This month we examine the impact of rising disposable income in China. Chinese disposable incomes grew at a CAGR of 19.3% from 2008-2011. Over the same period, nominal GDP grew at a CAGR 14.6%. A stronger consumer class, driven by higher wages, is emerging while the old model of export-led growth is no longer viable.
Growth in disposable income since 2008 has outstripped nominal GDP growth in all but one year, as Table I shows. Although four years is too limited a period to draw any concrete conclusions, we believe this trend will continue. A spread between wage and GDP growth means that business overall will face margin pressure if unable to grow sales faster than costs. The same holds true for an economy, as an economy is the sum of the businesses that comprise it.
The winners, or at least those best positioned against wage inflation, are businesses with high exposure to Chinese consumers benefitting from increased wages. This drives our conviction that Chinese consumer businesses as a whole offer the most compelling opportunity for investors in China. Conversely, businesses with limited growth prospects, or growth that falls short of wage growth, will face significant margin pressure. Of those, the businesses with high labor costs as a percentage of revenue will suffer the most. Exporters stand out as a clear example with growth uncorrelated to rising income levels and a business model dependent in large part on cheap labor. Table II illustrates this point. From 2006 to 2011, retail sales grew at a CAGR of 21.4% while exports grew at a more muted 14.4%.
However, despite the overall attractiveness of consumer businesses, they too are subject to wage pressure. The table below summaries labor costs as a percentage of revenue at certain consumer companies where data is obtainable from public filings. Notably, only two of the businesses below, Golden Eagle and Want Want, have grown their businesses in line with wage growth. The remaining eight companies have seen labor costs rise, with wage growth in certain sectors, such as restaurants, surging at a rate far in excess of top-line growth.
When evaluating prospective investment opportunities, we believe it is critical to incorporate wage growth into our financial models. Public comparables provide a good benchmark and serve as a clear reminder that early stage, privately-held businesses are often able to hold wages artificially low in early stages of their growth due to a less imminent need for the cost of external professional management and the ability to fly beneath the radar of costly evolving regulatory and tax burdens.