Between now and 2020, the Chinese economy is forecast to grow at 2.5x the rate of the UK economy. This means that while China’s economy is 3.85 times bigger than the UK’s economy today, in three years’ time it is expected to be 4.55 times larger.
Beyond that, it seems highly likely that China’s economy will continue to grow faster than that of the UK. That’s particularly pertinent since the uncertainty created by Brexit makes the UK’s economic future seem highly uncertain.
All of this makes me more bullish on consumer goods companies which are focused on China. After all, the world’s second largest economy is transitioning towards a more consumer focused economy where higher wages are due to fuel higher demand for consumables.
Burberry (LON:BRBY) is well placed to benefit from this through its strategy and operational changes, while its valuation indicates that it offers good value for money in my view.
Stunning growth appeal
In recent years there have been concerns that China will experience a hard landing. However, I believe that this is not the case.
In my view, it is undergoing a period of significant change which will see it move away from the infrastructure-led economic growth of recent decades and towards a more balanced economy.
Although the country’s economic growth rate is now in the mid to high-single digits rather than the double-digits of years gone by, there is still an incredible opportunity for consumer goods companies to grow their sales and profitability.
For instance, wages are expected to rise by 45.5% between now and 2020, which means that the affordability of consumer staples and discretionary items will increase. In fact, it is estimated that demand for consumer goods in China will rise by 7% per annum over the next three years.
Therefore, while the country may not be seen as the fast-growing economy that it once was in terms of the headline GDP growth rate, I believe that there is as much opportunity as ever. Only now it is in the consumer space, rather than in commodities.
Contrast with the UK
This contrasts markedly with the outlook for the UK economy. Although Brexit could be beneficial in the long run and will free up the UK from the slow growing EU economy, in my view the uncertainty which exists over the medium term makes it a less appealing place in which to invest.
In the long run, the Chinese market offers unparalleled growth in my view.
Take the consumer goods and retail industries, for example. In 2017, the Bank of England forecasts that inflation will hit 2.7%, which is likely to be ahead of wage growth. This will mean consumers have less disposable incomes in real terms and are therefore likely to delay the purchase of non-essential items while becoming increasingly price conscious.
Beyond 2017, wages are expected to rise by only 2.2% per annum until 2020. During that time, inflation is expected to remain at or above that level, which does not bode well for consumer spending levels.
Against the backdrop of a rapidly growing consumer industry in China, Burberry has a clear opportunity to generate higher sales and profit in my opinion. In recent months it has increased its exposure to the world’s second largest economy through the purchase of the remaining 15% of its Chinese distributor for a sum of £54 million.
Although in recent years Burberry’s sales in China have come under pressure, the fiscal stimulus put in place by the government could ease the pain felt by luxury lifestyle brands in the short run. In the long run, the Chinese market offers unparalleled growth in my view.
Burberry is also likely to record a strong growth rate as a result of management changes which have seen Marco Gobbetti replace Christopher Bailey as CEO. This should provide the company with greater operational focus and it would not surprise me if further efficiencies and productivity gains are experienced further down the line.
Alongside this, Burberry continues to have scope to widen its product range and benefit from further improvements to its digital offering. Under fresh leadership, the company could become a slicker operation.
The right time to buy
The company’s share price has risen by 30% in the last six months and at least some of this is due to the tailwind from weaker sterling. In my view, this will continue as a ‘hard’ Brexit is increasingly likely.
The UK seems adamant that it will not compromise on the topic of immigration, while the EU is likewise determined that access to the single market will not be granted unless the UK agrees to free movement. Therefore, sterling could weaken further as investors and businesses become more pessimistic and uncertain about the UK’s future.
Under fresh leadership, the company could become a slicker operation.
Burberry has a P/E of 20.1, but with EPS growth expected to hit 7% next year and 10% the year after, I believe it is a fair valuation. When the prospect of even weaker sterling, operational improvements and the growth potential of China are added in, I feel that it is the right time to buy it for the long term.
Although Burberry has disappointed in the last couple of years, in my view it has growth potential. China’s slowing economy is still far more appealing than the UK for consumer goods companies in particular, with high wage and GDP growth providing ideal trading conditions.
The Chinese economy may be growing at a slower pace than a few years ago, but I believe that it remains highly appealing. In future, though, it may be more associated with consumer stocks rather than commodity companies.
At a time when Brexit is causing the UK economic outlook to be highly uncertain, China offers the prospect of growing sales and profitability. Investing in Burberry is one way of potentially tapping into this growth, with its financial performance likely to benefit from fresh leadership as well as a weaker pound.
With a fair valuation and an impressive long term outlook, I think that Burberry has significant investment appeal.