17 MARCH 2007, Page 42

How to avoid the Shanghai surprise

Elliot Wilson says the smarter, safer way to invest in China’s growth story is via blue-chip stocks elsewhere When China sneezed on 27 February, the whole world caught cold. Within a few hours the Shanghai composite index plunged 8.8 per cent, its biggest one-day fall since February 1997, causing Hong Kong’s markets to shiver. The contagion quickly spread to Japan, Korea, Australia and India. Before the day was out, leading stocks in Europe and then in the United States had joined the sick list.

Shanghai’s unwelcome surprise was a new development in global markets more commonly shaken by American ailments and it has served only to raise the level of unease many investors already felt about buying Chinese stocks directly. After all, the Shanghai and Shenzhen markets are still stuffed with the same moribund state-run enterprises that mainland investors were trading ten years ago. Most have pedestrian names sprung from a more socialist era China First Pencil and Xinxing Ductile Iron Pipes come to mind — and are run by local cadres who treat corporate governance with the sort of contempt China also reserves for democracy and human rights.

Fortunately, there are better and more reliably profitable ways to invest in China, notably via foreign companies that are helping to write whole chapters of the country’s staggering growth story. Take for example China’s crying need both to clean up its horribly polluted air, land and waterways, and to cut its growing dependence on foreign oil. Auto majors Toyota and Honda and, to a lesser extent, General Motors have taken the lead in alternative drive systems — hybrid and electric cars that burn cleaner fuel more efficiently and their stocks are a good long-term bet.

The Beijing-based management consultant David Wolf believes that China will leapfrog even hybrids and go straight to electric cars, just as it once bypassed clunky old VHS cassettes and went straight to DVD. ‘We’ll see the pace pick up quickly in the next five years to the point where China will pass Europe and match California when it comes to clean cars, high-end technology and alternative fuels,’ Wolf says. A great green leap forward, perhaps.

China’s need to freshen up its choking skies will also benefit makers and operators of wind farms, notably General Electric of the US, Suzlon Energy of India, and two Spanish firms, Gamesa Eólica and Iberdrola. In fact, any corporate investing heavily in proprietary technology that can purify air, desalinate or detoxify land, enable a business to operate more fuel-efficiently or improve infrastructure without further degrading the environment, will benefit from China’s need to grow cleaner as it grows richer. Here it’s worth mentioning one domestic Chinese company that does embrace the concepts of investor relations and shareholder value: Broad Air Conditioning, based in the industrial city of Changsha, makes highly efficient air conditioners that can be adapted to any energy source, including solar, wind, ethanol and natural gas. Broad is preparing for a simultaneous listing in Hong Kong and on London’s Aim market.

Hungry investors looking for another way to play China might also take a look at the country’s fast-changing dietary regimen. When China reopened its economy in 1978, a curious world saw only Mao-suited workers chomping on bowls of rice, maybe with some greens and a little pork, washed down with pints of green tea — a diet that, at least for China’s peasant army of laobaixing, or ‘old hundred names’, had changed little in the previous two millennia. Yet to live in any major Chinese city now is to be assailed by Western influences — fried chicken, hamburgers, coffee, pizza and dairy products (milk consumption was a no-no in Mao’s day because of its perceived imperialist connotations). The main beneficiaries of this change are the palm oil, grain and soybean growers, processors and shippers of Southeast Asia. Shipments to China, already the world’s biggest importer of palm oil, will balloon now that Beijing has scrapped an import tax on edible oils. That put a rocket under Malaysian palm oil prices, which soared 40 per cent in 2006.

Local analysts tip a number of regional stocks to benefit from China’s bigger bellies, notably two Malaysia-listed palm oil growers and processors: IOI Corp, the world’s largest palm oil grower, and KLK. Ivy Ng, a plantations analyst at CIMB in Kuala Lumpur, also picks out a couple of Singapore-listed Indonesian firms, Golden Agri-Resources and Wilmar Group, as good China-focused plantation plays. Astra Agro and London Sumatra, two Jakarta-listed soybean and palm oil growers, round out the picture. And if you’re a sophisticated trader you can even take a punt on the commodities themselves. You can buy and sell soybeans and soybean oil on the Chicago Board of Trade, and the Bursa Malaysia in Kuala Lumpur is the place to trade palm oil futures.

If China’s sprawling trade tentacles make it look increasingly capable of taking over the world, investors should remember that, outside its thriving urban hubs, this is still a dirt-poor country with a brittle economy in the very early stages of development. But this, too, breeds opportunity. The country has barely enough planes to keep pace with roaring passenger demand, for example. Both Boeing and the ailing Airbus will sell hundreds of aircraft to Chinese carriers over the coming decades. The likes of Alstom of France and General Electric will benefit from demand for high-tensile steel train tracks as Beijing pours billions of pounds into its currently rather spindly rail network. Infrastructure-financing specialists such as Australia’s Macquarie Bank will also benefit from a pressing need to build out urban and rural infrastructure.

Last but not least, natural resources. This may sound like a hoary old investment tale — China has been guzzling Australian coal, Peruvian tin and African oil for years now but it still has a long way to run. Investments in the likes of BHP Billiton, Rio Tinto, Xstrata and Brazil’s CVRD will remain solid bets for years to come. One Australian mining analyst thought for a minute when asked what stocks to buy before answering, ‘All of them. If they’re China-related, you’ll profit. If they’re not [profiting], it’s only a matter of time before they are.’ If this global range of China-play choices seems like quite a lot to take in, then that’s today’s China for you. It reflects both the country’s growing economic clout and the volatility and uncertainty that make direct investments in mainland-listed stocks such a risky business. Far better, in such an environment, to sink your hard-earned capital into foreign corporates whose stocks also stand to benefit from China’s rise, but won’t be flattened each time there’s a sneeze in the country’s immature and rickety capital markets.