Fedon 1919 is a fancy leathergoods store in Italy. While visiting family there last month, I popped in and made a small purchase—a beautifully crafted leather keyring. The store attracted a small crowd, so I did some further research. It led to some thinking about broader themes for investors. Those thoughts led to China.
Fedon’s parent company was founded in Italy back in—you guessed it—1919. Over the following decades it expanded throughout Europe and the United States, becoming a leading manufacturer of cases for eyeglasses and optical accessories. In the 1980s, fashion houses entered the eyewear market and demand for cases soared. Fedon’s business boomed.
Industry growth attracted new competition and in the second half of the 1990s Chinese firms won significant market share. Although Chinese cases didn’t match the quality of Fedon’s, they were much cheaper. Fedon had to lower its prices to remain competitive and its profitability evaporated.
It’s a familiar story. Over the past three decades Chinese firms have become the lowest cost producers in many industries. These industries have been mostly low-tech, like Fedon’s, where branding provides no competitive advantage. That’s the old part of the story.
The first of two new chapters is that Chinese firms are now making inroads into industries that require greater levels of technological know-how. The second new chapter is that Chinese companies are increasingly building their own valuable brands. ‘Made in China’ is no longer necessarily synonymous with mass produced, low-quality, unbranded goods.
The rise of Chinese brands
Smartphones are a great case study. The iPhone recently celebrated its 10th birthday. Apple (Nasdaq: AAPL) and Samsung (KOSE: A005930) dominated the smartphone market during its first decade.
Yet Chinese companies such as Huawei and Xiaomi now offer consumers valid alternatives. In 2011, 70% of smartphone sales in China were from foreign brands and as this article points out ‘any self-respecting Chinese consumer wouldn’t be seen dead with a local brand’. But six years later Huawei is not only the mainland’s top smartphone brand, it is currently number two in Europe and number three in the world.
Chinese automakers are lifting their game too. The quality and safety of Chinese cars has improved significantly over the past five years while their price has fallen, making them more competitive against foreign brands.
Forager analysts recently visited Hyundai Motors (KOSE: A005380) in South Korea, where management explained a significant fall in Chinese sales by pointing to increased competition from local brands (as well as Chinese retaliation over the THAAD missile system).
In some cases, Chinese firms are even becoming industry innovators. Shenzhen-based DJI now controls 70% of the consumer drone market. Its products have a reputation for quality and reliability, defying old stereotypes.
Implications for investors
The rise of Chinese brands should give pause to those companies that have made China their key export market. Share prices incorporating lofty expectations for growth in China might suffer if those growth rates are not met due to higher than expected local competition.
Also under threat are those companies facing tougher Chinese competition in their home markets. In some cases though, competition can prod a company to grow elsewhere.
Fedon responded by launching its new leather goods business. It’s rolling out retail stores in airports across the world. And many drone manufacturers are now focusing on higher margin software as opposed to competing with DJI on hardware.
Finally, investors might be able to find direct opportunities in Chinese stocks. Some of these high growth companies might still be trading at reasonable valuations due to investors looking at them through the old, negative lens previously associated with Chinese manufacturers and brands.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.