Six years ago, the markets could not get enough China. The iShares FTSE/Xinhua China 25 Index (ETF) (NYSEARCA:FXI) quadrupled in just three years, and shares of PetroChina Company Limited (ADR) (NYSE:PTR) had surged 1,175% in the seven years before October 2007.
Though most of the hard-landing crowd has been discounted, sentiment has clearly turned against the world’s second-largest economy. Shares of the largest China fund are down 12% over the past four years and have underperformed the S&P 500 index by 77% over that period.
But those focusing on the short-term economic weakness, a result of overcapacity and the government’s attempt to reposition economic drivers, are missing a very important figure that will drive real long-term growth.
$8.1 trillion.
That is the amount of investment needed over the next six years to meet urbanization needs in the country and to support more than 300 million people that will be moving from rural areas, according to the China Development Bank. That is nearly equal to the population of the United States — and all those people need housing, utilities and a transportation network.
Currently, just 52% of China’s population lives in cities. That number is expected to increase to 60% by 2020. Double-digit growth has slowed but the world’s second-largest economy still has a long way to go. To put this into perspective, the United States had a comparable urbanization level in 1920 but didn’t reach 60% for more than 20 years. China is on pace to do it in less than a third the time.
Eight trillion dollars over just six years is a huge growth driver, a stimulus package almost 14 times larger than the efforts used to move the U.S. economy out of recession in 2009. That stimulus package helped the China Large Cap fund return 80% in the year after the 2008 announcement.
The reform of economic drivers means that not all Chinese shares will benefit, but investors should do well with a mix of communications, transportation and utility companies. As a bonus, I’ve included a pollution control company that has already booked some major contracts in China. Last spring brought a historic crisis of pollution to the major cities, and the urbanization of 300 million more people will only drive revenue higher for companies like the last company mentioned below.
Communications
China Unicom (Hong Kong) Limited (ADR) (NYSE:CHU) is the third-largest telecom company in China at $35.8 billion. Total revenue jumped 19% in the first half of 2013, to $23.1 billion, as subscribers upgraded to 3G services. The company has consistently gained market share from a larger rival, China Mobile Ltd. (ADR) (NYSE:CHL), by focusing on lower-priced phones while offering comparable services. Investors have been worried about expenses as selling and marketing costs increased 25% over the comparable period last year to $3.3 billion. Shares have been under pressure for the shrinking margins, but this could present a great time to buy for new investors. The faster increase in marketing expenses now may lead to higher future revenue against slower growth in expenses, boosting top- and bottom-line growth.
Transportation
The only Chinese railroad traded on the U.S. market, Guangshen Railway Co. Ltd (ADR) (NYSE:GSH) is my favorite of the group. More than 50% of the country’s trade is transported by rail, more than any other developed nation, and the industry carries more than three times the passengers and freight than carried in the United States. More than 240 million people traveled by train during the 40 days of this year’s Chinese New Year celebrations. More people moving to the cities will mean more trips by rail to visit family in rural areas.
