Sectors Getting The Most From China's Economic Recovery

China's reopening has given several sectors, such as the retail luxury segment, a major boost. But are those benefits sustainable long term? Greg Bonnell speaks with Ben Gossack, Portfolio Manager at TD Asset Management, about China's recovery and the implications for investors.

Transcript

Greg Bonnell: One of the big themes for investors to start the year was the surprise reopening of China after years of COVID restrictions. But as we get deeper into the year, which sectors of the market are still benefiting from that trend and which have begun to lose some steam? Joining us now to discuss, Ben Gossack, portfolio manager with TD Asset Management. Ben, great to have you back on the show.

Ben Gossack: Greg, happy to be back. I love chatting with you.

Greg Bonnell: So that was one of those stories at the beginning of the year that we thought and I mean, stocks had a good start to the year and it was one of the catalysts, right. China, after will they or won't they, suddenly reopens. And everyone thinks, well, this is going to be good for everything. You've been taking a look at some sectors that perhaps got the bounce early and not so much. What's happening under the surface there?

Ben Gossack: Yeah. So I mean, at the start of every year, we always look into our crystal balls--

Greg Bonnell: Exactly what's going to happen in 12 months.

Ben Gossack: Those great crystal balls, what's going to happen. Definitely China was a big catalyst. My bingo scorecard didn't have deposit crisis issues for US regional banks, so can't win them all. What was really interesting about the China reopening, when we spoke to management teams in November that really depend on China, we had no visibility on when China was reopening. So when we got that surprise reopen in December, the game was on.

And so what you saw is that everyone got the benefit that China was reopening. And it didn't matter if you were a material stock, if you were tied to travel or consumer consumption, industrial activity. It was just everything was China. And there was almost FOMO, Fear Of Missing Out, because stock prices went up.

One of the first sectors that really caught our eye was the casino stocks in Macau. So again, no activity. Their stocks have been cratered. And right away, they were up 100%. And so what we've seen now - and we're about five, six months into reopening - they now have to grow into those price movements. So we've had these 100% moves off the bottom. Some have retraced by 20% but they're going sideways.

The enduring sectors, the one that has continued to work, has been luxury. This is a theme that we have been talking about for quite some time. China reopening has helped enfuel the luxury companies. And we've seen companies like Hermes (FHI), LVMH report, and their stocks are pushing to brand new highs. The part that's quite interesting -- and I think we have some charts to show just the performance. So people talk about the choppiness of the market and the uncertainty in the market and where to put their allocation. And we've seen people gravitate to cash or GICs. And yet when you look at a chart like an LVMH (OTCPK:LVMHF) or Hermes or other luxury stocks, you wouldn't even know that there were any issues going on. It's quite amazing. There are specifically US listed companies that would get the benefit of China. So let's say a Nike or a Starbucks or Estee Lauder. We've seen mixed results.

Greg Bonnell: And Starbucks (SBUX) is supposed to be counting on China for sort of a big growth engine for it.

Ben Gossack: And in fact, Greg, they reported yesterday. Their March comp store-- so comparable store sales in March alone were up 30%. So the activity is there. What was disappointing for investors and why the stock took back 9% in its market cap is that the expectations weren't carried forward through the rest of the year.

So there is this question now. We've seen this big move in activity. Does that continue? So is management telling us that that's not sustainable? Or is management being very conservative, wanting to lower our expectations and something that they can grow into? So I lean more on the conservative part. But definitely the activity showed up.

Greg Bonnell: Estee Lauder. I mean, this is makeup, right?

Ben Gossack: Yeah.

Greg Bonnell: This is like, you get to go out of the house, you get to do things, and you know, you want to look good. Why -- I think you have it as one of those companies that's losing steam. Why is that?

Ben Gossack: Yeah. And not just any makeup. We're talking about prestige makeup. So it's one of those companies we look at financials.

Greg Bonnell: The kind of stuff that we use. Be in front of a camera, prestige.

Ben Gossack: Of course. And their margins look a lot like a software company. So again, this is a very profitable business. What's really interesting is if you look at the stock chart for Estee Lauder (EL), Greg, just prior to COVID, around October, this was trading near lows. It gets the benefit of the reopening. And for Estee Lauder, a lot of their sales are tied to travel. So if people are going to go somewhere, they go to duty-free. They will buy makeup in all those stores that you see in the airport. So they depend on that. And so they got the benefit of the doubt.

And much like investors, we had to make assumptions on which companies would benefit from reopening. Management teams have to make assumptions of how much do I order? How much do I try to sell to the channel, the retail, the end, let's say, merchant that's going to sell to you and me so that we can look good? And so they made a lot of big assumptions. And so there is activity, just like we said with Starbucks. There is activity, but they're not converting the customer into those sales. And so right now, they have a very bloated inventory and a bloated channel. So they make a revenue recognition when they sell to the merchant, and right now the merchant is just sitting on too much stock.

And so even provinces like Hainan, which would be very popular for a resort area, there is tremendous volume activity, but the customer is just not buying the beauty product. So we saw consumer confidence get really impacted in COVID with China. People are coming out. They want to travel. They want to feel good. But they're being very selective of what they spend their money on.

Greg Bonnell: Well, let's talk about traveling, right. I mean, once you start to reopen an economy and people can go on vacation, they can move about, there's obviously some names that are tied to that. This one, Trip.com (TCOM), Ctrip. From the name alone, I'm assuming that's something to do with travel. Am I making a big leap there?

Ben Gossack: So this is their online e-travel company, similar to what people would think of like a booking.com Tripadvisor (TRIP). So yes, has it gotten the benefit of the doubt. And then now it's sort of that there might be some profit taking. We've seen some-- the activity is not as much as our expectations going into it. I will say for travel, and what I've learned just speaking to people on the ground, is that a lot of Chinese citizens, their passports expired over COVID. In many countries, they need to apply for visas. And so, yes, you're thinking, okay, they're going to go and travel. We've seen domestic airline activity exceed pre-COVID levels. International activity is still very subdued.

And so when I look at opportunity, there's still a tremendous opportunity, probably late spring into summer, where travelers can get their visas updated, can get their visas, will go to Europe and other countries and start spending money.

Greg Bonnell: What are the risks for a name like that, if you are counting on a travel rebound? Simply that people don't want to go abroad.

Ben Gossack: Yeah. They definitely do want to go abroad. I think the issue is really getting into the mind of the consumer and saying, okay, they might buy A, but they might not buy B. And I think that has been challenging. It'll be challenging for investors, and it'll just be as frustrating for the management teams. If you're selling something that you put on a shelf, you never want to have an empty shelf. But the risk in terms of supplying those products is you oversupply, and then you have to work through the inventory. No different than during the pandemic. We bought too much goods, then the supply chain got tight, and then it got over-delivered and we saw companies have to discount.

So this is the part where the euphoria is over. We're starting to see the dust settle, and we're seeing some companies have been working. And we've seen companies like, let's say, an Estee or a Starbucks that have taken a step back. But even we talk industrials and materials. So we thought that COVID coming away, we thought there would be stimulus. We've seen manufacturing activity kind of be lackluster versus expectations. And we've seen materials like iron ore get a lift up and then have completely retraced and rebounded. So it goes across all sectors.

So I'd say that initial wave, that initial euphoria has come down, the enduring sectors, I'd say, have been, let's say, aerospace and luxury.

Original Post