Profit From China’s Dirty Secret

“Become a Chinese farmer, that’s what you should do”, this quote from the ultimate China stock and commodity bull, hedge fund guru, Jim Rogers was much more than just an off the cuff remark.

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  • Jim believes in the future of China so much that he uprooted his family to move there several years ago.  He even hired a Chinese nanny to teach his kids Mandarin his belief in the future of China is so strong!

    Well, as time goes by, many investors are doubting Roger’s wisdom for holding such strong beliefs about the future of China.

    Over the last year or so, China has been in the headlines due to slowing growth and currency troubles.

    In fact, the U.S. stock market plunge during the first two weeks of 2016 has been blamed squarely on China.

    The sharp decline was triggered by weak manufacturing data and a falling yuan.  These numbers panicked Chinese investors who dumped stocks resulting in a 7% fall in mainland Chinese stocks, prompting authorities to halt trading early for the day.

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  • The data indicated a slowdown for Chinese manufacturers for the 10th consecutive month, and cemented doubt on China’s growth prospects and the effectiveness of Beijing’s policies of monetary stimulus to spur growth.

    Clearly, the U.S. stock market overreacted to China’s issues.  Market’s always overreact to negative stimulus.  Truth is, despite China’s slowdown in manufacturing, manufacturing is still growing rapidly.  IN addition, the slow decline, has been evident for months.  The bearish numbers are no surprise.

    This sent waves of panic into the U.S. markets. We firmly believe that China’s manufacturing slowdown and the Chinese stock market sell off will only have a short term effect on our stock market.

    Remember, even with the economic slowdown, China is still projected to grow at 6.8% this year.  Not to mention, the Chinese service sector is thriving.  Rather than focus on this, Chinese investors chose to focus on the negative and panic.

    Reuters reported, China’s annual economic growth is likely to slow to 6.8 percent next year from an expected 6.9 percent this year, the People’s Bank of China said in a working paper published on Wednesday.

    The world’s second-largest economy still faces downward pressure and the impact of fiscal and monetary policies that were rolled out this year will be evident by the first half of 2016, the central bank said in the research report.

    “Although downward pressures on growth will persist for a while due to overcapacity, profit deceleration, and rising non-performing loans, we expect that the number of positive factors will gradually increase in 2016,” it said.

    The Real Problem In China

    Despite the Chinese economic issues not being near as dire as the financial media and fear mongers would like you to believe, there is a real problem in the world’s second-largest economy.

    This problem will only get worse, as the economy grows, if nothing is done about it.

    The good news is that we have discovered 2 stocks that are poised to create outsized long-term profits from this vexing issue.

    This problem goes far beyond the Chinese economy and it could easily make life on earth very difficult.

    If you have not guessed it, I am talking about pollution.   Pollution is so bad in China that according to research group Berkeley Earth it kills 4000 people per day!  Bloomberg reported:

    Air pollution is killing an average of 4,000 people a day in China, according to researchers who cited coal-burning as the likely principal cause.

    Deaths related to the main pollutant, tiny particles known as PM2.5s that can trigger heart attacks, strokes, lung cancer and asthma, total 1.6 million a year, or 17 percent of China’s mortality level, according to the study by Berkeley Earth, an independent research group funded largely by educational grants. It was published Thursday in the online peer-reviewed journal PLOS One from the Public Library of Science.

    Coal is the number one pollutant in China. China obtains around 80 percent of electricity and 70 percent of its total energy from coal, much of it polluting high-sulphur coal.

    It is estimated that six million tons of coal is consumed daily to power factories, heat homes and cook meals.

    The growing middle class leading to greater car ownership, heavy traffic and low-grade gasoline have led to automobiles being another major factor to the air pollution problem in Chinese cities.

    Edward Wong wrote in the New York Times: “In February 2013 Deutsche Bank released an analysts’ note saying that China’s current economic policies would result in an enormous surge in coal consumption and automobile sales over the next decade. “China’s air pollution will become a lot worse from the already unbearable level,” the analysts said, calling for drastic policy changes and “a strong government will to overcome the opposition from interest groups.” The report estimated that the number of passenger cars in China was on track to hit 400 million by 2030, up from 90 million now.

    Beijing just issued its highest smog alert of 2015 in December making this a problem that needs to be solved immediately!

    What Is The Solution?

    Fortunately, China’s State Council created a national plan in 2013 to reduce particulate matter by 15% to 25% through 2017 in key regions.

    The government earmarked $275 billion to be allocated to solve this problem.

    China is not the only nation with a serious pollution problem.  Worldwide the market for air pollution control equipment climbed to $61 billion in 2014.  This exploding market is expected to grow to $78.4 billion over the next 3 years.

    We have identified two companies that are on the forefront of helping to solve China’s pollution problem.

    The companies are Donaldson Company (NYSE:DCI) and CLARCOR (NYSE:CLC).

    Let’s take a closer look at each company.

    Donaldson Company is a maker of engine and industrial air filtration products with a solid presence in the Asia Pacific region.   In fact, 33% of its 2015 operating income has been from the Asian Pacific region.

    The Company serves customers in the industrial and engine markets,

    including dust collection, power generation, specialty filtration, compressed air purification, off-road equipment, industrial compressors, heavy trucks and light vehicles. The Company’s products are manufactured at 39 plants around the world and through three joint ventures. The Company has two reporting segments: Engine Products and Industrial Products.

    Noted analyst Michael Farr stated, The company has dominant market share in many of its end markets, which are very diverse and have attractive long-term secular growth potential. And perhaps most important, well over half of company sales are for high-margin and recurring aftermarket products and services, including replacement filters. Financial performance has been outstanding, including very impressive low-teens annual growth in EPS over the past 20+ years. Finally, the balance sheet is very strong and free cash flow generally approaches net income an annual basis.

    We concur completely with Mr. Farr and firmly believe Donaldson will make a great addition to your long term portfolio.

    The second company on our list is CLARCOR

    It is the most diversified air filtration company on earth.  The company boasts two manufacturing plants and a sales office in China.  9.7% of total sales came from China in 2014.  This represents $146 million which is a 42% increase from the previous year.

    The Key Takeaway:

    China is still growing at breakneck speed despite the recent slowdown.  This growth has resulted in extreme levels of pollution.  Investing in companies like Clarcor and Donaldson that develop and manufacturer filtration devices is a smart long term investment in China’s growth.

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