Avoid second tier consumer company

I like China consumer stock. Names like Hongguo, China Hongxing and Synear food are inside my portfolio. The emerging middle class and progressive increase in country wealth would increase the consumer spending power. These companies are good buy for long term, as they capitalize on their strong brand name to capture the market.

At the same time, I would avoid investing in second tier consumer stock. How do I classify them into second tier? I remember I read some analyst reports previously regarding company produces the intermediate goods for consumption. Analyst would claim there is a growing demand and bright industry outlook, hence a good buy. Sometime when you tell a story, you tend to emphasize more on the bright side. When time is gloomy, people tend to focus on the downside more.

As the demand soar, indeed they are getting good business, but don’t forget the supply side! For intermediate producer, you source the raw material and make into intermediate product. This good is sold to the end manufacturer which piece them together to produce the final good. The commodity bull cycle is squeezing the margin for these players. Very often, in the middle of value chain, there is a limit on how much you can pass on the cost. If you are really big player, you pass on all the cost increase, then your margin won’t be affected. What if you are not that strong?

For the first tier or end consumer company, I would think the situation is much more manageable. That is because you own the brand. If you are a big industry player, most of the time you can squeeze your supplier to lower the cost. If your brand is strong, you can pass on the cost to end consumer. There are also other ways of passing the cost on, like decrease the weight a little and repackaging. Of course, I sound too simplistic in these arguments. But I really think that they have better bargaining power. Go to the local supermarket to do a comparison. Price of same goods from different brand might vary a lot. However, the more expensive brand does not go out of business!

Companies like China Sun, Luzhou, Celestial didn’t have a good year because of the dramatic cost increase. Celestial does have its own strong brand, but it also has industry soy bean processing. The fiber player like China Sky and Fiberchem did amazing well to defray the oil price increase. Soft packaging companies also had a tough time because of the oil.

However, every company’s situation is different. It doesn’t mean by stereotyping the company, it is not worth the investment. We have to analyse the company on case by case basis to understand the growth driver and business prospect, in order to arrive at a conclusion.