More Factory Work Means Gains for Made-in, Sold-in China

TAIPEI ( TheStreet) -- It's not over yet for the world's biggest collection of smokestacks.

Although China has been on a jag for the past two years to stimulate domestic spending as an economic engine after decades of dependence on manufacturing, HSBC's November purchasing managers index (PMI) came in above 50 for the first time in more than a year.

Anything above 50 means the manufacturing sector grew. So the November finding of 50.4 signals that something is right again with the classic foundation of China's economy.

Much of that foundation is foreign invested, notably from Japan, South Korea, Taiwan and the United States. Pick a company you've heard of and it's probably got a China factory.

China has traditionally relied on manufactured exports, from toys to PCs, to grow its economy. Factories run by the likes of Honda Motor ( HMC) and Whirlpool ( WHR) would hire a cheap yet competent workforce, saving money -- yet pumping it into the local economy -- to spin out umpteen-thousand thing-a-ma-jiggers for Europe and the United States.

Just when China was beginning to look like Planet Lorax with all its smokestacks, problems stemming from the global financial crisis weakened consumer demand for manufactured stuff in the country's major overseas markets. That's one reason China's economy is forecast to grow just 7.5% this year, not 9% to 10% as in the past, though economists say the dip is merely cyclical.

At the same time, some foreign investors had found profits thinning as labor costs went up along with the prices of land and raw materials in China. Chinese leaders are also pushing for a cleaner economy as well as one that depends less on the rest of the world.

But domestic consumption slid from 1992 to 2010 from more than 60% of GDP to less than half, according to the International Monetary Fund. Time to let exports back into the mix?

A PMI of 50.4 would mark the first spurt of growth over the past 13 months, HSBC says in a Nov. 22 statement. It had hit a low of 47.6 in August.

New export orders and "new business inflows" contributed to the November PMI gain, the investment bank says. HSBC also cites the end of a destocking cycle.

More significant for foreign companies invested in China, however, would be HSBC's fourth reason: domestic consumer spending . This official economic development goal enshrined in the 2011-2015 Five-Year Plan and repeated at the national Communist Party congress this month is stoking demand for stuff produced by the factories.

A flow of goods from foreign-invested factories directly to Chinese consumers would benefit companies already rooted in Chinese industrial parks with existing domestic sales channels. In the case of expensive, breakable stuff with moving parts, consumers also look for local after-sales service and local (or global) product warranties.

Chinese consumers with enough money prefer foreign-made stuff, especially pricier items such as cars, electronics and handbags. Items from Europe, Japan, South Korea and the United States are seen as longer-lasting and offering higher status.

Among the numerous examples of listed multinational corporations with vibrant China sales networks are Kraft Foods ( KFT), which opened a factory last year near Shanghai to make stuff expressly for the local market. Chinese shoppers are partial to Oreo, Chips Ahoy, and Uguan snacks, Kraft said in a news release to mark the factory opening. The plant with an investment of $8 million is one of Kraft's two China factories. It's got 250 offices around the nation as well.

A better-known case is Apple ( AAPL), which contracts Taiwan-based Foxconn Technology (which trades under 2317.TW) to make iPhones and iPads in China. Despite labor issues, a riot and a mysterious rash of suicides at Foxconn plants in the past two years, its deal with Apple is clearly paying off through the Silicon Valley icon's wildly popular (to wit, lining up) China sales network.

Says Bryan Batson, president of China Business Group consultancy in the United States: "Items that become associated with status are just super-hot and the demand will continue to grow." Not much can out-heat an Apple device. He notes that 15% of Apple's revenue came from China this fiscal year, up from 12% last year and 2% in 2009.

Others to watch are fashion brands such as Gap ( GPS). Gap manufactures in China, and in 2010 the American clothier opened its first four company-owned Gap brand stores there. Last year it added a shop in China's Taobao Mall, a massive e-commerce center.

But HSBC notes that China's long-term average manufacturing PMI is 51.7 per month and warns against assuming that smokestacks can again run full blast.

"We remain in the early stages of recovery and global economic growth is still fragile, so calling for continued policy easing if a W-shaped recovery -- the last thing new leaders want -- is to be avoided," the investment bank's statement says.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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