How can investors benefit from China’s 1-child policy?

When Maslow's hierarchy of needs is applied to the increasing GDP per capita in China, it becomes obvious that stocks related to human being’s basic needs will be good investment candidates.

In fact this investment opportunity has existed as early as June 1993 when the first H share company was listed in Hong Kong, and that company was Tsingtao Beer (HK: 0168, TSGTY). Even for non-Chinese this name shall not be too unfamiliar to you as Tsingtao is available in some 95% of Chinese restaurants in the US and it was first introduced into US in 1972. How good was Tsingtao’s performance? Just look at the chart below:

Now the Chinese beer market is very competitive and it may be too late to invest in Tsingtao. So what’s the next Tsingtao?

When investing in China, we always need to take the Chinese cultural factors into our consideration in order to increase our winning chance.

To control population growth in China, Chinese government has enforced the “1-child policy” very long time ago (at least as early as my first visit to China more than 30 years ago).

Any family violated this policy and raise more than 1 child is subject to heavy penalty imposed by the government.

As this policy applies to all families regardless of their income level, it is easy to imagine that wealthier parents will devote whatever they can afford to their only child in the family. Applying this fact to Maslow’s theory, milk and food juice shall have a very promising domestic market potential.

In China, the leaders in milk and fruit juice are Mengniu Dairy (HK:2319) and Huiyuan Juice (HK: 1886) respectively. The share price performance of Mengniu is shown in the following chart.

Huiyuan Juice (HK: 1886) was just listed on HK Stock Exchange last Friday (23 Feb 2007), its stock price went up by 79% in just 2 days. With P/E of 66x and 84x respectively, it may be irrational to invest in Mengniu and Huiyuan now regardless of how those sell side analysts present the rosy growth stories.

What if there is a company with a historical P/E of 25 and still have a high exposure to the Chinese beverage market? The answer is Groupe Danone (ADR: DA)

Groupe Danone is a French food company that primarily produces dairy products, biscuits and cereal products. The Company's portfolio of brands and products include Danone, a brand of fresh dairy products; Evian and Volvic for bottled still water. It has also a well executed China strategy, it owns 51% in a joint venture with Mengniu Dairy to produce and market yogurts in China.

It also owns 22.18% of Huiyuan Juice, the red hot stock just listed in Hong Kong. As early as in 1996 Danone has invested US$43 million in five Wahaha (China's leading domestic beverage producer) factories and owns 51 per cent of each of the subsidiaries.

With 14% of operating income generated from Asia in 2005, China contributed Euro 1.18B sales and ranked no. 3 in its top 10 country list by revenue, plus a proven track record of well executed China strategy, it won’t be too long before Groupe Danone becomes a prominent foreign player in the Chinese beverage market.

One added advantage investing in Danone is that it can provide a comparatively better reporting transparency, something those Chinese firms are lacking.