Dear Fellow Investor,
As you know, the China stock market has been on a tear lately, up 40% in the last three months! The key to grabbing the lion's share of that growth is to invest in well-positioned and well-managed companies that are growing their earnings steadily. That's exactly what we do here each week in Inside China Dispatch and China Strategy. But, just as important to our strategy is knowing how to avoid companies and sectors that are out of favor and are likely to stay that way. Many fortunes have been made by only owning a handful of the right stocks, but many more portfolios have been destroyed by owning the wrong stocks.
I was reminded of this important approach recently while watching the news. General Motors and the United Auto Workers made headlines earlier this week when UAW workers at GM facilities went on a two-day strike.
The strike, which ended yesterday, didn't have much to do with investing in China. But it reminded me of an industry in China that is loaded with portfolio-busting companies—China's auto industry.
With China growing by leaps and bounds, many people are wondering if the incredible growth there will spread to domestic car makers. I'm here to tell you that China's auto industry is one of the areas that smart investors should avoid. On the surface, it seems like investing in Chinese car companies makes perfect sense—after all, China is the fourth-largest car market in the world, has a giant economy growing at nearly 12% with over 100 million middle-class consumers, and has a new highway system stretching over 40,000 miles long. But like many things in China, what seems obvious on the surface is often not true when you know the real story.
It's important to me to help investors like you steer clear of the pitfalls of investing in China. That's why we're going to talk about China's car industry today. But if you want to learn about the other areas of China that all investors should avoid, you need to read my special report called "The Biggest Scandal in Investing History." This report is free if you sign up for China Strategy today. Click here to join now and learn which Chinese sectors to stay away from.
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Now let's get back to China's bloated car industry.
Don't Get Taken for a Ride by Chinese Automakers
The first and most important reason to avoid Chinese auto makers is that there are just too many car companies there. Although demand for new cars is strong, there are more than 100 car companies in China!
Also, China's domestic auto industry is heavily protected and simply not globally competitive. In order for a foreign company to set up production in China, it needs a 50% local joint-venture partner—most often a state-owned enterprise (SOE) of some sort. (The only exception has been Honda Motors, which is well-respected in China and allowed to own 65% of its made-for-export car factories.)
Domestic car producers in China come from a mixed bag of different backgrounds. Most independent Chinese car companies focus on the low-margin economy segment of the market where pricing pressures are cutthroat. More than half of these car companies have their roots in manufacturing other goods and only jumped into car making in the past several years as Chinese citizens started to buy more cars.
If you dig a little deeper, you'll find that a large percentage of these companies are controlled by local municipalities, a sneaky variation of the infamous SOEs that a lot of analysts miss. As you would expect from the nature of SOEs, most of these companies overproduced and are losing money today.
As China's economic miracle unfolds and more citizens have disposable income, I fully expect auto demand will continue to increase in the coming years. That doesn't mean that there are viable investment opportunities there though. The current Chinese car companies are not a smart way to invest in that growth, and I believe most will not survive the next decade in their existing form. Stay far away from Chinese auto stocks for now, and I'll continue to watch the industry for opportunities as it matures in the coming years. If new developments arise, my China Strategy subscribers will be the first to know. Sign up for China Strategy today and be among the first to learn how and when to profit from Chinese automakers.
What about Chinese Automakers in America?
Last year, Chinese car maker Geely made headlines when it announced its cars will hit dealerships across America in 2008. Their economy models will sell for less than $10,000. And last month, five Chinese vehicle manufacturers said they'd be displaying cars and trucks in Detroit at the 2008 North American International Auto Show. In addition, Chinese auto producer Chery recently signed deals with both Dodge and Chrysler to develop vehicles. It's clear that China is trying to make a big splash on the American auto scene.
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While some analysts are talking about this as a possible threat to car companies already in America, I'm not ready to make that leap quite yet. I believe that these Chinese-produced cars will need to establish a reputation for quality before they can succeed in the most advanced and sophisticated auto market in the world.
In fact, Chinese-made cars have failed recent safety tests in both Germany and Russia. Vehicles made in China have a long way to go before they can compete with ones made by major global car manufacturers that have lengthy track records of producing safe and reliable cars.
What do I see for China's auto industry? I see a much bigger, though less-visible role as more established international companies outsource their manufacturing to China to take advantage of cheaper costs. Some of you may remember that VW's Porsche division started to profit after years of losses by outsourcing production of its lower-priced Boxster to Eastern Europe. I see the same thing happening in China, but on a much larger scale, as more parts will be made and assembled for cars destined for outside of the country.
It is likely that, in a few years, you or I might buy a Mercedes or BMW that is 60% made in China—and most of us won't even know it. The cost savings for the global car giants will be the main profit center for the Chinese auto industry, and we will continue looking at stronger sectors with far more profitable stocks to pay for our new Mercedes.
P.S. Last week I told you about a solar company that was roaring ahead thanks to its position as a top solar cell wafer supplier. Since last week at this time, the stock has jumped another 15%! Don't wait another week to get in on this explosive growth. And if you sign up for China Strategy today, in addition to my report, "The Biggest Scandal in Investing History," I'll give you six additional FREE reports with your subscription! Click here for details about all of the benefits of joining us at China Strategy.
