Aug. 16 (Bloomberg) -- Investors should buy shares of companies that stand to benefit most from the development of China's cities and migration to urban areas, UBS AG said, naming Tsingtao Brewery Co. and Datang International Power Generation Co. among its top picks.

Breweries, retailers, power generators and coal companies that are located in fast-growing cities are among stocks that will outperform, said Henry Ho, a Hong Kong-based strategist at UBS. These companies provide goods and services that are required by migrants and local businesses.

``While the long-term trend of urbanization will continue, growth has been pretty uneven,'' Ho said in an Aug. 14 telephone interview. ``We like companies that are based in areas that have done well and dominate those markets.''

Chinese stock benchmarks are the region's best performers this year. The Shanghai Composite Index, which tracks the larger mainland market, has surged 39 percent, while the Hang Seng China Enterprises Index, which tracks the so-called H shares of 38 mainland companies in Hong Kong, is up 33 percent. The Morgan Stanley Capital International Asia-Pacific Index, a regional benchmark, has climbed just 5.3 percent.

Today, the Shanghai measure jumped 1.3 percent, while the Hong Kong index gained 0.7 percent to a three-month high.

China's economy, the world's fourth biggest, grew 11.3 percent in the second quarter, the fastest pace in more than a decade, the statistics bureau said on July 18, as spending on factories and real estate accelerated. The U.S. had the second- fastest growth among the top five economies, expanding 3.5 percent, less than a third the pace of China.

`Stable' Profits

Government curbs on lending and investment won't significantly cool the Asian nation's growth, UBS predicts. Ho forecasts that the economy will grow between 8.5 percent and 9 percent for ``the next few years.''

``The growth trend in China continues to be positive,'' said Khiem Do, who helps manage $4 billion of Asian equities at Baring Asset Management (Asia) Ltd. in Hong Kong. ``We have a number of consumer staple companies, property developers and financials including insurance companies. We also like some of the infrastructure stocks including port operators.'' He didn't name any holdings.

UBS favors companies that have businesses in cities with high urbanization levels and fast-growing populations, Ho and Louis Shan, a Hong Kong-based analyst, said in an Aug. 9 report. These cities include Shenzhen, Shanghai, Beijing, Nanjing, Guangzhou and Foshan.

Shares of companies that are able to tap into growing local demand are also better bets, UBS said. Retail sales in China climbed 13.7 percent from a year earlier to 601.2 billion yuan ($75 billion) in July as rising incomes in the world's fourth- largest economy spurred spending on clothes, furniture and cell phones, the statistics bureau said in an Aug. 14 report.

Spending

The Hong Kong-listed shares of Tsingtao Brewery, China's biggest beer producer, have gained 10 percent this year. The company, which is 27 percent owned by St. Louis-based Anheuser- Busch Cos., has 50 breweries across China. Its mainland-listed shares surged 31 percent during the period.

``The rural population is moving to work in urban areas and once they arrive in the city, their spending patterns start to change,'' Ho said. ``These are developments that we've seen in other major economies and it will happen in China.''

To leverage on increasing consumption, investors should also buy shares of Beijing-based Parkson Retail Group Ltd. in Hong Kong and the mainland-listed shares of Beijing Hualian Department Store Co. and Nanjing Xinjiekou Department Store Co., UBS recommended.

Meanwhile, the influx of migrants into cities will also boost demand for power and infrastructure in those areas, the brokerage said.

Spending on urban infrastructure and industrial construction nationwide may increase 26.9 percent to 11.2 trillion yuan for the full year, faster than last year's expansion of 25.7 percent, the National Development and Reform Commission said in a research report published in the China Securities Journal Aug. 3.

Datang Power

Shares of Beijing-based Datang Power, the third-largest Chinese electricity generator listed in Hong Kong, have slid 9.3 percent this year. Datang on Aug. 9 said first-half profit increased 14 percent because of higher power prices and demand.

Ho, 49, worked for Merrill Lynch & Co. and Morgan Stanley before he joined UBS in 2004.

The strategist in December predicted that the Hang Seng China Enterprises Index would rise 17 percent in 2006, saying concern about a government clampdown on lending and investment would ease. So far this year, the measure has surged 32 percent to 5330.34 and Ho predicts it will reach 7400 to 9900 in the first half of 2007.

Further Gains?

Other analysts also foresee further gains for the measure. Thomas Deng, Goldman Sachs Group Inc.'s Hong Kong-based China strategist, in May predicted that the index will reach 8000 by the end of 2006 on rising profits and yuan gains.

Gains in Chinese stocks this year have made the shares more expensive, deterring some investors. The Shanghai stock index, which has slid 9.6 percent since rising to the highest in more than two years on July 11, is valued at 23 times earnings. The MSCI regional measure is valued at 18 times.

``The domestic A-share market has had a great run,'' Lan Xue, head of China research at Citigroup Inc. in Hong Kong, said. ``People are becoming very valuation conscious and the market has been correcting for the past four weeks.''

Sustained profit growth and the strong economic outlook in China are justifying the strong gains in the nation's stocks and will help lift prices further, Ho at UBS says. Profit at Chinese industrial companies grew 28 percent in the first half after increasing 25.5 percent in the first five months, official figures show.

``Corporate profits in China are a lot more stable,'' he said. ``Growth there is still a lot better than most other economies.''

To contact the reporters for this story: Chen Shiyin in Singapore at schen37@bloomberg.net

Last Updated: August 16, 2006 04:25 EDT