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Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. Content selected and published by FICS drawn from affiliated Fidelity companies is labeled as such. FICS selected content is not intended to provide tax, legal, insurance or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by any Fidelity entity or any third-party. Quotes are delayed unless otherwise noted. FICS is owned by FMR LLC and is an affiliate of Fidelity Brokerage Services LLC. Terms of use for Third-Party Content and Research.

A safer way to invest in China

The growth engine called China is slowing. Here are stocks that could do well in the region.

  • By Daren Fonda,
  • Fidelity Interactive Content Services
  • – 08/19/2013
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Perhaps you've heard: China is in a rut.

Economic growth is slowing and the government is trying to cool an overheated real estate market. Chinese authorities have tightened credit to rein in what some observers call a credit bubble, and concerns are mounting about China's "shadow" banking system, a loosely regulated market of loans and investment products worth $5.5 trillion that is estimated to account for 36% of China's outstanding credit, according to research firm Fitch.

"The slowdown in China is real and the economy is heading down, not up," says Jim Kee, president and chief economist at South Texas Asset Management in San Antonio, Texas, who doesn't own Chinese stocks for his clients.

Yet while China isn't the explosive growth story it was a few years ago, investors may still want exposure to the world's No. 2 economy — especially its growing middle class.

Despite the slowdown, China is still targeting a growth rate around 7% a year, more than triple the rate of developed countries. Wages are rising, lifting millions into the middle class every year.

The new government in Beijing, meanwhile, seems determined to rebalance the economy: shifting away from fixed-asset investments in factories and the like toward more consumer spending and domestic consumption. Household consumption now accounts for only 35% of China's economy, down from 46% in 2000, according to China's National Bureau of Statistics. In the U.S., consumption accounts for 70% of the economy.

Making the leap to a consumer economy won't happen overnight. China may never return to the days of 10% growth, and a surge in infrastructure spending since 2008 has left the country with more factories, roads, railways and apartment buildings than it can use — which could take years to become economically viable, if at all.

Yet in the long run, the consumer economy is likely to continue to grow at a robust pace, boosting demand for products and services from cars to health care, according to some veteran money managers.

Multinationals with Chinese exposure

To some investing pros, multinational companies offer a good way to tap these trends. Chinese consumer stocks are now richly valued, says Alexander Walsh, a portfolio manager with investment firm Harding Loevner in Bridgewater, N.J. Multinationals based in Europe or the U.S. may be better investments, he says. Their stocks look cheaper and they have exposure to other markets, lessening the risks of investing directly in China.

Here are a few stock ideas from fund managers we interviewed and our own research. Keep in mind that individual stocks are riskier than a diversified fund. Though these stocks trade in the U.S., some are listed in foreign markets, posing additional risks to U.S. investors. As always, you should consult an adviser and do your own research before investing.

Diabetes, watches and infants

One stock the fund manager Walsh likes for its exposure to China is diabetes drug maker Novo Nordisk (NVO). The Danish company is the world's largest insulin manufacturer and has a dominant position in mainland China, controlling over 60% of the insulin market.

Revenues in China have been growing more than 20% in recent years and growth is likely to stay strong as demand for diabetes treatment rises, says Walsh, who holds the stock in the Harding Loevner International Equity Portfolio (HLMNX).

The downside: U.S. regulators have requested more testing for a new, long-acting insulin drug the company is developing. The stock could take a hit if the drug faces setbacks or isn't approved. Regulators in China could cut drug prices or reimbursement rates, pressuring the company's profits.

Swatch Group (SWGAY) also looks compelling, says Walsh. The world's largest watchmaker, Swatch owns 19 brands, including luxury names Omega and Breguet, and gets more than half its sales in China. Overall company profits are expected to grow more than 10% a year, and the Swiss firm's business is resilient to competition and solidly profitable, says Walsh.

The downside: Slower consumer spending could pressure watch sales. Competition in the luxury market is heating up in China.

New moms may load up on Huggies and Pampers in America. But Moony and MamyPoko are big diaper brands in Asia, and the Japanese company that makes them, Unicharm (UNICY), has a solid position in China, says Walsh, who owns the stock in his fund.

Unicharm is the No. 2 diaper seller in China, he notes, and it sells toiletries throughout Asia, including fast-growing markets in Indonesia, Thailand and Vietnam.

The downside: Unicharm faces tougher competition from rivals like Procter & Gamble (PG), which could pressure sales and profits. The stock trades around 27 times estimated 2014 earnings, a premium to the broader market, according to Barclays, and yields just 0.6%.

China is the world's largest infant formula market, and Glenview, Ill.-based Mead Johnson (MJN) is one of the biggest players in the business, with around 12% of the Chinese market, according to Oppenheimer analyst Ingrid Yin. The company is the only pure-play multinational formula maker, she noted in a recent report, and it gets roughly 30% of its sales and profits come from China and Hong Kong, a market with strong long-term growth potential.

The Chinese government recently fined Mead and other formula makers for price-fixing. Mead, which agreed to pay a $33 million fine, has trimmed its formula prices. And it may come under more pressure to cut prices further, impacting its profitability.

Even so, Yin expects China's infant formula market to grow 14% a year over the next five years. With 70% of Mead's sales in emerging markets — which are more profitable than developed markets — she forecasts earnings per share growing at a healthy 8.2% rate in the next five years.

The downside: Mead trades at a steep 21 times earnings. Yin suggests waiting for a pullback to buy shares. Stiffer competition and government regulation could pressure profits.

Pharmaceuticals, advertising and cars

China is forecast to be the world's second-largest pharmaceutical market by 2015 and French drug maker Sanofi (SNY) looks well-positioned to benefit from that growth, says Kee, the Texas money manager, who owns shares of Sanofi in his clients' portfolios.

Sanofi sells a range of products from diabetes drugs to vaccines to cancer medicines. Revenues in China grew at a 38% rate from 2008 to 2013, according to Sanofi, and the company is expanding its regional sales force, aiming to capture sales outside major cities.

The downside: Sanofi's drug pipeline could fail to meet expectations. China's government is aiming to control health care costs and may cut drug prices, pressuring profits at Sanofi and other drug makers. Sanofi is facing a bribery probe in China. The company has said it is "committed to cooperating with the authorities."

Global ad agency WPP Group (WPPGY), a major player in digital advertising, has a growing presence in China, where it runs ad agencies and provides other media services. The company has about 14,000 employees in greater China, where sales have been growing 16% a year since 2000, reaching $1.3 billion in 2012, according to the company.

China still represents a small share of WPP's $16.5 billion in global revenues. But the company is better positioned than rivals in China, says John Maxwell, manager of the Ivy International Core Equity Fund (IVIAX), which owns WPP's stock. The company looks reasonably priced, he says, trading around 15 times estimated 2013 earnings.

The downside: Rival ad agencies Omnicom Group (OMC) and Publicis Groupe (PUBGY) recently announced plans to merge; the combined agency could lure clients and pressure WPP's profit margins.

China is now the world's largest car market, and German automaker Daimler (DDAIF) has made strong inroads over the last decade. Sales in China of its Mercedes-Benz cars and other vehicles now account for 20% of its profits, up from practically nothing a decade ago, says the fund manager Maxwell, and the business should continue growing as more consumers trade up to luxury vehicles.

Daimler faces some tough markets — notably Europe which is in a recession. But sales are starting to stabilize in Europe, says Maxwell, and Daimler sells a large share of its vehicles to corporations, many of which have remained quite profitable. "They have a more stable foundation in Europe and China should provide a nice growth driver," he says.

The downside: Higher oil prices could hurt auto sales and tougher emissions standards could force Daimler to sell more fuel-efficient but less profitable vehicles. A sharper economic slowdown in China would also pressure sales.

Daren Fonda is Senior Writer and Investing Columnist with Fidelity Interactive Content Services, a provider of objective investing content on Fidelity.com. He does not own any of the securities mentioned in this article.

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© 2008-2013 Fidelity Interactive Content Services LLC. All rights reserved.
Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. Content selected and published by FICS drawn from affiliated Fidelity companies is labeled as such. FICS selected content is not intended to provide tax, legal, insurance or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by any Fidelity entity or any third-party. Quotes are delayed unless otherwise noted. FICS is owned by FMR LLC and is an affiliate of Fidelity Brokerage Services LLC. Terms of use for Third-Party Content and Research.
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