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One stock that will profit from China’s slowdown
China’s slowing economy is bad news for commodity producers. But it's great news for commodity consumers, says Matthew Partridge. Here, he picks one stock that is set to benefit.
China's economy is slowing down - there's no debating that anymore. It's gone from being a fringe doomster' prediction to near-consensus.
Some still hope for a soft landing'. But judging by recent havoc in the banking sector, it looks as though Beijing has no plans to step in with a massive stimulus package this time. It can't take the risk of increasing the bad debts already clogging up its financial system.
This is already having a big knock-on effect on countries and commodities which depend largely on voracious Chinese demand.
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Australia the most China-dependent developed economy has seen its currency crash to a near three-year low against its US counterpart. The iPath Dow Jones-UBS Industrial Metals Subindex one measure of commodity prices - has also fallen nearly 20% from its high in September.
But for certain industries, a slide in commodity prices is very good news indeed. And investors who get in now could share in their good fortune
China won't be able to put off this slump
China's banking system is a mess. Due in large part to the earlier stimulus in 2008 and 2009, banks have made too many loans to too many projects that will be unable to repay or even service the debt.
Beijing is now trying to encourage the banks to be more careful about who they lend to, and the projects they back. But it's a little late for that. Returning to a system that makes sensible loans to productive enterprises will take a long time and a lot of restructuring.
Perhaps more importantly, the nature of China's economy is changing, and the rapid growth seen in recent years will become a thing of the past. The vast supply of cheap labour that enabled factories on the mainland to undercut the rest of the world is now drying up, while wages are rising, and, thanks to the one-child policy, the Chinese workforce is set to decline.
The large productivity gains from the partial move towards a more market-based economy have also been exhausted.
The government is meant to be encouraging the economy towards growth that is led more by consumption, than infrastructure investment, or exports; but that will take time.
All this means that instead of a quick rebound and return to rapid growth, we will see a long recession (or near-recession) followed by a much more modest rate ofgrowth.
Dr Copper is set to lose out
Copper is a key industrial metal, used in manufacturing and construction. Some traders even call it 'Dr Copper' the metal with a PhD as many see its price as a great predictor of global economic prospects.
China's long boom has been very good for copper. Beijing's emphasis on infrastructure meant a huge increase in the number of buildings. These buildings needed wiring, roofs and plumbing all of which use copper. China now accounts for roughly 40% of the copper used around the world.
However, there is now a huge oversupply of property, with firms struggling to sell buildings or let offices. This means that firms will have to focus on finding buyers, rather than constructing new buildings. As a result, demand from the Chinese construction sector is likely to plummet.
At the same time, the disruptions that have kept copper supplies tight are easing: strike action at copper mines, once a major problem, is sharply down compared with previous years. The fact that prices are still well above the $6,000 per ton needed to keep mines profitable should also help maintain output.
So supply is up, while demand is down. The ratio of copper stocks to consumption is at its highest since late 2011 in other words, for every user, there's a big pile of copper sitting in a warehouse somewhere. That suggests the price has to fall.
Good news for copper consumers
One such firm is Mueller Water Products (NYSE: MWA). Mueller specialises in water-related infrastructure, usually to US cities and local authorities. It manufactures and distributes fire hydrants, pipe-fittings and valves. It also helps to detect leaks.
Mueller is the lead company in this sector, giving it pricing power, as Robert Royle, co-manager of the Smith & Williamson North American Trust, points out. In the past few years, the company's revenues have been hit as many cities and districts have cut spending, as they struggle with debt, falling property taxes, and large public pension bills.
The fall in spending has also prevented Mueller from passing on rising costs to its customers. Instead it has had to absorb the impact of high brass and copper prices. So profits have suffered too.
However, while cities can postpone infrastructure projects for a short while, they cannot put them off indefinitely. There are strict laws governing the quality of the water supply. Fire brigades need water pressure to be maintained. So leaks have to be dealt with, and equipment needs to be updated regularly.
And in the longer run, delaying investment in the water supply makes no financial sense either. Investing in new hydrants saves money in the long run by reducing the number of leaks.
As a result, Mueller is starting to see business pick up again. Combined with savings made as copper prices fall, earnings are starting to bounce back too. The company returned to the black last year, and earnings per share are expected to rise fivefold over the next three years. That means that by 2016, the stock will be trading on a price/earnings (p/e) ratio of just over eight. If copper prices drop further, earnings could improve even more rapidly.
So if you agree that China's slump is likely to be worse than most think, while the US will continue to see some sort of recovery, we reckon Mueller is a good way to play it.
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