What do China consumer firms have in common with global peers? From a simple credit perspective, a lot. We rate many of these China companies in the category of 'A-' to 'A+', similar to Coca-Cola or from 'BBB-' to 'BBB+', the same as McDonald's. However, the China firms took very different paths to investment grade. These differences could have credit implications as the country's growth slows.

S&P Global Ratings has stable outlooks on the majority of China consumer companies we cover, in sectors ranging from staples like dairy to discretionary purchases, such as apparel and consumer appliances. We expect most of the rated companies in this sector to be financially cautious over the next year or two, while China's consumer sentiment and economy gradually improve.

Looking down the line, a different playbook might be necessary. China's growth rate is structurally slowing, and the catch-up development story for retail is somewhat fading. We expect China retail sales to increase 4.2% in 2024, underperforming GDP growth. In future, growth strategies might entail more mergers and acquisition (M&A), global expansion, and debt.

China's Domestic Markets Still Offer Good Relative Opportunities

Though slowing, economic growth in China will outpace global averages in the coming years.

Chart 1

We expect that in most segments, China's rated consumer companies will grow revenue at a faster pace than that of selected global leaders in the respective retail and consumer categories over the next few years (see chart 2).

Chart 2

However, Chinese consumers are becoming more cautious with spending amid a slower economic outlook. They are saving more and shying away from big ticket items such as property and new cars in the midst of higher financial uncertainty as the economy slows (see "China Retail: Tighter Belts, Broader Defenses," published on RatingsDirect on Oct. 16, 2023).

Shifting demographics, urbanization and lower birth rates are also changing consumption habits. Chinese consumers are more likely to spend on experiences and services (instead of buying a home). We believe this will support the growth of things such as travel and catering, and small luxury items such as high-end appliances, premium food or beverages products, cosmetics, or clothes.

The Winning Formula Is Changing For Chinese Consumer Firms

Historically, Chinese firms focused on the domestic Chinese market. With its high growth, there was little incentive for them to look for overseas growth. Many of international acquisitions were geared toward bring foreign goods and services into the Chinese market.

This means China's consumer sector is more geographically concentrated than that of global peers. By our estimates, 72% of the rated consumer firms have over 90% revenue originating from China. This concentration could result in higher volatility in EBITDA and cash flows versus more geographically more diversified firms.

Table 1

For example, baby-formula manufacturers face lower demand and hence increased competition, amid the structural decline in China's birth rate. Another example is impact of China's zero-COVID policies during the height of the pandemic. Profit and cash flows declined longer for China-only retailers and restaurants versus those with a global presence.

As the second derivative of China's growth decreases, consumer firms concentrated in China will be more sensitive to macro headwinds such as slower economic growth, deflation, and demographic changes.

At the same time, more sophisticated consumers, changing tastes and consumption habits will, in our view, require companies to increase innovation, deploy multi-brand/co-brand strategy or acquire emerging brands to keep up.

Along the way, they may learn from more established international peers that went through similar economic transitions decades ago. Chinese consumer firms may also need to focus more on shareholder returns when growth opportunities become more scarce, as is the case with Western peers.

The credit profiles of major global brands, such as McDonald's and Coca-Cola, benefit from strong global name recognition and diversified market exposures. This underpins solid investment grade (IG) ratings despite riskier financial policies relative to many of the IG China peers.

What's The Next Step For Chinese Consumer Firms?

Decelerating growth rates in China's consumer retail space will likely motivate new strategies, which could also raise risks.

Options on the table

More innovation?  Companies will likely accelerate new product roll-out, launch more tailored products or deploy novel marketing strategies to keep abreast of fast-changing consumer tastes and maintain their market shares.

More deals?   With China's growth structurally slowing, market leaders may look to enhance revenues through consolidation, expansion into different subsegments, or expansion overseas (including via M&A). One recent example, online retailer JD.com is reportedly considering a bid for U.K. electronics retailer Currys.

More risk?   Going offshore will expose the firms to more execution risks, including: culture and consumer behavior in different countries/markets and a different set of regulatory/geo-political risks (i.e., Australia barred a planned acquisition by China Mengniu Dairy). Chinese firms will also need to compete with larger global consumer brands in the absence of home advantages (e.g., brand recognition, knowhow on consumer preference, local supplier relationship etc.)

More debt?   The quickest way to enter a new market is through M&A. But the associated execution risk is high and would likely result in higher debt leverage. We believe Chinese consumer product firms will be more likely to pursue M&As in their pursuit of growth in the next decade.

Can China Brands Go Global?

China's efficient and low-cost production has helped some companies and brands compete globally. The success of fast fashion retailer Shein and budget e-commerce platform Temu, for example, is built on offering stylish products to young consumers at ultra-low cost. Other notable examples include consumer electronics brands Xiaomi and Oppo.

Product innovation also matters. For example, Midea's best-selling product in the U.S. is a U-shape window air conditioner tailored to address the needs of urban consumers in older apartments. We believe the design sold well because of its easy installation and quietness.

In short, Chinese consumer firms can expand overseas with the right price and right product. Yet different subsectors and firms, considering cultural limitation, political sensitivity and their respective preferences, may vary willingness and timing of going offshore.

In our view, appliances, apparel and dairy are subsectors that will continue to have stronger overseas expansion appetite, given price and product competitiveness.

Financial Policies: Change Will Be Gradual

We don't expect a sudden shift to the fairly conservative financial policies of rated Chinese consumer firms. Issuers are cautious on macro headwinds in China and would hesitate to take on incremental risks. We expect low leverage over the next 12-24 months (see chart 3).

Chart 3

That said, strategy shifts toward more M&A, global expansion, or higher shareholder returns could be on the cards for certain consumer niches. We believe that Chinese consumer product firms are more likely to pursue deals and investments in search of growth in the next decade. These investments could increase over the next few years when consumer confidence in China improves and firms have higher confidence in prospects of healthy growth.

If executed well, such shifts in strategy could bring growth and revenue diversity. They could also require more debt and leverage in the next decade. In short, if China consumer firms increasingly go global, their credit profiles would likely come to look more like global peers.

Writer: Cathy Holcombe

Digital design: Evy Cheung

Related Research

• China Retail Sales Will Likely Grow Slower Than GDP This Year, Jan. 22, 2024
• China Retail: Tighter Belts, Broader Defenses, Oct. 16, 2023