Is It "Game Over" for China's Pollution Problem?

If not, what companies could benefit from it.

Jun 18, 2014 at 1:14PM

A factory in China on the Yangste River. Source: Wikimedia Commons.

We've all seen photos of heavy smog or pollution in China. But how bad is the pollution problem really? According to a recent report by The Washington Post, more than 20% of the farmland in China is polluted, as is more than 60% of its water supply. Furthermore, Beijing's concentration of PM 2.5 (particles that are harmful to the lungs and bloodstream) reached 505 micrograms per cubic meter earlier this year -- astronomically higher than the World Health Organization's recommended level of 25.

However, the battle against this pollution may present an opportunity for renewable-energy investment within the country.

Given the current makeup of China's energy consumption, it's unlikely that its current rate of pollution will be reduced anytime soon. China became the largest energy-producer in 2007 and the largest energy-consumer in 2010. In particular, China is the top producer, consumer, and importer of coal, accounting for nearly half of the world's coal consumption. China is the second-largest net importer of oil and is on pace to surpass the U.S. as the largest this year. In addition, China's oil-consumption growth accounted for nearly one-third of worldwide growth in 2013 and is expected to have the same share this year.

As if that weren't bad enough, China is also the largest auto market in the world. As of last year, there were only 183 cars per 1,000 people in China, compared to 797 cars per 1,000 people in the U.S. However, many multinational automakers are looking to change that as Chinese consumers find themselves having more cash to spend. Ford (NYSE:F) has found great success in China, with year-over-year sales up 32% in May, while year-to-date sales are up nearly 39%. While General Motors is still the U.S. leader in Chinese auto sales, Ford has pursued an aggressive expansion plan and has been narrowing the gap every month. In Q1 of this year, Ford's market share in China rose 0.9%, bringing its total market share to 4.5%. While Ford's plan to dominate Chinese auto sales will likely prove profitable, more vehicles on the ground in China will ultimately mean more pollution.

Public outcry and government action
The Chinese public has become increasingly restless about the pollution, leading to a growing number of violent protests. Last month, dozens were injured in a demonstration against the construction of a waste incinerator. Such protests have left the Chinese government hesitant to construct similar types of pollution-emitting facilities. As a result, Premier Li Keqiang has "declared war" on pollution, saying China needs to not only shut down coal-burning power plants, but also shift to a different kind of power generation. China is already the world leader in renewable-energy investment, having invested $54.2 billion in 2013. China led the way in solar installation last year, installing nearly 12 GW of solar power

One Chinese stock that has undoubtedly benefited from this solar boom is Trina Solar Limited (NYSE:TSL). Last year the company saw revenue grow an astounding 84%, while the industry average was only 5.3%. Furthermore, the company's earnings grew 117.3% last year, which fueled a 150%-plus rise in its share price. This growth comes after Trina wasn't expected to achieve profitability this year but blew away analysts' expectations by reporting EPS of $0.36 compared to the estimated -$0.01. By contrast, peers such as Yingli Solar and ReneSola are not expected to achieve profitability until 2015. Trina has achieved this growth via its vertically integrated business model and broad geographic diversity. Going forward, Trina has several advantages that should help it outperform relative to its peers. For one, it was announced that the U.S. Department of Commerce issued a 18.6% import duty on Trina, while most other Chinese solar companies received a 27% duty. Second, Trina has a long-term debt-to-equity ratio of 0.12 -- much lower than the industry average of 0.29. This gives it more capacity to invest in panel technology than its peers..

However, solar power only accounts for a tiny fraction of China's electricity capacity today, and its share is forecast to rise to only 2% by 2040, with all renewable energy only accounting for 42% by then. If China is serious about reducing pollution, it will have to quickly ramp up investment in all renewable energy, including solar. Currently, China plans to add 35 GW of additional solar energy by 2015. Trina seems to be in a perfect position to take advantage of this initiative. 

On the automotive front, General Motors and Ford aren't the only companies with sizable investments in China. In China Tesla Motors (NASDAQ:TSLA) delivered its first vehicles to China, the market CEO Elon Musk claims could be its biggest. In addition, the company plans to manufacture vehicles in China in the next three to four years. Not only will Tesla avoid shipping fees, but it will also be exempt from China's 25% import tariff on automobiles and will qualify for electric-vehicle subsidies. Yet given the severity of China's pollution, the Chinese government may encourage the spread of electric cars. Thus the government may push for measures to reduce the tariffs on imported electric vehicles or increase the EV subsidy. At the beginning of the year, China announced that EV subsidies would be cut by 5% instead of the previously announced 10%. Such measures are easier to enact than closing a coal-burning power plant, and they would help reduce the cost of a Tesla for Chinese consumers, which recently stood at a staggering $121,400 for the flagship Model S. 

Additionally, Tesla's move to open up its patents to competitors may also help the company in China. Veronica Wu, vice president of Tesla's Chinese operations, says, "We want more new players to enter [the electric-car market], the more the better, in order to compete with the traditional forces." This thinking follows Ford CEO Alan Mulally's logic that a greater variety of cars is needed to attract the attention of the Chinese consumer. Likewise, some argue that Tesla has released its patents in order to increase demand for its lithium ion batteries.

As the war against pollution intensifies, Tesla and renewable energy seem to have vast opportunities in China. Yet Li Keqiang faces numerous challenges as premier, such as a slowing economy and human rights issues. Whether pollution remains a top concern or takes a backseat to other problems will partly shape these companies' fortunes over the next few years.

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Joe Lepera owns shares of Tesla Motors. The Motley Fool recommends Ford and Tesla Motors. The Motley Fool owns shares of Ford and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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