A new way to profit from China’s slowdown: get into the wine business

China's slowdown could be great news for Chile's wine industry, says James McKeigue. Here, he explains why, and picks the best stock to buy.

Chile is the Switzerland of South America.

Trains run on time, the economy generally outperforms its larger neighbours and the politicians have a solid record of prudent macroeconomic management.

Throw in Chile's relatively sound legal system, free press and established democracy, and it's easy to understand why it's popular with investors.

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But a storm is brewing for the Chilean economy. As the world's biggest copper producer, Chile is very dependent on China's appetite for raw materials. And right now, China isn't feeling as hungry as it once did.

Yet this could be very good news for one specific Chilean industry and one company in particular. Let me explain

A lesson from Chile for Keynesian' economists

Mining accounts for around 20% of Chilean GDP. China buys almost a quarter of everything that comes out of the country. But with China in the throes of a major slowdown (see my colleague John Stepek's recent Money Morning for more on this), demand for copper and other industrial metals is falling.

That means lower commodity prices. And Chile will be among the countries most affected.

Now, it's not time to hit the panic button just yet. The Chileans knew prices wouldn't stay high forever and have shrewdly built up a massive rainy day fund. This is the part of the Keynesian equation that all the Western economists braying about the need for stimulus strangely forgot to mention during the boom years.

When prices fall, the Chileans will have $15bn to spend on stimulus and infrastructure works. That should mean the country and its leading firms won't be hammered by social unrest or populist measures.

And meanwhile, a price crash would be great news for the wine business. Here's why.

The Chilean peso is going down

As well as copper, Chile exports a decent amount of wine. With production mainly in Chile itself, costs for wine companies are largely in Chilean pesos. Meanwhile, their sales are in euros, dollars and pounds.

The Chilean peso is something of a commodity currency. So the resources boom has kept it strong. But as commodity demand falls, so the peso should weaken. That's good news for both sales and profits for Chilean wine producers. Their sales will be in strong currencies, and their costs will be in a weaker currency.

Another factor likely to send the peso down is Chile's central bank. Unlike Mervyn King and co, Chile's central bank has raised its benchmark rate since the crisis. It's now sitting at 5%, yet during the crisis it got as low as 0.5%. That suggests it has plenty of room to cut further if needs be.

Why does that matter? Falling interest rates means a weaker currency: more good news for the wine business.

So how can you take advantage? By buying Chilean wine producer Via Concha y Toro (NYSE: VCO). It's the world's second-largest wine producer, in terms of vineyards planted, and sells mainly to Europe and the USA.

Now of course, anyone selling to Europe seems to have a lot to worry about. The first is that recession will cut demand for its wine. The second is that the euro will fall father than the peso.

The first problem shouldn't be an issue. The firm's main markets are those in prudent' northern Europe. As the company's exports director, Thomas Domeyko, told me the other day: "We never managed to sell much of our wine to southern Europe - now maybe that's not such a bad thing."

Another advantage is that 77% of the firm's wine is 'varietal & entry level' ie it's cheap, selling for £6 or under. The next 20% goes for under £11. In recessions people don't stop drinking, they just start drinking cheaper stuff - and Concha y Toro has that segment of the business cornered.

Yet it's not any old cheap plonk. MoneyWeek's wine critic, Matthew Jukes describes the £7 Casillero de Diablo Cabernet Sauvignon 2010, as "the finest value Cabernet on the planet".

As for the euro, there's no denying the single currency could collapse. Indeed, since the start of 2011 the euro has fallen by 4.5% against the Chilean peso. But so far, Via Concha y Toro has been able to raise prices in euros to compensate mainly because it sells to the stronger countries.

In fact, since 2005, the firm has increased the average export price per case by 4.8% per year, says Citi analyst Alexander Robarts. He expects that to continue this year and next. Also, it's worth remembering that 26% of the firm's exports are denominated in dollars and sterling.

This company has a great record

Even without a currency boost, Via Concha y Toro is a great company. Consolidated sales have grown at an average annual rate of 18% since 2001. Its success has been down to great products and shrewd marketing and distribution.

Chilean wine often has the reputation of being cheap and cheerful option, coming behind New World favourites from Argentina and California. Via Concha y Toro has spent the decade doing its best to change that, by marketing the wine at golf competitions and alongside Manchester United football club. The tactic has worked, with exports up by an average of 15% per year since 2005.

The company has also cashed in on the success of its rivals by buying vineyards in Argentina and California. In particular, last year's $268m purchase of Fetzer, a struggling top ten US winemaker, should help Concha y Toro reach new markets in the US. And given its record, it should be able to boost the flagging US brand's fortunes in other parts of the world.

The best thing about the firm is that it looks cheap. Thanks to concerns over the euro, the shares have fallen 27% since last June. That leaves it trading on a price/earnings (p/e) ratio of 14, far lower than its five-year historical average of 20, and cheaper than peers such as Australian rival Treasury Wines. The current price is $38, but Citi expects it to reach $47 within 12 months.

From next month we'll be broadening the focus of our free MoneyWeek Asia email to cover other exciting emerging market stories including Latin America.

James will be regularly joining our current editor, Lars Henriksson. So if you've not already done so, sign up for MoneyWeek Asia here .

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

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James McKeigue

James graduated from Keele University with a BA (Hons) in English literature and history, and has a certificate in journalism from the NCTJ. James has worked as a freelance journalist in various Latin American countries.He also had a spell at ITV, as welll as wring for Television Business International and covering the European equity markets for the Forbes.com London bureau. James has travelled extensively in emerging markets, reporting for international energy magazines such as Oil and Gas Investor, and institutional publications such as the Commonwealth Business Environment Report. He is currently the managing editor of LatAm INVESTOR, the UK's only Latin American finance magazine.