Southeast Asia Steals Business as China Prices Itself Out

 | Apr 18, 2017 | 11:00 AM EDT
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Has China priced itself out? The "world's factory" is a workshop floor no more. Rising Chinese wages are making Southeast Asian destinations much more attractive for manufacturers. Investors looking for plays in Asia would do well to take note of the companies making the necessary changes to reflect that reality.

Export growth has now accelerated to between 5% and 6% per year in Indonesia, Malaysia and the Philippines, as makers of everything from electronic components to garments shifted production in that direction. The spurt in shipments has been nothing short of remarkable in Vietnam and India, export growth running at 9% to 10% each of the last two years.

Samsung Electronics (SSNLF) has become the largest foreign investor in Vietnam, according to Reuters, with operations both in Saigon and Hanoi. It had pledged investment of more than $12 billion in the country by the start of last year.

Its competitors in the field of consumer electronics have followed suit. LG Display LPL is spending $1.5 billion in Vietnam to build its first factory making organic light-emitting-diode screens.

Nokia (NOK) is opening its first Southeast Asian plant near Hanoi. Intel (INTC) has spent $1 billion on its plant in Saigon, its seventh chipset factory globally, encouraging some of its business partners to follow suit. 

A couple of Taiwan-based suppliers to Apple (AAPL) have also shifted to Southeast Asia to save on costs. Wintek TPE:2384 is gearing up production of LCD and touch screens for iPhones and iPads at its new operation in Vietnam. 

The world's biggest maker of electronics components, Hon Hai Precision Industry (HNHPF) , has sought to shift low-end manufacturing from China to Indonesia so it can save on costs and diversify its risk. The company, better known as Foxconn Technology Group, has reportedly struggled over land issues, having said it would invest $1 billion in Indonesia. But it would benefit from a new requirement that smartphones being sold in Indonesia have 30% of their parts made locally.

What's driving the shift to Southeast Asia? Wages in China have risen from $2.0 per hour in 2010 to $3.9 per hour in 2016. In the same time period, they've grown from $1.0 to $1.4 per hour in Vietnam.

The commercial real-estate brokerage Jones Lang LaSalle (JLL) notes that land is also much cheaper in Southeast Asia. Thailand's eastern seaboard has half the cost of comparable space in Shanghai. Construction costs are also much lower outside China, JLL points out in its newly released white paper, "A revival of Southeast Asian manufacturing hubs."

Its top picks for industrial development are Indonesia and Vietnam, where the yield on the cost of building such facilities can run 10% to 12%. The Philippines runs at 8% to 10%.

Borrowing costs are also high in the region, however, eating up much of the yield in places like Indonesia and Vietnam. But since developers borrow 50% to 70% of the construction cost, the "cash-on-cash" yield for money actually put down ranges between 10% and 15% in those nations as well as the Philippines, Singapore and Malaysia. Only Thailand, with cash-on-cash yields of 8% to 11%, fails to match that pace.

More than half the Chinese economy now comes from the services sector. Consumption, which Beijing would desperately like to stimulate, accounts for three-quarters of all economic growth. That's part of the government's overarching scheme to shift away from exports and toward a domestically driven economy, as I explained yesterday.

Infrastructure has historically been sorely lacking in Southeast Asia. Only Singapore and, to a lesser extent, Malaysia had something close to proper distribution networks until recently.

But Southeast Asian governments, particularly Indonesia as I explained last week, have committed to heavy spending in that area. Several infrastructure developers are already benefiting, so their shares are worth a watch.

Sumitomo (SSUMY) , Mitsubishi (MSBHY) , Itochu (ITOCY) and Marubeni (MARUY)   -- Japan's massive trading companies -- have all committed to the construction of power plants in Malaysia, Vietnam, Indonesia and Thailand. Construction specialist Shimizu (SHMUY) is participating in the construction of Vietnam's first subway line.

From China, Changchun Railway Vehicles, now a division of China's largest railway-equipment maker, CRRC HK:1766, and China Communications Construction  (CCCGY) , are building transportation routes across Jakarta. The privately held Korean contracting heavyweight Lotte Engineering and Construction is hard at work on the first section of the Da Nang-Quang Ngai Expressway along the coast of central Vietnam.

China's raw numbers are slowing. Between 2000 and 2010, China's economy rose an average 12% per year, largely on the back of manufacturing and exports. But the days of double-digit GDP gains may have gone. A $9.5 trillion economy simply can't sustain that pace.

Still, at 6.7% for 2016 China's economic growth remains the second-best among major economies, behind only India's 7.4% pace. China isn't even slowing as expected, as figures showed on Monday. Gross domestic product rose 6.9% in the first quarter.

That surprised economists and suggests there could be further upside, particularly since March was the strongest of the three months. Beijing may have undershot by forecasting growth of around 6.5% this year. 

It's obvious that Chinese workers have more take-home pay in their pockets. I see them flashing the cash here in Hong Kong. Retail sales rose a handsome 10.9% in March, while wages showed solid gains.

Consumer confidence is at multi-year highs, and the best way of playing that outside China's borders is through listings in South Korea. Korea replaced Japan as the biggest importer to China in 2013, and now accounts for 10% of shipments into China -- business that amounts to a full 8% of South Korea's entire economy. 

TV- and computer-screen maker LG Display -- which, as noted above, is now operating in Vietnam -- is the Korean company with the highest share of business coming from China, 69% of all revenue in fact.

Snack specialist Orion KS:001800, semiconductor producer SK Hynix (HXSCL) , petrochemicals giant LG Chemical (LGCEY) and fellow chemist Hanhwa Chemical KS:009830 all also get more than one-third of sales from China. 

All present solid consumer proxies for mainland listings capturing the shift occurring in China's economy.

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