Winners of China's "daigou" crackdown
Hainan duty-free stores and cross-border e-commerce platforms stand to benefit. Estimated reading time: 13 minutes
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The Chinese word “daigou” means purchasing agent and refers to individuals who buy goods overseas and bring them back to China to avoid taxes.
The Chinese government has cracked down on the illegal daigou trade through capital controls, restrictions on group travel and greater border control.
COVID-19 also hurt the daigou industry. Now that China’s borders have reopened, we will probably see a marginal recovery for retailers selling goods to daigou resellers. But don’t expect a full recovery back to the 2019 peak.
The beneficiaries of the government crackdown will be retailers on Hainan island, where Chinese individuals are allowed to buy up to CNY 100,000 (US$15,000) worth of goods duty-free each year. They can then bring them back to the mainland without many restrictions.
Companies that might benefit from said crackdown include China Tourism Group Duty Free (1880 HK - US$56 billion), Hainan Meilan Airport (357 HK - US$1.1 billion) and the cross-border e-commerce platforms run by NetEase (NTES US - US$56 billion) and Alibaba (BABA US - US$217 billion).
1. Introduction to China’s daigou industry
The Chinese word “daigou” (代购) means “purchasing agent” in English. It refers to individuals who buy goods overseas and then bring them back to China.
Once back in China, the goods are sold to friends & family via Tencent’s WeChat platform or Alibaba’s Taobao e-commerce marketplace.
In the past ten years, daigou resellers have gone overseas primarily to buy luxury goods, baby formula or cosmetics. In other words: high-value, authentic goods that might not be available within mainland China.
Up until COVID-19, the daigou market had grown to almost CNY 250 billion (US$36 billion), according to Beijing-based consultancy firm Proresearch.
At the peak prior to COVID-19, around 1 million people were employed in the daigou trade, making money by bringing foreign products across the border back into China.
In practice, the daigou trade takes place either by carrying parcels across the border in luggage or by shipping them via mail and not declaring the true value of the items to customs.
The major factor that’s been driving the daigou industry is the way that it’s been used to evade taxes. Customs officers have often ignored the contents of luggage and small parcels sent through the mail. And therefore, they’ve been able to avoid paying taxes on them.
China’s import taxes can be significant. Products are subject to three separate taxes:
Customs Duty: These depend on the type of product imported and the country of origin. Typically 0-20%.
Value-added tax (VAT): 13% for agricultural goods or staples and 17% for all other goods.
Consumption tax: Additional duties imposed on luxury goods such as jewellery (10-30%) and cosmetics (15-30%), high-end passenger vehicles (10-20%) or products that are harmful to one’s health, such as tobacco (20-56%) or alcohol (30-50%).
If you add all of them together, you’ll find that typical luxury goods or cosmetics can be subject to overall taxes of around 30-40%. If daigous can help end-consumers avoid this tax, then a lot of money can be saved for them.
2. The government crackdown begins
Since 2016, we’ve seen the government crack down on the daigou industry in a gradual fashion, culminating in extensive border control during COVID-19.
2.1. The government imposes capital controls
The first hit to the daigou industry came in 2016. The government started to crack down on the underground banks that had historically facilitated cross-border money transfers. That made it more difficult to get hold of foreign currency.
Soon thereafter, the government reduced the annual limit for purchasing foreign currency from US$100,000 per person and year to just US$50,000.
2.2. The “THAAD crisis”
The next stage of the daigou industry’s development was the so-called “THAAD crisis” of 2017.
South Korea had installed US-manufactured THAAD missiles on its soil to protect itself against North Korea. The Chinese government believed that the THAAD missiles could be used against them as well and decided to impose economic sanctions on South Korea.
These sanctions included restrictions on the sale of Korean goods and services in China and making it more difficult for group travel to South Korea. Cosmetics imports from Korea to China were curtailed. In addition, certain Korean businesses, such as Lotte, were targeted by state media. Sales of Hyundai and Kia vehicles plummeted. Samsung almost completely exited the Chinese market following this event.
And the impact on tourism was severe, too. The number of Chinese tourists to South Korea dropped by 80% from the peak in 2016 to the bottom in mid-2017 before recovering slightly in 2018, causing a huge drop in Korean duty-free stores.
2.3. Hong Kong travel restrictions
A similar scenario played out in Hong Kong when protests against a new National Security Law broke out in mid-2019.
The Chinese government responded by issuing travel warnings to its citizens, suspending group tours and restricting visitor permits for travellers to Hong Kong. Mainland Chinese tourism to Hong Kong dropped precipitously, just like it did for Korea two years earlier.
2.4. The 2019 e-commerce law
On 1 January 2019, the Chinese government rolled out a new e-commerce law to regulate daigou activities. From this point onwards, all purchasing agents became legally required to register as e-commerce operators and pay taxes.
The purpose of the law was to ensure product quality and safety. But of course, it was also a way to deal with the tax evasion that the daigou industry had been engaged in for so many years.
Since the new e-commerce law was introduced, any agent found guilty of smuggling can now be fined CNY 500,000 (US$73,000) on top of potential prison sentences. And the e-commerce platforms are also liable for any transgressions with penalties up to CNY 2 million (US$290,000). That has made the entire industry more cautious about breaking the rules.
2.5. COVID-19 border closures and checks
The final blow to the industry was the outbreak of COVID-19 in late 2019 and early 2020. The Chinese government responded by shutting down its borders and the cross-border daigou industry pretty much disappeared.
During COVID-19, we’ve seen consumers move to other channels to source their overseas goods, including legitimate cross-border e-commerce platforms such as NetEase’s Kaola and Alibaba’s Tmall Global.
And the crackdown has continued. Since 2021, border controls have become significantly more onerous, with border guards checking every other bag. As one Shenzhen-based purchasing agent said to the online magazine Sixth Tone:
“It’s much more difficult to do now than before the pandemic… the orders have dropped, and the border checks have become much stricter.”
And today, individuals are now only allowed to bring in US$730 worth of goods every two weeks. That makes it almost impossible for daigou resellers to survive unless they do it part-time.
These border controls make me sceptical that the daigou industry will ever recover completely. We might be entering a new normal whereby the sale of luxury goods, baby formula, and cosmetics primarily take place within mainland China.
3. The new reality
3.1. Hainan island as a shopping destination
It looks to me like the Chinese government wants to deal with the daigou industry by bringing the business back to mainland China. And in particular, by making Hainan island a haven for duty-free shopping.
Duty-free shops have existed in Hainan since 2011, but it was only in 2020 that the Hainan duty-free industry really took off:
The duty-free shopping limit increased from CNY 30,000 (~US$4,500) CNY 100,000 (~US$15,000) per year. An individual can buy CNY 100,000 worth of goods tax-free on Hainan island each year and then bring them back to the mainland without a need to go through any border.
The number of products that can be sold via duty-free shops has also been expanded to luxury goods such as designer clothing, watches, jewellery, etc. Today, shoppers can buy cosmetics, luxury goods and baby formula on Hainan island.
For these reasons as well as COVID-19, Hainan’s duty-free industry has been taking significant market share from South Korea, Hong Kong and Australia, as you can see from the following chart:
3.2. China’s 2023 border reopening
The big question today is whether China’s border reopening in early January will lead to a rebound in the daigou trade. There’s a lot at stake since many brands, such as A2 baby formula, Korean cosmetics brands and Hong Kong retailers, have been highly dependent on these resellers.
On 15 March 2023, the Chinese government announced that group travel to 40 countries and regions would resume, including to Hong Kong, Thailand, Singapore and the Philippines.
But Japan, Australia and South Korea were excluded from the list, meaning that group travellers to these markets will remain absent.
A recent survey shows that there’s massive interest in both outbound travel and luxury spending. But increasingly, that spending is staying within mainland China, either in people’s home cities or on Hainan island.
4. The investable universe of stocks
I’ve been discussing daigou-related stocks extensively in the past:
New Zealand baby formula maker A2 Milk (A2M AU - US$2.8 billion) used to get a majority of its revenues from daigou resellers trying to evade taxes. Their sales dropped precipitously in 2020. The question for A2 Milk is whether mainland buyers will be willing to pay a higher price for the legitimate, fully-taxed, higher-priced domestic version.
I wrote about Li Ka-Shing’s conglomerate CK Hutchison (1 KS - US$24 billion), in 2022. CK Hutchison’s health & beauty stores in Hong Kong used to sell cosmetics, baby formula and so on to Chinese daigou resellers and tourists. This is not a major part of their business, but worth mentioning nevertheless.
Jardines-controlled retailer Dairy Farm (DFI SP - US$3.8 billion) used to derive a significant portion of its profits from Chinese individuals buying goods from its health & beauty stores in Hong Kong and reselling them in mainland China. I doubt we’ll see a full recovery there, and the Southeast Asian operations are also troubled.
I recently sent out a presentation on commercial property landlord Hysan Development (14 HK - US$2.9 billion), whose shopping malls used to be frequented by mainland Chinese tourists. Roughly half of the mainland tourists to Hong Kong used to be overnight visitors, and many of those were probably daigou resellers. But I’m still reasonably positive about Hysan’s retail shops. Many of the brands who set up stores in Causeway Bay did so to build a brand name - to market themselves to the millions of tourists that used to pass by each year.
Other duty-free operators such as Dufry (DUFRY US - US$5.3 billion), Hotel Shilla (008770 KS - US$2.3 billion), Shinsegae (004170 KS - US$1.6 billion) will also be impacted. Expect a certain recovery in their businesses starting from the second quarter of 2023, but not a complete one.
Whether consumer brands such as those owned by LG Household & Health (051900 KS - US$7.0 billion) will recover depends on their relative market share in Hainan vs overseas duty-free shops. But generally, I think they’ll lose market share, all else equal.
How about the beneficiaries of the daigou crackdown, then?
In my view, there are three categories of companies that are well-placed to benefit from the implosion of the daigou trade: domestic duty-free stores, Hainan transport operators and the owners of cross-border e-commerce platforms.
4.1. Domestic retailers
The company dominating the Hainan duty-free market is China Tourism Group Duty Free (1880 HK - US$56 billion), also known as “CTG”.
It’s a state-owned enterprise operating duty-free stores across mainland China, including on Hainan island. They used to own a travel agency called CITS as well, but that business was sold to its parent just before the IPO.
CTG has stores in the key airports for Haikou and Sanya as well as downtown duty-free stores in Haitang Bay, close to Sanya, as well as in the smaller city of Qionghai. The company sells a variety of items, including cosmetics, perfumes, watches, jewellery, electronics, etc. Roughly 60% of revenues come from duty-free items, and the rest from taxable goods.
4.2. Hainan island transport operators
Hainan Meilan Airport (357 HK - US$1.1 billion) operates the largest airport in Haikou, the capital of Hainan province. It has two terminals and two runways serving both domestic and international travellers.
People I’ve spoken to are sceptical about the HNA Group, which controls the Hainan Meilan Airport. There have been related party transactions in the past between Hainan Meilan Airport and its parent. And the parent entered into bankruptcy proceedings in 2021, though it looks like the restructuring plan has been completed. For an introduction to parent HNA, check out Asianometry’s video on it here.
Hainan Meilan itself has a clean balance sheet with a net cash position, and the stock trades at a forward-looking P/E ratio of 15.2x. The company suffered during the zero-COVID policy of 2022, but cross-provincial travel has now fully resumed, and the airport operator stands to benefit from that recovery.
A company with a much weaker balance sheet and a weaker business model less connected to the duty-free industry is Hainan Airlines (600221 CH - US$11 billion). It focuses on both passenger and cargo transportation services, primarily in its home market of Hainan. Hainan Airlines’ debt level makes me wary of the company, though it should, in theory, benefit from greater travel back and forth to Hainan Island.
4.3. Cross-border e-commerce platforms
I also believe that the legitimate cross-border e-commerce platforms such as NetEase’s (NTES US - US$56 billion) Kaola and Alibaba’s (BABA US - US$217 billion) Tmall Global should take some market share from unregistered daigou resellers. But note that these platforms represent a tiny portion of their overall businesses and so are unlikely to move the needle for their bottom lines.
Please find a comparables valuation table below. CTG Duty Free trades at a high multiple of 29x. I’m personally more attracted by Hainan Meilan Airport, which trades at 15.2x P/E with a clean balance sheet. It should benefit significantly from the opening up of China’s cross-provincial travel in late 2022 and also from the rise of duty-free sales on Hainan island. NetEase and Alibaba also trade at low multiples.
I’ve written about the Asian travel recovery in the past, including reports on stocks such as CK Hutchison, Dairy Farm, LG Household & Health, and more. These companies should benefit from China’s recent border reopening, especially if the number of international flights ramps up as expected.
But I also think that we need to face the reality that China’s daigou trade was built on insecure foundations. It was built on tax evasion by smuggling items across the border. Since the government has now cracked down hard on this practice, I don’t think we’ll ever see a full recovery of the daigou industry.
Potential beneficiaries of the crackdown include duty-free stores within mainland China. And in particular, duty-free stores on Hainan island, from which goods can be transported to the rest of China without any restrictions.
Given this positive backdrop, I wonder whether it might be worth digging deeper into Hainan Meilan Airport (357 HK - US$1.1 billion), which trades at a reasonable multiple and should see rising passenger numbers now that cross-provincial travel has opened up. It should also benefit from greater duty-free sales now that China’s border controls have become much stricter than in the past.