This is the second in a series of articles regarding the outlook for emerging market investments in 2006 and beyond.
Ever since 1978, when the late Chinese leader Deng Xiaopeng saw the writing on the wall and enacted reforms that launched his nation upon the path toward a more market-oriented economy -- a process euphemistically called "Socialism with Chinese characteristics" -- this ostensibly Communist country has been on an economic tear.
According to government statistics (always subject to political expediency), the poverty rate was reduced from 53% of the population in 1981 to approximately 8% in 2001, GDP increased 10-fold over that period, and the Chinese nation became the manufacturing center of the world.
The Chinese economy, already the world's fourth largest with a reported 2005 GDP of $2.22 trillion, continues to expand rapidly. It grew at a stunning 11.3% annualized rate in the second quarter, and it's expected to overtake the German economy by 2009. Exports reached a record $429 billion in the first six months of 2006, up 54% from last year's period, on pace to drive China's annual trade surplus to more than $125 billion. Its foreign exchange reserves should reach more than $1 trillion by year-end.
Little wonder that utilized foreign direct investment (FDI) grew to more than $60 billion in 2005, according to the Chinese Commerce Ministry. While FDI certainly has been a major contributor to China's incredible economic expansion, Chinese companies are increasingly driving growth in their own right. According to China's National Bureau of Statistics, industrial companies (both private and state-owned) reported an average 28% increase in profits in the first half of 2006, an acceleration from the 23% gain reported in 2005.
Not too shabby, eh? Just imagine investors' response if the S&P 500 component companies managed to post an average gain of 28%.
As new factories are built and new workers hired, China's middle class is growing as well -- a middle class that McKinsey & Company expects to reach 520 million by 2025, with a purchasing power exceeding $2.5 trillion.
Hmm . rapid industrial expansion, growing corporate profitability, and a burgeoning middle class. What more could an eager investor ask for?
The question facing investors is quite simple: How can we profit from this growth?
In my previous article, "You Can't Afford Not To," I mentioned that investors in emerging markets needed to focus on corporations that held a dominant share of their home markets, had strong growth prospects, and were attractively valued: essentially, blue-chip companies by any other name. This is especially true in China, where -- and I realize it may seem counterintuitive -- I believe that the best China plays for the individual investor are the successful "red-chip" companies in which the Chinese state retains a large stake, since the government is less likely to bite the proverbial hand that feeds it.
In that vein, let's take a quick look at two of my favorite China plays fitting this criteria: China Life Insurance Company
Simply put, I believe that China Life offers an extremely attractive risk-to-reward ratio to long-term investors, thanks to its dominant share of China's underdeveloped life insurance market, the recent easing of government restrictions on certain types of investments, and a relatively attractive valuation.
China Life is the leading player in China's underdeveloped life-insurance industry, holding a 49.3% share of this market as of June 30, 2006. (Incidentally, that's up from a 44% share at the end of 2005.) This market is still in its infancy. According to a recent Swiss Re report, China had just a 1.9% share of global premium volumes at the end of 2004, with insurance premiums per capita of $27.30 and a premium-to-GDP ratio of just 2.14%. To put these numbers in perspective, the global average for premiums per capita stood at $292.20, while the premium/GDP ratio averaged 4.53%.
Think there's a bit of room for growth?
Equally important is the government's recent easing of restrictions on the types of investments that Chinese insurers are allowed to make, which include the ability to invest in domestic corporate bonds, to use foreign currency-denominated insurance funds to make deposits in foreign banks, and to purchase shares of Chinese companies listed on foreign exchanges, among others.
This easement is evident in China Life's first-half results. The company reported that its investment yield rose to 4.24% (4.54% if you exclude cash), compared with a 3.9% return in 2005. That's well ahead of its maximum guaranteed payout rate of 2.5% on new policies. Of course, increased investment yields trickle down to bottom-line results, and China Life put up some impressive ones for the six months ended June 30, 2006. While revenue grew an impressive 47% to $9.1 billion, the company reported that net profits had risen even more dramatically to roughly $1.13 billion. That's a 72% gain over last year's period, and 5% ahead of Street estimates.
In terms of valuation, shares of China Life aren't exactly cheap by conventional insurance measures, trading at roughly 21 times fiscal 2007 estimates of $3.30. However, that still represents a 30% discount to the company's projected long-term growth rate. I believe that the company's ability to drive top- and bottom-line growth, all while gaining market share and improving its investment yields, makes China Life a premium addition to any portfolio.
Just as China Life dominates the nation's life insurance market, China Mobile rules China's wireless market. The mobile behemoth is the world's largest cellular operator, with a subscriber base of 274 million, and it holds a 66% share of the Chinese cellular market. That percentage is increasing as China Mobile grabs roughly four out of every five new subscribers to the market.
While China Mobile's subscriber base is huge by world standards -- 46% larger than runner-up Vodaphone's
These higher-margin revenues are boosting the company's results. China Mobile reported that while revenue grew an impressive 20% to $17.2 billion for the six months ended June 30, 206, net profits increased some 25% to $3.8 billion.
Call me a Fool, but I like seeing strong revenue growth coupled with margin expansion -- especially when the company in question trades at an attractive valuation, which China Mobile certainly does. Despite a nice run-up since the beginning of the year, shares of China Mobile trade at roughly 15 times fiscal 2007 estimates, a slight premium to its estimated long-term growth rate of 13%. Given the company's dominant position in the still nascent Chinese cellular phone market, and its above-average growth rate, I believe that long-term investors might try adding some shares of China Mobile to their portfolios.
All in all, it's my Foolish opinion that China Life and China Mobile are attractively valued companies that are perfectly positioned to profit from China's rapid economic expansion and the burgeoning growth of the nation's middle class. As Deng Xiaoping famously said, "To get rich is glorious." I hope that investors take that advice to heart.
Related emerging-market Foolishness:
- You Can't Afford Not To
- A Premium Play on China's Middle Class
- HDFC Banks on India's Growth
- China Mobile 1, Fear 0
Which Chinese stocks made Tom and David Gardner's list of today's best investing opportunities? Find out with a free 30-day trial to Motley Fool Stock Advisor.
Fool contributor Will Frankenhoff is enjoying his time writing for The Fool more than reading The Financial Times, rooting for the N.Y. Giants, or pondering the vagaries of life (pretty unsuccessfully up to this point). He welcomes your feedback. He does not own shares in any of the companies mentioned above. Vodafone is aMotley Fool Inside Valuepick. The Fool has adisclosure policy.