China's future sits in the consumer and technology sectors
Head of Equity Strategy
Summary: China will most likely become the largest economy and consumer market within the near future and with that projection comes interesting investing opportunities. Due to China's political and economic structure we prefer to be specific rather than passively invested in China as many large companies are partly government owned. The most interesting part of the private sector where the government has allowed a high degree of free market to take place is within consumer goods and technology. This is the future of China and our equity theme basket focusing on this trend consists of 40 companies representing $4trn in market value and high expected growth rates.
No equity investor should ignore China which is now world’s second largest economy and the dominating equity market in the emerging markets. Due to China’s political and economic structure getting broad exposure to the Chinese equity market is not our preferred option. China holds great potential for security selection and active management due to market inefficiencies and large government involvement in the economy and capital markets. China’s consumer and technology sectors offer in our view the best access to the most interesting part of China’s innovative private sector and arguably the future of China. As a result, we are launching a new equity theme basket focusing on China’s consumer and technology sectors.
Our filters for selecting stocks for this basket have been companies with domicile in China, listed on exchanges in either the US, mainland China, or Hong Kong. Only companies in the technology (hardware, software, and semiconductors), medical equipment, media & entertainment, consumer staples, and consumer discretionary sectors have been selected. As per usual we have selected the largest companies on market value, so the list does not reflect our subjective views on the companies but rather the market’s view.
|Name||Industry||Market Cap (USD mn.)||Sales growth (%)||EPS growth (%)||Diff to PT (%)|
|Tencent Holdings Ltd||Gaming & social media||764,701||27.8||48.0||27.0|
|Alibaba Group Holding Ltd||E-commerce||611,140||31.8||8.0||44.3|
|Kweichow Moutai Co Ltd||Beverages||396,997||10.3||13.3||14.6|
|Kuaishou Technology||Social media||145,637||50.2||NA||32.9|
|China Tourism Group Duty Free Corp Ltd||Duty free goods||93,087||-3.1||14.3||22.5|
|Midea Group Co Ltd||Household appliances||88,883||-0.3||-4.6||36.3|
|Foshan Haitian Flavouring & Food Co Ltd||Food seasoning manufacturer||86,775||15.1||20.6||4.0|
|Xiaomi Corp||Smartphone manufacturer||84,889||19.4||-8.8||16.3|
|Hangzhou Hikvision Digital Technology Co Ltd **||Video surveillance||82,037||7.1||6.5||3.6|
|Baidu Inc||Online search & advertising||77,146||-0.3||39.6||55.8|
|BYD Co Ltd||Car manufacturer (EV & ICE)||71,172||22.6||173.5||39.0|
|KE Holdings Inc||Housing transaction platform||66,404||53.2||NA||30.6|
|NIO Inc||Car manufacturer (EV)||61,068||107.8||56.3||64.5|
|Gree Electric Appliances Inc of Zhuhai||Air conditioners||56,805||-17.1||-36.0||27.6|
|Nongfu Spring Co Ltd||Beverages||55,951||-4.8||7.5||19.1|
|WuXi AppTec Co Ltd||Drug manufacturing technology||54,339||28.5||29.0||28.3|
|ANTA Sports Products Ltd||Sports apparel||46,985||4.7||-1.6||7.2|
|JD Health International Inc||Online healthcare platform||46,380||78.8||NA||35.8|
|Haier Smart Home Co Ltd||Household appliances||44,028||4.5||135.7||20.9|
|Foxconn Industrial Internet Co Ltd||Networking equipment||43,568||5.6||-3.7||34.0|
|Will Semiconductor Co Ltd Shanghai||Semiconductors & image sensory||39,426||39.7||8388.5||19.5|
|Semiconductor Manufacturing International Corp **||Semiconductor foundry||37,193||25.4||206.5||-7.7|
|Luxshare Precision Industry Co Ltd||Connectivity manufacturer||36,383||63.3||59.9||66.8|
|SAIC Motor Corp Ltd||Car manufacturer (EV & ICE)||36,263||-12.0||-19.9||28.0|
|Haidilao International Holding Ltd||Restaurant chain||35,361||7.8||-91.4||19.1|
|BOE Technology Group Co Ltd||Display panels manufacturer||34,120||16.5||108.8||NA|
|Tencent Music Entertainment Group||Music streaming||33,259||14.6||27.3||53.7|
|Shenzhou International Group Holdings Ltd||Textile manufacturing||33,025||1.6||-0.7||3.6|
|XPeng Inc||Car manufacturer (EV)||26,912||151.8||NA||52.9|
|Sunny Optical Technology Group Co Ltd||Optical instruments||25,832||0.4||19.4||27.3|
|Yum China Holdings Inc||Restaurant chain||25,124||-5.8||-15.9||13.5|
|Trip.com Group Ltd||Online travel agency||23,328||-48.6||NA||14.9|
|Focus Media Information Technology Co Ltd||Offline advertising solutions||21,513||-11.7||13.7||51.0|
|ZTE Corp||5G & telecommunication||18,945||11.8||69.2||47.7|
|Oppein Home Group Inc||Household furniture manufacturer||15,401||6.9||6.8||1.8|
|Topsports International Holdings Ltd||Sports retailer||9,247||-5.6||NA||23.8|
|Aggregate / median||4,040,443||13.2||16.8||27.6|
Source: Bloomberg and Saxo Group
* Sales and EPS growth is measured on 12-month trailing figures, Diff to PT is the difference between consensus price target and the current price in %
** These companies are under US sanctions
The basket consists of 40 stocks with a combined market value of $4trn with a diverse set of companies representing everything from smartphone production, e-commerce, gaming, social media, restaurants, carmakers, household appliances, and travel agencies. There are two companies in the basket there are subject to US sanctions which could have impact for certain investors. The median revenue and EPS growth the past year are 13.2% and 16.8% respectively highlighting the attractive characteristics of investing in Chinese equities. The median price target is 28% above the current price suggesting strong sentiment among sell-side analysts.
Our basket is down 0.5% year-to-date underperforming MSCI Emerging Markets up 4.4% and MSCI World up 8.1% highlighting the bumpy start to the year for Chinese equities following a very strong 2020 as the country aggressively controlled the pandemic and its impact on the economy. Since late 2015 the basket is up 552% but as we have selected the companies on market value there is a survivorship bias in the performance metric and as such past performance is no indicator of future performance, but regulation requires that we can show five years of data.
Technology regulation and the new consumer boom
The biggest theme in China excluding the new climate policy goals and the focus on social stability is that of technology regulation. It all started late last year with postponement of the Ant IPO (the fintech and payments arm of Alibaba) and subsequent antitrust investigation of Alibaba. The moves came following a negative speech by Alibaba co-founder Jack Ma of state-owned banks and a series of comments from Chinese regulators of the influence of technology giants such as Tencent, Alibaba, and Baidu, and their negative impact on consumer choice and lack of competition.
Since then, the rhetoric has worsened on Chinese technology companies with company forcing Baidu and Alibaba to spin out media assets and previous acquisitions are under scrutiny as well. Lately, the Chinese government has proposed a public-private joint venture on private user data to limit the power of technology giants which value is derived from user data. Yesterday, Tencent’s largest shareholder Prosus announced that it had reduced its stake from 31% to 29% in the second largest block trade in the history of equity markets, which could suggest investors are beginning to discount a lower earnings growth trajectory following the new technology regulation regime. The recent developments have created a valuation discount on large Chinese technology companies relative to US technology companies and the risk premium could continue to go up.
That is why we have included more traditional consumer companies in our basket as we believe this part of the private sector will be allowed to grow rapidly and under less scrutiny by the Chinese government because they rely less on private user data and thus do challenge the political power structure in China. The largest traditional consumer companies outside pure e-commerce on the list are Kweichow Moutai, Midea Group, Foshan Haitan, Xiaomi, BYD, KE Holdings, NIO, and ANTA Sports.
The China consumer and technology basket will likely experience high long-term growth above the global average and driven by an expanding middle class expected to reach the level seen in the EU by 2030. According to figures from Global Insight, the Chinese middle class defined by household income above $20,000 will rise to little more than 400mn by 2035 becoming the largest consumer market in the world. This is what you are betting on in this basket.
China’s domestic market will provide at least 15-20 years of runway for growth before internationalisation will be key to sustain growth and shareholder creation. A successful internalisation of Chinese brands will require a positive view of China in the future and thus this part of the growth story will depend very much on how the geopolitical landscape unfolds over time.
The obvious risks to this basket are a significant slowdown in growth which could come as a result of US-China trade frictions, low women fertility reduce population growth towards 2050, more technology regulation has we have outlined above, higher risk premium on Chinese equities to reflect increasing political oversight of the economy and the private sector.
Many of the stocks on the list are traded on exchange in mainland China and thus come with higher volatility and less liquidity than if they were listed on more mature exchanges. The companies also get the dominant part of their revenue in CNY and thus foreign investors are subject to currency translation risk in their own currency.
China has arguably been the biggest beneficiary of globalisation since the early 1980s and even more so after the inclusion in WTO in 2001. US and European backslash against a rising China could disrupt China’s wealth creation which is still predominantly driven by its export machine. Over time the domestic economy will take over as the economic driver, but in the meantime the escalating tensions between China and US/Europe pose a risk to China and its growth rate.