A LETTER FROM CHINA

29 September 2013

The Fujian Discount

It was still hot in Xiamen when I visited last week. A recent typhoon had swept the city clear of pollution, so the sun’s glare was particularly pitiless, and I had to screw up my eyes to see the way ahead. I have suffered from similarly impaired vision over the years with regard to my Fujian investments, the performance of which has been distinctly mixed. We now have only one long-term investment in the province, an autoglass-maker called Fuyao, which is strange when one considers the size of the province (official population 37 million) and its wealth (the China Daily reported its January–August GDP as US$203 billion, +11.2% year on year). I am not alone, however. It is one of the strange truths of the Chinese market that companies in Fujian tend to trade at a discount to similar stocks in other provinces.

“The Fujian Discount” would be an interesting topic for a diligent student embarking on a PhD. Until such a thesis is completed, I can only speculate as to the causes of this phenomenon. First, not to beat about the bush, there is a long history of fraud here. The list of stocks suspended from the Hang Seng is heavily populated with Fujian-based companies, and they account for almost all of the Chinese companies listed in Germany (yes, there are 23 of them). Fujian is far from Beijing and, for much of its history, was cut off by mountains from the interior. There is a long and complicated coastline ideal for smuggling, both in and out (for those interested in more detail on this, I recommend Oliver August’s Inside the Red Mansion about the lurid career of Lai Chanxing). Companies tend to be family-based and concentrated in light industry (garments, shoes, furniture and food) or agriculture. For some reason, about 80% of China’s private hospitals are owned by men from the Fujian city of Putian. The province is also close to Taiwan, both physically (you can see Taiwan’s Kinmen Island from Xiamen) and culturally (they share the same Minnan dialect).

But hope springs eternal, so I visited the province to see if any of the stocks were unduly discounted. We drove from Xiamen via Jinjiang, Putian and Anxi to Fuzhou. My first impression was of the excellence of the motorway system, which enabled such an ambitious schedule. My second was of the sheer scale of the new residential property construction I saw – vast arrays of half-finished or unoccupied apartment blocks. This was most evident in Jinjiang, which is making a big effort, having seen some of its biggest companies, such as sportswear retailer Anta, relocate to Xiamen. But it could also be seen in rural areas, where everywhere farmers were adding extensions on top of their houses; one agricultural company joked that it was difficult to find labour as it was all off mixing cement.

Chinese culture: new residential blocks going up in Fuzhou

I do not belong to the school of thought, popular in the US, that this will result in some leveraged collapse – most of the property is sold for cash. But it is a sad misallocation of resources and savings to have all this dark property when so many people cannot find affordable housing. I also worry that the poor quality of much of this construction will prove the Chinese perception of property as a gold-bar-like store of value to be false. The case for introducing a nationwide recurring property tax is a strong one. This would both help address chronic local-government funding issues, reducing their dependence on land sales (apparently 45% of the budget in Xiamen), and introduce a cost of carry so that holders of multiple units would be incentivised to rent or sell. The largest property developer in Xiamen discounted my arguments, assuring me that the huge infrastructure investments made by Xiamen were now starting to pay dividends and industrial growth would compensate for any decline in land sale income.

The companies I visited represented a cross-section of the provincial economy. Fujian is famous for its Oolong tea, particularly Tieguanyin. The two tea companies I met (one of which had until recently been a textile company) both complained about how the crackdown on conspicuous consumption by Xi Jinping, a former governor of Fujian, was hurting their high-end tea business. Companies are no longer giving officials gifts of the most fragrant spring-picked Tieguanyin or aged Pu’er. They are now pushing mid- to low-end teas, while hoping that the crackdown will ease by next Chinese New Year. Visiting the tea factory in Anxi, in the midst of beautiful, verdant mountain scenery, I saw numerous brown road signs, showing the way to beauty spots: an indication of the growth of domestic car-based tourism.

Agricultural companies have been hurt by labour-cost inflation. One company we met, Le Gaga, has reacted by concentrating on greenhouse production so as to be able to sell vegetables in the winter season when prices are high. It is now introducing soilless production with drip-feed irrigation, to cut fertiliser and labour input and meet increasingly stringent environmental protection requirements. The inability to source rural land at a reasonable price was a major complaint. Another less fortunate company we met, Asian Bamboo, holds 54,000 hectares of mountainous bamboo plantations, rented for up to 20 years, which it can no longer operate profitably and cannot automate. Le Gaga is one of those “orphan” stocks listed in the wrong market (in this case the US) and now in the process of privatisation. Asian Bamboo remains happy with its listing in Germany.

Chairlady Chiu and CEO Ma of Le Gaga illustrate the new soilless way of growing peppers

The young CEO of a wrapping-tissue company claimed that business was steady as exporters sought a cheap way to upgrade products. He felt, however, that based on his own experience and the unwillingness of his peers to make new investments, official GDP growth numbers are overstated. This company counters cost-inflation issues through its de-inking process, which allows it to source 60% of its pulp from waste paper. Two of its new projects reflect the changing Chinese lifestyle – it is working to supply McDonald’s with wrapping paper for its hamburgers, which is now imported from Japan, and has also started to make backing paper for wallpaper.

With Yongyou CEO Ke and one day’s supply of pulp

Moving further downstream, I visited a candy manufacturer where business is growing steadily. This company produces a vast range of jellies, chocolates and other sweets; the very air around the factory smells of sugar. This is one of the few visits when it would have been useful to have my younger daughter along, as the CEO enthusiastically urged us to sample his wares. The company spends 8–10% of revenues on advertising and makes extensive use of character merchandising (Angry Birds seems particularly popular). Although based in Fujian, the company has a nationwide production network with factories in Tianjin, Sichuan, Anhui and, shortly, Hubei. It looks to follow in the path of rivals Want Want and Tingyi by expanding from its speciality into wider consumer products. Consequently, it has recently launched a range of fruit-flavoured milk drinks with the help of rising actress Yang Mi.

Chairman Zheng’s new banana milk comes in two types of packaging

Electronics plays a substantial role in the Fujian economy, often Taiwan-invested. I visited only one technology firm on this trip, however, a slightly creepy company called Meiya Pico, which specialises in “digital forensic investigations”. In some ways the company is admirable, being spun out of Xiamen University and spending heavily on R&D (15% of sales). But its main customer is the Public Security Bureau and its main role is helping this organisation to police the web and extract information from mobile phones. It claims to be an “Eric Snowden beneficiary”, now that the government has realised that it should not buy foreign security equipment or software. The downside, as with all companies dependent on government sales, is payment. The CFO assured me that his invoices are usually paid within one year, and at the very latest, within three.

I enjoyed my road trip to Fujian, even though it has not, as yet, resulted in any new buys. Thinking back to my first visit to Fujian in the 1980s, not only has there been a revolution in the ease of travel, but also a huge improvement in places to stay. Jinjiang offered me a Marco Polo Hotel and Putian a Doubletree Hilton. The service was good and, being rather quiet at present, they were able to offer me a discount. A Fujian discount.

Chris Rufflewww.odfund.com