it is now clear that he will not repeat the stimulus policies which have created today’s problems for the economy.  And as the Chinese phrase says, “if the lips are gone, the teeth will be cold”.

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