The lowest valuation globally, is China's consumption about to reverse? UBS: Alpha is hidden in these tracks

The valuation of China's consumer sector has reached a global low point. UBS pointed out in its latest report that in the current environment, investment opportunities are hidden in specific tracks and companies' "Alpha" opportunities.

According to news from the Chase Wind Trading Desk, UBS's report on the Chinese consumer industry released on November 18 clearly states that the valuation attractiveness of Chinese consumer stocks cannot be ignored. The 12-month forward price-to-earnings ratios of the MSCI China Consumer Discretionary Index and the MSCI China Consumer Staples Index are approximately 40% and 10% lower than their global counterparts, respectively. So far this year, the MSCI China Consumer Discretionary Index has recorded a return of 35%, which is basically in line with the 38% increase of the MSCI China Index.

Against this backdrop, UBS's strategy focuses on "finding Alpha." UBS is optimistic about specific segments such as restaurant franchise expansion, innovative products, trendy toys, and pets. Yum China and MIXUE rely on a light asset model and have strong store growth potential, while whiskey and trendy toys have become new blue oceans. Domestic pet consumption also shows resilience, with leading companies in this sector seen as having robust long-term potential.

Valuation Low Point Highlights, New Models Seek Alpha

Data from the UBS report shows that the valuation of China's consumer sector is at a low level both historically and in global comparisons. The 12-month forward price-to-earnings ratio (P/E) of the discretionary consumer sector is about 40% lower than the global average, and the discount for the staples sector has also reached 10%.

The 35% year-to-date increase in discretionary consumption indicates that investors have higher expectations for sectors related to travel and entertainment. In contrast, the staples sector has only recorded a 10% increase.

In the face of challenges in the consumer industry, achieving counter-cyclical expansion through business model innovation has become one of the key clues for UBS to explore Alpha opportunities. Among them, accelerating the adoption of a light asset franchise model is helping some restaurant brands break through traditional expansion bottlenecks.

UBS views Yum China as a typical case and believes the market has underestimated its potential to achieve a target of over 20,000 stores through the franchise model. The report predicts through scenario analysis that by 2030, the total number of Yum China stores is expected to reach 30,000. The main driver of this growth is the lower investment new store formats such as KFC Mini and Pizza Hut WoW, which have an initial capital expenditure of about RMB 500,000 to 650,000, only half that of standard stores, significantly lowering the entry barrier for franchisees and helping penetrate lower-tier cities.

The same logic applies to MIXUE, which UBS has upgraded to a "Buy" rating. The report raises its long-term potential for domestic stores by about 28% to 80,000, believing there is still significant room for expansion and penetration in lower-tier cities. The brand Luckin Coffee under MIXUE is also seen as a new growth engine, with UBS Evidence Lab data showing that this brand has become the third-largest preferred coffee brand in third- and fourth-tier cities, second only to Luckin and Starbucks.

Product Innovation Opens Blue Oceans: Whiskey and Trendy Toys Tap New Tracks

In addition to business models, entering new tracks with structural growth potential is another major theme that UBS believes can create Alpha. Some companies are gaining advantageous positions in new "blue oceans" through forward-looking layouts and product innovation Bairun Co., Ltd. has been upgraded to a "Buy" rating by UBS due to the enormous potential of its whiskey business. The report points out that the Chinese whiskey market is experiencing a shift in consumer preferences, particularly favored by women and young middle-class individuals in third-tier cities and below, gradually diverting from the traditional liquor market. UBS Evidence Lab's consumer survey also confirms that whiskey is the only alcoholic beverage category with rising consumption willingness. The report believes that Bairun is in a favorable position to capture this strong demand due to its first-mover advantage in local production capacity, channel synergy with its ready-to-drink cocktail business, and more competitive pricing strategies.

Pop Mart, a trendy toy company, is another example. Its third-quarter revenue surged by 245%-250% year-on-year, with strong performance in both domestic and overseas markets. UBS is optimistic about its strong IP portfolio and monetization capabilities, noting the expansion opportunities in its overseas business, especially in the U.S. market. The report suggests that as the popularity of the Labubu series stabilizes, the new IP "Twinkle Twinkle" is becoming a "rising star," combined with upcoming catalysts such as the Christmas season, which is expected to drive stock price momentum.

The pet economy exhibits resilient counter-cyclical attributes. According to data from the "Pet Industry White Paper" cited in the report, the market size of pet food in China is expected to grow by 8.5% year-on-year in 2024, outpacing the overall pet industry growth. At the same time, consumer confidence in domestic brands is increasing, providing a solid growth foundation for local leaders like Zhongchong Co., Ltd. UBS has rated it as "Buy."