China One Market Investors Can't Ignore

By: Money_Morning

Individual investors who still hold any doubts about Mainland China's future growth potential should take a long hard look at Airbus SAS, the Pan-European commercial airliner maker that is now building airplanes in that country.

When Airbus recently announced the delivery of its first China-built passenger jet, it was more than just the usual bit of corporate PR. It was an admission that any company that wants to remain a global leader in its industry will have to embrace China as a customer - and probably as a partner.

Airbus - a subsidiary of defense giant European Aeronautic Defense and Space Co. NV, also known as EADS NV - said it assembled the A320 passenger jet in a plant in Tianjin, China's sixth-largest city. The factory is 49%-owned by a Chinese consortium, and is expected to produce another 10 passenger jets this year alone.

The China connection doesn't end there, either: The just-completed A320 will be sold to a leasing company and eventually put into service by Sichuan Airlines Co. Ltd., a regional carrier.

Both Airbus and its U.S. rival, The Boeing Co. (NYSE: BA), understand that the Chinese market is crucial to their futures. Boeing has said that China will become the largest aviation market outside the United States by 2028, with the mainland set to require 3,700 additional aircraft - worth more than $350 billion - in that time. Airbus, which projected a slightly lower figure of about 2,800 aircraft, hopes to see its market share rise from about 30% now to about 50% in the next couple of years.

In the near term, the global downturn has left China's carriers feeling the pinch, too, but it's the long term that has companies such as Airbus and Boeing feeling both excited - and worried.

In many industries, partnerships represent the price of entry. And in the long haul, China has ambitious plans of its own. In the commercial airliner business, for instance, it is already developing a regional airliner and more recently has launched plans to design and build a globally competitive jumbo jet of its own.

The Rise of China as a Powerhouse Market

One of the hallmarks of any great economy is its ability to produce technically complicated machinery. I'm not talking flat screen TVs here but stuff like spaceships and, closer to earth, commercial and military aircraft. While Airbus is a partner right now, the point is that China is moving up on the technology scale both hard and fast. Faster, in fact, than most Westerners realize.

But the rollout of a completely Chinese-built Airbus A320 highlights something else, the significance of which is lost on most investors: It's not really about Chinese airplanes or even the fact that China is making something new. The real key here is that Airbus - like many companies - understands that the Chinese market is growing so fast, and has the potential to be so huge, that that it has to invest there, and do so as a partner, or risk getting left behind.

Chances are good that Airbus understands something else that I've been telling investors since I first visited China nearly 20 years ago: There will come a time when China makes the transition from just being the world's biggest manufacturer and becomes the world's biggest market. In the long run, it's not about China the export machine - it's about the Red Dragon's transition into a full-fledged consumer market.

With more than 300 million people - the majority of whom save an average of 35% of their income, China's quickly emerging middle class is by itself potentially larger than the entire U.S. population. And the top 2% of China's academic community - I'm talking the best and brightest only - is larger than our entire university population.

The bottom line: China not only has the capability to produce entirely new and different products, but its consumers increasingly have the ability to buy them. Consider Snow Beer. Most people have never heard of the ubiquitous green bottled stuff because it's sold only in China. Yet according to beer-market-researcher (yes, they do exist) Plato Logic Ltd., Snow Beer sold about 6.1 billion kiloliters of beer in 2008, up 19.1% from the year before - outselling such former brand leaders as Bud Light and Budweiser.

Not surprisingly, Snow Beer is a partnered product - the result of a collaboration between China Resource Enterprise Ltd., and London-based SABMiller PLC (OTC ADR: SBMR) news portal alibaba.com reported.

Maybe this won't surprise you, but it never fails to surprise the majority of people I talk with when they learn that China is now the world's largest beer market, having surpassed the United States as early as 2001.

It's much the same story with cars. For the past four months running, China has been the world's largest automobile market. There are still a dozen or more automakers slugging it out for Chinese consumers' hearts and minds, but all the biggies are there - including the only profitable business unit of General Motors Co., the Japanese, European makers and more. China this year also became the world's largest producer, consumer and exporter of light-duty electric automobiles.

China Profits Poised to Zoom

And that brings us back to Airbus.

After delivering the 10 planned A320s from its Tianjin factory this year, Airbus plans to deliver aircraft at a rate of four a month by the end of 2011. Overall, Airbus expects to deliver 70 A320s to China in 2009 - a total that includes jetliners built in Europe.

But it's just not enough, notes Airbus China President Laurence Barrons. In fact, the executive told the China Daily that the "ramp-up [production] capacity of 48 planes a year is insufficient to meet [domestic] demand."

It's not surprising, then, that Airbus is planning on boosting production to 286 aircraft a year in Tianjin, which puts the China production facility on par with Toulouse and Hamburg, where the company has its European plants. Ultimately, and again here's the really important stuff, there's no reason in the world why Airbus won't begin selling Chinese-made aircraft overseas to non-Chinese carriers within the next few years. Not only will this further pressure Boeing, but also it demonstrates yet again that there isn't an asset class on the planet that won't be affected by China's growth - a point that I've made so often that it's basically become a Money Morning mantra.

Speaking of which, Chinese domestic air passenger growth would make a western air exec drool. According to China's Aviation Administration, domestic traffic is up 17% to 56.9 million in the first four months of 2009, at a time while international traffic fell 17% to 5.6 million. Some consider that a wash, but get this: Over the past 30 years, air passenger traffic rose at an average annual rate of 16% - reaching 190 million at the end of 2008.

In a statement issued on April 8, Li Jiaxiang, the director of the Civil Aviation Administration of China, stated that China intends to boost travel to some 700 million trips a year by 2020. And that underscores yet again the projected growth in China's middle class strength. Somebody's going to be paying for all that travel. My own travel experiences in China suggest that it will be the Chinese Yuppies, or "Chuppies."

With the increase in demand has come an escalation in quality - of products and services. Gone are the days when flying Air China meant taking your life into your own hands and ghostly silent terminals at a few scattered airports. Also gone are the formerly ubiquitous souvenir shirts depicting overcrowded aircraft with parts falling off as they zoom skyward.

Flying in China today is a wonderful experience that I look forward to each time I visit China. The airports are modern and well staffed, the security is generally excellent and the flight crews are as sharp as they get. Increasingly, the aircraft are mostly all new - a welcome change from some of the timeworn airframes I routinely hop aboard when traveling back here in the United States. Of course, having real food with real silverware is a nice perk, too, in an era when a boxed lunch sets you back seven bucks.

Now, before you guys jump all over me with comments about state subsidized travel and the like, I know - you're right. But that doesn't change the fact that air travel in China is a throwback to an earlier - and eminently more pleasurable - time when travel was an experience to be enjoyed, and not just time spent getting from Point A to Point B, as is now the rule in the Western world.

In a recent interview, the president of Sichuan Airlines Co. Ltd., showed me that China understands the path to take to win in the global game of business when he said that "when air travel becomes a consumer pastime, that's when you will see the real peak of aviation demand and industry growth."

That's true of virtually every market in China these days - which is why investors better not miss their flight: The Red Dragon's domestic market is just getting ready for takeoff ...

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