Carl Setzer was 25 years old when he landed a job as an IT specialist in Shiyan, China. The recent university graduate was looking forward to finishing long days at the office by sitting down to a quality pint with his coworkers.
But when the Cleveland, Ohio native soon realised that this was nearly impossible, he saw a great business opportunity.
So, although Carl had a lucrative career ahead of him, he quit his job to open a micro-brewery named Great Leap Brewing in 2010. Since then, there has been a micro-brewery boom in China.
China has long been dominated by five major beer brands, which occupy 70% of the sector. I had a colleague who wisely invested in one of these companies, Tsingtao (HK: 0168), about a decade ago. Since then, China has become the world’s largest beer market. And in that time, the Tsingtao stock price rose by more than ten times.
But Chinese consumers’ tastes are changing, and that means they want more than just lagers and Tsingtao. Just ask Lu Yizhi, a 32-year-old tour guide. He used to think foreign beer was an expensive indulgence. But now he has the disposable income to indulge himself.
And when Carl Setzer first opened his micro-brewery, it was dominated by expats. But that has recently changed. As more Chinese go abroad and return home and have greater levels of disposable income, Carl has seen his clientele diversify to include locals.
There are now so many options available to Chinese beer drinkers these days that they don’t even have to make the trip to Munich to experience Oktoberfest. The German brewery Paulaner has set up shop in China and hosts the annual event in Beijing.
Strangely enough, analysts have ignored these trends when it comes to forecasting Tsingtao’s share price. And now the Chinese economy is going through some serious structural growth deceleration that is also yet to be fully priced in. But that’s exactly why I see Tsingtao as a simple contrarian indicator of when it is time to start buying Chinese stocks again. Let me explain what I mean…
Analysts love Tsingtao – but they’ve been wrong 78% of the time
Tsingtao is a Chinese brewery giant. It is the second largest beer producer in terms of volume, with around 60 brewing plants and an annual capacity of around 13m tonnes. It is partially controlled by the state (30.5%) and the Japanese brewery giant Asahi (20%). The remainder is balanced between a ‘who’s who’ in asset management from London, New York and Singapore.
Tsingtao recently reported its 2013 results. Net profit increased a respectable 12% to RMB 973m. This was supported by 10% higher sales volume to 8.7 million tonnes and an increased market share to 17.2%. But the net profit was inflated by non-operating income (eg, financial income and government subsidies) accounting for 37% of the net profit, compared with 13% in 2008.
Furthermore, the principal brand (Tsingtao) grew only 5% and accounted for 52% of total volume, down from 56% in 2011.
The outlook looks less rosy. The market is characterised by heavy capital spending and a falling utilisation rate, as well as intense competition, according to BoA Merrill-Lynch.
Analysts are rather gung-ho about growth prospects and believe earnings will grow by 6% (2014),18% (2015) and 8% (2016) respectively.
I would take those estimates with a huge grain of salt. Since 2006, sell-side analysts have only been right two out of nine times – that’s a paltry 22% success rate – as measured by Bloomberg’s ‘surprise’ index (eg, estimated versus actual earnings per share (EPS)).
You would hope that savvy investors would know this and demand an earnings discount.
But it doesn’t look like that will happen. How else do we explain why the stock is trading at price/earnings (p/e) of 26.1x times 2014, price to growth ratio (PEG) of 1.7 times and a dividend yield of 1.0%? In contrast, the Hang Seng China Enterprise Index (HSCEI) is trading on a p/e of 10.1 times 2014. And that’s in spite of having superior return on equity.
I’m aware of that the HSCEI is crammed with banks, property and telecom stocks that are not exactly on the brokers’ top buying list. But I think the gap between Tsingtao and its underlying index is way too wide…
The truth about the Chinese stock market
The truth is that the China stock market story is as popular as a Premier League football club which is just about to be relegated. Indeed, the sentiment can be best captured by the acronym ‘ABC’ – anything but China.
Despite being ‘underweight’ by a lot of global funds, China still has quite a few backers. This is particularly true among Asia funds that are forced to measure their performance against indices full of China related stocks. In these backward looking indices, big size and liquidity are more important than growth and return potential.
I pity many fund managers who are being held hostage by investment consultants that spend most of their time looking for emerging markets which look and feel like developed peers – we all know that’s an impossible task.
I regard Tsingtao and similar expensive consumer stocks as being the final straw in the de-rating of China. The concentration of foreign fund managers in a few sectors/stocks make them vulnerable to a sharp reversal of fund flows.
Indeed, Tsingtao offers a contrarian indicator for when it is time to invest in China again. A sharp drop would mean the last bulls have been snuffed out. And that would be a green light to start buying Chinese stocks for the long-term (not the trading market, which has been the case for the last five years or so).
If you think I’m too bearish, well, have a look another consumer darling which reported earnings last week. The retailer Lianhua Supermarket Holdings (HK: 0980) reported its first ever half-year miss since going public in 2003.
Once again, the forecast errors here were gargantuan: the surprise index was only positive three out of nine times (33% forecast accuracy between 2005 and 2014). And on top of that, in the last three years, the misses were a whopping -54% (2013), -35% (2012) and -19% (2012). Simply put, the trend has actually worsened.
Chinese people still love beer – but it has to be the right kind. Carlsberg AS, the Danish brewery giant, is trading at a p/e of 13.4 times 2014. This is a pretty good indicator of which level it would have to get to to be worthwhile looking at Tsingtao again.