May 7, 2014
News Briefs  
Consumer
China Services PMI Reaches Four Month High
Activity in China's services industry rose to a four-month high in March, with the Markit/HSBC Services Purchasing Managers' Index (PMI) rising to 51.9 in March from February's reading of 51.0. This was the second consecutive rise in the monthly index, taking the PMI further into expansionary territory - a reading 50.0 that separates industry expansion from contraction. According to the survey, service-sector firms remained optimistic with the majority expecting business activity to be higher than current levels over the coming 12 months. In 2013, the service sector made up 46.1 percent of China's gross domestic product, surpassing the industrial sector for the first time. China's service sector has fared far better than the factory sector in recent years and is beginning to emerge as the primary growth driver of the country's economy.
 
CPI Rises in March
China's consumer price index rose 2.4 percent in March from a year earlier, according to the latest report from the National Bureau of Statistics. Fresh food prices were a major contributor to rising prices, with fruit prices increasing by 17.3 percent and vegetables up 12.9 percent. While fresh food prices are rising, food prices as a whole are moderating, for example, pork prices have fallen by 6.7 percent year-on-year. While March's reading was the second consecutive increase in the CPI, inflation on a whole in China remains low. With inflation currently running below 2.5%, it is unlikely China will return to the 6% level of inflation experienced in the middle of 2011, providing producers and consumers with relative price stability and policy makers with additional flexibility on monetary policy.
 
Alibaba Agrees to Acquire Stake in Youku Tudou
Alibaba Group Holding Ltd in cooperation with Yunfeng Capital (a private equity firm co-founded by Jack Ma, the founder of Alibaba) have agreed to acquire an 18.5 percent stake in Youku Tudou, China's largest video sharing site, for $1.22bn. Alibaba and Yunfeng Capital will pay $30.50 per American Depositary Receipt of Youku, or a 26.3 percent premium over the stock's last closing price. The deal is another indication of the growing rivalry between China's two internet giants - Alibaba and Tencent Holdings Ltd - as both firms continue to expand into each otherís primary business lines. For example, last month Tencent and online retailer JD.com (China's second largest e-commerce player behind Alibaba) agreed to combine their ecommerce operations in order to challenge Alibaba's market dominance. With its stake in China's largest online video portal, Alibaba is moving outside of just e-commerce and into web portals which has been one of Tencent's primary focuses.  
 
Disney to Increase Investment in Shanghai Park  
Walt Disney said in an statement it has reached a deal with its Chinese joint venture partner, Shanghai Shendi, to increase investment in its Shanghai Disney park by an additional USD800 million. The additional capital will be used for building additional attractions and to increase the park's capacity. The increased investment comes with an eye on capitalizing on the expected growth in both China's tourism and entertainment industries - from 2012-2015 the Chinese tourism industry is expected to grow by 34% and the entertainment industry is forecasted to grow by 23%. Following the increased investment, the joint venture's total investment in the park will reach USD5.5 billion and the original ownership structure will remained unchanged with Shanghai Shendi holding 57 percent and Disney holding the remaining 43%.
Food & Beverage
Bright Dairy Partners with Pactum
On April 11th, Bright Dairy signed a cooperation agreement with Australian based Pactum Dairy. Under the agreement Pactum will produce liquid milk in Australia for Bright Dairy to sell in China under Bright Dairy's Excellent Plus brand. In addition to production in Australia, Bright Dairy will continue to produce Excellent Plus brand milk domestically, however, Bright Dairy will differentiate between the domestically produced and imported product offerings.
 
Bright Dairy's partnership with Pactum allows the company to address two of the main challenges facing the liquid milk industry in China today: domestic production capacity and product quality. In 2013 China consumed 50 million tons of liquid milk, of which approximately 40 million tons were produced domestically. With a shortfall in supply of 10 million tons, the partnership with Pactum will help meet rising demand for liquid milk in China while alleviating pressure on Bright Dairy's domestic production facilities. In addition, importing milk from Australia will help ease concerns of domestic consumers which are increasingly skeptical of the quality and safety of domestically produced food products.
 
Uni-President Shifts Focus to China's Premium Bottled Water Market
Uni-President has announced that the company will exit from the low-end bottled water market in China, shifting its focus to expanding its higher-end bottled water offerings. The decision by Uni-President is in line with the performance of the company's bottled water sales. According to Uni-President's 2013 annual report, the company's sales of bottled water as a whole increased 47%, however, sales of Alkaqua, its premium bottled water offering, increased 82%. In addition to increasing sales of high-end offerings, Uni-President can achieve a higher margin on premium products. Industry analysts estimate the average profit margin of bottled water in China at only 3.8%, while the profit margin of premium offerings range from 23-25%.
 
COFCO Acquires Noble's Agricultural Division
COFCO, China largest grain trader, has announced that the company in conjunction with Hopu Investment has acquired a 51% stake of Nobleís agricultural trading unit for USD1.5bn. The company will now serve as the primary channel for COFCO's global purchases of grain, oilseeds and other food products. The acquisition will help COFCO expand its access to overseas food supplies at a time when China is increasing its reliance on imported food.
 
According to estimates from China's National Bureau of Statistics (NBS), by 2020 China's grain production capacity will reach 550 million tons, while consumption will be more than 650 million tons. Realizing the shortfall in domestic production capacity, the Chinese government is reportedly loosening its stance on imported food, considering a reduction in the nationís total food crop to consumption ratio from 95% to 80%. COFCO's acquisition of Nobel's Agricultural Unit, as well as acquiring a majority stake in the Dutch grain trader Nidera BV in February, positions COFCO to capitalize on increasing food imports to China. 
 
Room for Growth in China's Convenience Store Market
In April the China Chain Store & Franchise Association released its annual China Urban Convenience Store Index. According to the index the saturation level of convenience stores in urban China is one convenience store per 5,000 people, far below the level seen in the Japanese or Taiwanese markets where there is one store per 2,000 people. Dongguan, located in China's southern Guangdong Province, is the Chinese city with the highest saturation rate of convince stores with a rate of one store per 2,667 people.
 
The number of convenient stores in China is expected to rapidly expand over the next five years, increasing from 30,000 at the end of 2013 to 43,000 by the end of 2018. The majority of this expansion will come in 2nd and 3rd tier cities such as, Wenzhou (Zhejiang Province), Xuzhou (Jiangsu Province), and Hohhot (Inner Mongolia) where the number of convenient stores is already rapidly increasing, with store growth exceeding 50% in each city in 2013.  
Industrials
PMI Shows Slight Increase
China's official purchasing managers index (PMI) increased to 50.4 in April from 50.3 in March, while the HSBC PMI increased from 48.0 to 48.1 - the official index is weighted more towards large SOEs while the HSBC index is weighted towards small private enterprises. With the official index slightly in expansionary territory at 50.4 (a reading above 50 indicates expansion while a reading below 50 indicates contracting) and the HSBC index well in contractionary territory, the Chinese manufacturing sector remains weak. Although both indices are showing signs of recovery, as the official PMI inched up for the second consecutive month and the HSBC PMI was also up after falling for the previous three months. To support the manufacturing sector and the broader economy as a whole, the government announced this month plans to increase investment in railway construction, reduce taxes for small firms, and cut the required reserve ratio for rural banks.
 
China to Increases Rail Construction
With continuing softness in the Chinese economy - China's GDP grew by 7.4% in the first quarter, below the full year growth target of 7.5% - the government is exploring options to provide modest stimulus to the economy in order to ease the country's transition to a consumption and service based growth model. Therefore, it was not surprising that the China Railway Corporation (CRC) announced this month that it has revised total rail investment upwards by USD16bn (RMB100bn) from USD113bn (RMB700bn) to 129bn (RMB800bn) for the year. The USD129bn in total investment for 2014 will cover forty-nine new rail projects and over 7,000 kilometers of new rail will be completed. The majority of the investment will be in China's central and western provinces, with 78% of construction investment dedicated to these regions.
 
 
Revenue & Profit Margins Fall in the Industrial Sector
Revenue of Chinaís industrial enterprises, measured by companies with an annual revenue above USD3.2mm (RMB20mm), increased by 8.0% in the first quarter of 2014, a decrease of 3.9% from Q1 2013. Following a slowdown in revenue growth, the industry's profit margin has also fallen, decreasing from 12.1% in Q1 2013 to 10.1% in Q1 2014. Revenue growth and profitability haven been negatively affected by rising labor and input costs as well as continued overcapacity in the key industrial sectors such as, steel, cement and shipbuilding. 
 
Losses Continue for Steel Industry
Overcapacity and losses continue to be wide spread in China's steel industry with the China Iron and Steel Association (CISA) reporting that more than 45% of Chinaís steel companies suffered a loss in the first quarter of 2014. While the industry racked up a combined loss of RMB2bn (USD323mm) in the first quarter of 2014, this was significantly down from the RMB8bn (USD1.29bn) loss the industry experienced in the first quarter of 2013. Overcapacity also could be showing signs of improvement as output only increased by 2.4% in the first quarter of 2014, down from a 9.1% increase in the same period last year.