Forget designer clothes – to profit from China, buy cakes

Many Western companies are setting up in China, hoping to sell luxury-branded goods to the newly-affluent population. But a lot of them are wasting their time, says Cris Sholto Heaton. Forget high-end designer goods, it's in the lower-end of food retailing where the money is currently being made.

If you've visited Beijing or Shanghai, you may have heard of the tea ceremony scam. Briefly, it involves being invited to a "traditional Chinese tea ceremony", in which you'll be served a few cups of dishwater and then presented with an eye-popping bill.

By now, it's a hackneyed routine and typically pretty obvious as an overly friendly man or suspiciously attractive woman stops you on the street and blurts out the invitation within seconds.

So I was surprised to see how much subtler the con had become in Shanghai since the last time it was tried on me.

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Even China's scam artists are getting more sophisticated

My first would-be scammers were a likeable couple who introduced themselves as students from the northern city of Qingdao on holiday for a few days.

They were apparently keen to practise their English and we'd been talking for a good 15 minutes, until they invited me to accompany them to a tea festival not just a ceremony this time allegedly arranged by the municipal government.

At that point, alarms went off and so did I. But had I not already known the trick, I might well have fallen for their story. And the same with the amiable electrical engineer from Hebei I met shortly afterwards, followed by another pair of holidaying students.

But that's China. It's always changing in ways you don't expect, be it slicker con artists or the 20-storey building that you're convinced wasn't there a few months ago.

Every visit shows you something new. And it can be hard to get a grip on what's real and what's an illusion.

What's the cost of a maglev ride in dumplings?

Many people find this aspect of China alarming. Noted short-seller Jim Chanos has called it "Dubai times 1,000", arguing that it's impossible that a country can grow and develop so quickly without some major mistakes taking place.

Chanos has never visited China, something he's taken some flak for. His response is that he actually has a clearer picture of the country by just looking at the numbers from afar. Spend too much time on the ground and you'll get carried away by all the new buildings, he says.

I'd disagree. If Chanos visited the country and saw all that impressive development, it'd probably reaffirm his belief that China is a bubble. Because there is much about the country that is not as grand as it seems.

In fact, the disconnect begins pretty much the minute you get out of Shanghai Pudong airport. Of course I like arriving on the city's famous maglev train. It's hard not to be impressed as it accelerates to 431km/h and whisks you 30km in just eight minutes. But the maglev is a prestige and engineering project, mostly used by foreigners rather than locals.

To see why, look at the prices. A one-way ticket costs RMB50 ($6.50). If I say that's about the price of coffee and cake at a city centre Starbucks, it may not sound too expensive. But Western-style cafes are not mass-market venues in a country like China, where prices are much too high for the average worker.

For better context, a bowl of shengjian pork dumplings with the bottom of the case burned slightly crispy at famous local chain Yang's would set you back just RMB5.50. Which, coincidentally, is about the price of getting to the airport by metro instead of the maglev.

Lots of companies in China are wasting their time

You see the same divide if you stroll around many shopping centres. These are full of outlets from Western brands trying to build a high-end image.

The vast majority of people in them seem to be bored sales attendants painting their nails, and migrant labourers incessantly mopping the floor. One new mall I went to, in the expensive Xintiandi entertainment district, was so quiet that a man on a motorised lift changing light bulbs managed to draw a small crowd.

There are exceptions. Take Apple, whose official stores always seem to be heaving. I've no idea how many people actually buy anything, but there seems little doubt that the firm is succeeding in building a coveted brand name in China, as everywhere. However, Apple may be a special case, offering something that is both practical and desirable.

I've seen this over and over in China, to the point where I simply don't believe that most high-end retail is making money. Some people have told me I'm overestimating how much these stores need to sell in a day; others that I'm visiting at quiet times.

But I'm increasingly convinced that a lot of companies are wasting their time trying to build brands in a market that simply isn't deep enough yet, and which will have forgotten them by the time it is.

The best way to invest in Chinese consumption

A few years ago, the view was that 'consuming China' was less than 50 million people, almost entirely in Beijing, Shanghai and Guangzhou. The rest of the population was just surviving. Today, there are a lot more people with a bit of discretionary income probably 300-400 million. (If that sounds like it's grown too fast, development seems to have a tipping point where a huge bulge of people moves up the ladder very quickly.) But that doesn't mean they're in a position to dress in Calvin Klein yet.

Mid-range malls and stores were doing significantly better when I visited. Still, I rarely saw anything that made me want to stick money in a retailer. In all the time I've spent in Chinese shopping centres, I've not seen the kind of buying volume you might hope for. Where it always gets more interesting to me is the food courts.

While I've yet to be convinced that mass consumption has taken off in China, I have little doubt about casual dining. Western imports such as KFC, Pizza Hut and McDonalds; other Asian chains such as Japan's Yoshinoya and Ajisen Ramen and Hong Kong-based Caf de Coral; and homegrown operators such as Little Sheep, were all doing a roaring trade wherever I looked. So this kind of business remains a far better prospect than retailers for now.

Sure, it's competitive. Successful concepts spawn hordes of imitators. Singaporean bakery chain Breadtalk has any number of local rivals copying its signature dishes like the pork floss bun a soft bun covered in dried, fluffed meat and filled with mayonnaise although the original still seems best.

Indeed, staying relevant in baked goods now seems to require an amazing amount of innovation, to the point where blind-tasting in bakeries is perhaps best avoided. In Taiwanese-owned chain 85 Degrees, I ended up with a doughnut stuffed with tapioca and fishpaste.

What soymilk tells you about shoppers

Still, it's important to remember that the crowds in these malls are still fairly affluent by local standards. It's in the back streets of individual storekeepers running print shops, ironmongers, textiles merchants and noodle shops that the majority of commerce still goes on.

But in a city like Shanghai you'll also see modern retail emerging in the form of supermarket chains such as Lianhua, where I poked around, checking on a few niches that interest me.

Take soymilk for one. The familiar tetrapak cartons from Hong Kong's Vitasoy were usually the main brand name in liquid soymilk. It seems to have left Singaporean rival Yeo's in the dust lately. But the racks of dry powdered soymilk were larger, with five or six different brands.

What's the relevance of that? Powdered soymilk is less healthy, but much cheaper. The fact that it still seems to be the biggest seller tells you a lot about the buying patterns of the average consumer. It also says a lot about Vitasoy's potential if consumers steadily move up to liquid soymilk as they get more spending power.

China is nothing like Dubai

If all this makes me sound cynical about all the new shopping centres being built across China, it's also this kind of thing that tells me that comparing China and Dubai is not at all helpful, even if it makes for a good soundbite. Dubai was built on sand both literally and metaphorically. There was virtually nothing between luxury shopping and construction workers sitting in camps in the desert.

China is a real economy, going from the super-rich there are plenty of luxury cars on Shanghai's roads these days to peasants and everything in between. And it's the inbetween that matters. They are far more important to the China story than a few shoppers for luxury watches.

China has excesses. It has mistakes. It has malinvestment, both by the state and private investors. But it is undergoing very real changes that are easy to underestimate. At a meeting this morning in the Pudong business district, my contact told me his colleague used to live where we were standing. "His family had a farm over there. He went to school over there." At the time, we were halfway up a 30-storey tower, with more towers on the locations he was pointing to.

Twenty years previously, the entire area had been countryside. A decade before, it was a construction site, with many people doubtful that all the new offices would ever fill up. Today, it's impossible to imagine Shanghai without Pudong.

I think in due course the same will be true of the shopping centres, housing developments and even the maglev. They will get eventually used. But will they earn a return for investors yet? Probably not. I'd rather stick to ramen and soymilk for now.

Cris Sholto Heaton

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.