China Stocks to Bet on Consumers - Part 1

Editor's note: Following is part 1 of an article that looks at China stocks focused on the newly emergent Chinese consumer. Here is part 2.

Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. He is a contributing writer to TheStreet whose views on these stocks are independent of TheStreet's news coverage.

BEIJING ( TheStreet) -- China stocks that focus on the consumer are the place to be this year.

China's GDP is expected to grow at nearly 10% in 2011. Some of that growth is clearly unsustainable. There's an obvious bubble in real estate, and the runaway growth of the nation's auto industry is likely to slow as the government takes steps to reduce air pollution and traffic.

As a result, I'm avoiding stocks tied to real estate, construction, steel and cement. I am also avoiding most of the auto sector.

But the country's growth has created a wealth effect that is building a new consumer class, and I'm extremely bullish on China stocks that benefit from this trend.

Because Chinese incomes are growing from a very low base level, each increase in income translates directly into disposable income, and from what I observe here in China, consumers are spending very heavily in all areas instead of saving all of the extra income.

Betting on China's Travel Industry

China is a vast, diverse country with seemingly limitless travel destinations, and travel appears to be one of the first things Chinese consumers want to spend their disposable income on.

What's more, the industry is also benefiting from increased business travel.

Every time I travel here, I use CTrip.com ( CTRP). Its Web service is fast and easy to use, features Chinese and English and offers the best prices that I have been able to find. The company also offers phone support in English and Chinese.

In fact, I would go so far as to say CTrip.com is my favorite company in China because of its exceptional service.

Unfortunately, the stock is already a bit too well-loved and trades with a price-to-earnings ratio of 45 and a $12 billion market cap. I have no doubt that CTrip.com will continue to pull in massive revenue and that the stock should see some upside. But it is hard to imagine it doubling from current levels.

As a result, I plan on focusing more on Universal Travel ( UTA). This company will never become CTrip.com. But its revenue and net income are growing strongly. It also focuses on providing package tours, a higher-revenue and higher-margin business.

The company's corporate governance is a complicated story, so I will do more research into this stock before buying any shares. Also, shares have doubled since their lows in September, so I clearly missed the bottom on this China stock.

Although I'm bullish on China's travel industry, I'm avoiding China stocks in the hotel sector such as Home Inns ( HMIN) and 7 Days Group ( SVN).

My concern is that there's excess hotel capacity, which is related to the country's real estate boom.

Whenever I travel I see many brand new hotels under construction, and in Beijing new high-rise hotels seem to pop up every week.

With all this construction, the hotel business in China is getting very competitive. Just by shopping around a bit haggling, I am often able to get 50% discounts.

The competition isn't just from Chinese companies either. International chains like Holiday Inn continue to expand their presence here.

Please look for Part 2 of this article on Wednesday. I'll reveal my favorite China stock in the food and beverage sector.

At the time of publication, Pearson had no positions in stocks mentioned.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.

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