An Australian stock to buy as China slumps

Australia is heading for a downturn as China's demand for raw materials evaporates. But there are still opportunities down under, says Matthew Partridge. Here, he tips a stock that should power through any bust.

Last week I went to hear fund manager Michael Riddell of M&G Investments talk about his views on emerging markets.

When it comes to the biggest of them all China his take is that "the question is not if, but when China's bubble will burst".

We don't disagree with Riddell. In fact, we'd argue that the bubble has probably already burst. It's now in the process of deflating.

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One country that's already feeling the pain is Australia. As such, it's an area we'd largely avoid. But not every Aussie stock will feel the pain from China's bust

China has passed the Lewis Turning Point'

M&G's Michael Riddell is a big fan of the work of the economist Arthur Lewis. Lewis's idea was that most growth occurs during the change from a rural subsistence economy to a modern urban one. During this period returns to capital are high, encouraging investment.

However, once all rural labour has been absorbed, growth quickly slows. Attempts to continue the pace of growth via ever-increasing levels of investment, simply lead to poor returns. It also risks creating a credit bubble.

This is the 'Lewis Turning Point'. And Riddell believes that China has passed it. He also believes that the increase in private credit, which grew by more than 50% each year from 2009 to 2011, shows that there is a bubble.

Rising debt isn't necessarily a bad sign in itself. Leverage usually increases as a country gets richer. However, Riddell points out that, despite its low per capita GDP, Chinese leverage is already on a par with much wealthier countries such as Hong Kong and Japan.

We'd be inclined to agree with Riddell's take. Even if you're not convinced, it's certainly becoming clear that China has passed some sort of turning point.

As well as facing a fall in its long-term rate of growth, China's short-term woes are mounting. April's industrial production growth slowed down to 9.2% year on year, the lowest figure since mid-2009. GDP growth fell to 8.1%.

Although these figures both still sound impressive, you have to remember that like every other government China's leaders aren't above fiddling the data for propaganda purposes. This means that the trend, not the actual figures are key.

An even bigger hint of major problems is the latest trade data. Exports grew by 4.9%, compared with a year ago. This was much lower than the 8.5% expected. Imports effectively stayed the same, going up by only 0.3%. This suggests that China can neither export its way out of trouble nor rely on domestic demand.

As we've already noted several times, a slowdown in China should have a big impact on its '51st state' Australia. While China's massive demand for resources has shielded Australia from the global financial crash to a great extent, this is now set to go into reverse.

This would be bad enough even if Australia was in a hugely sound economic state. But it's not. It has suffered a rampant housing bubble that has made it one of the most expensive places to live in the world. That bubble is already collapsing. According to the Australian Bureau of Statistics, average house prices have now fallen for five straight quarters.

Meanwhile, the latest economic surveys show that both the manufacturing and service sectors are in deep trouble, with activity in both shrinking rapidly. No wonder the Aussie dollar has toppled back through parity with the US dollar.

But there are still investment opportunities Down Under

Yet while this is clearly all bad news for the Australian stock market in general, you shouldn't shun all Australian shares. Firms that have all, or most, of their operations abroad will not be affected by a domestic downturn.

One such firm, which we've covered here before, is Wasabi Energy (ASX:WAS; Aim:WAS), which handily enough is listed on Aim as well as the Australian market. This company owns the 'Kalina cycle' process, which creates energy from the heat given out by power plants. It is cleaner and more efficient than competing techniques.

It makes its money in three main ways. Firstly, it operates several power plants around the world, or owns them outright, as in the case of the Husavik plant in Iceland. It also licenses its technology to other companies, such as FLSmidth, a support firm for the cement and mineral industries. It also makes money from engineering, design and procurement.

The technology can already pay for itself given current power prices. However, the high cost of wind and solar energy means that governments may start classifying waste heat as a renewable. Indeed, this may be the only way that the EU can realistically meet its target for 20% of energy to be renewable. This would greatly boost demand and increase margins.

It also has some promising sidelines. Wasabi owns most of Aqua Guardian Group, which makes sheeting that reduces water evaporation. Unlike similar products, it has been designed to withstand high winds. This makes it suitable for markets such as Texas and the western US. Wasabi also has stakes in Clean TeQ, which cleans up the water from mining and shale gas, and Arfuels, a biofuel company.

Clearly, given the field it operates in and its size, it's not a stock for widows and orphans. But if you're looking for an adventurous play on alternative energy that should be able to avoid the pain of a China slowdown, it's well worth considering for the high-risk part of your portfolio.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri