The "China Story" is Not Dead Yet

The city of Harbin lies on the banks of the Songhua River in the northeast of China, in what was Manchuria. This 10th largest city in China is a good place to see how some of the best opportunities in the next phase of China’s expansion come together. In particular, there are huge profits sitting out there in the expansion of China’s rail and subway systems.

But first, a little context…

Located near Siberia, Harbin is the most Russian of all Chinese cities. The skyline’s onion domes and spires evoke St. Petersburg or Moscow. At one time, Harbin was home to the largest Russian enclave outside of Moscow.

Today, it is a key rail hub and inland port like Chicago or Kansas City in the US. Harbin is the largest inland port in the northeast. Five major railways also converge here. They carry crops farmed from the black earth of Harbin and the surrounding countryside. The soil here is among the best in China, nutrient rich and fertile.

Harbin is also an industrial city making all kinds of things. It may be best known for its power equipment. Harbin alone has cranked out about one-third of all the installed capacity of hydro and thermal power in China.

It’s this confluence of rail, light industry and agriculture that makes Harbin emblematic of some of the most exciting and promising new opportunities for investing in China. Let’s look at the rail network.

Trains, like cars or aircraft, need lots of parts. They need a whole mess of stuff from motors to signaling equipment. China’s market for rail components is booming. That’s because the Chinese are laying track at a pace that would’ve made Cornelius Vanderbilt proud. The Financial Times reports that there are plans to lay nearly 19,000 miles of track over the next five years.

At that pace, China will overtake Russia as the world’s second largest rail infrastructure. Only the US will be bigger. These railroads will creak and groan under the weight of rail cars loaded with grains as well as coal from China’s hinterlands and Mongolia. Harbin is in the middle of it all.

China’s market for rail components will grow fivefold in the next three years, to more than $50 billion, according to estimates by McKinsey. In 2010, more than half of all the money spent on rail equipment in the world will be spent in China.

It’s not just railroads; China’s subway market is already the largest in the world, too. There are currently 10 cities that run 31 subway lines of more than 500 miles. In December, the Chinese government approved 22 new subway lines that will cost at least $129 billion to build.

The growth in this sector is simply staggering. By the end of 2010 alone, China will have 53 subway lines totaling more than 1,000 miles in length and requiring over 6,000 cars. In the next five years, China will add another 600-plus miles to the system, bringing the total number of systems to nearly 90.

So the opportunity for the makers of rail components is obvious. There is an added wrinkle here, though. The Chinese government mandates that 70% of the components have to be produced by Chinese companies. Therefore, the biggest beneficiaries will be you-know-who.

The Chinese rail outfitters are already tough international competitors. They are the low-cost providers. They are also becoming world-renowned for their rail exploits. The Chinese, after all, finally conquered the great permafrost on the road to Lhasa, Tibet.

China’s companies are also competing effectively abroad, bidding on work in South America and the Middle East. The main constraint is capacity. Their home market is giving them everything they can handle. It should stay hot for the next few years, at least.

In any event, the best way to get a piece of the action is to buy a Chinese company that makes the stuff the railroads and subways need.

Hearing the phrase “buying a Chinese company,” an investor might wince. Investing in China sounds risky, but I wonder how risky it really is and compared with what. The US, for instance, is hardly a safe haven anymore. The line that separates the US and Europe from emerging markets like China may be less than is supposed, at least from an investor’s viewpoint.

All this is to say don’t let your prejudices blind you to opportunities in so-called emerging markets. Most people still have little idea of just how big the so-called emerging markets have become.

Marko Dimitrijevic, who runs Everest Capital, pointed out in a recent Barron’s interview: “The BRIC countries [Brazil, Russia, India and China] are larger than developed Europe. But strikingly to us, the other emerging markets, the non-BRICs, are now larger than US or developed Europe.”

Even though emerging markets have been growing fast for years, these facts seem to have snuck up on us. A good analogy might be the old bit about the lily pads on a pond that double their population every day. One day, the pond is half full of lilies. The very next day, lilies cover the whole pond.

The biggest emerging market of all is China. I liked what Eric Kraus, the astute observer and Moscow-based money manager writes about China in his latest letter. He says he is “now almost embarrassed to go on about the secular rise of China – we would not bother were this not the single greatest economic and geopolitical shift of our lifetimes…”

Admittedly, China has its own problems, and it will have dramatic ups and downs. But China in 2010 is something like the US in 1910. It has lots of room to grow.

Some of the cheapest stocks in today’s market are the US-listed securities of China-based companies. It’s here you can pick up stocks in good companies, with strong balance sheets and owner-operators, growing 25%-plus a year for less than 10 times earnings.

I recently alerted the subscribers of Capital & Crisis to a Chinese company that has the inside track on those metro trains and freight cars. In fact, it’s the only Chinese company to have met international standards – and at half of the cost of imports from the competition. It is in prime position to be the vendor of choice in China. In fact, its equipment is so good, it is the only Chinese company exporting to blue chip US companies.

This world-class company is just one example of a “China Story” that is just getting started. But please bear in mind that the investment road ahead in China will not be smooth. Chinese stocks will certainly subject investors to gut-wrenching volatility. But that’s just the price of admission to the “single greatest economic and geopolitical shift of our lifetimes.”

Chris Mayer
for The Daily Reckoning

The Daily Reckoning