China's future sits in the consumer and technology sectors

China's future sits in the consumer and technology sectors

Equities 10 minutes to read
PG
Peter Garnry

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.

The basket

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.

NameIndustryMarket Cap (USD mn.)Sales growth (%)EPS growth (%)Diff to PT (%)
Tencent Holdings LtdGaming & social media764,70127.848.027.0
Alibaba Group Holding LtdE-commerce611,14031.88.044.3
Kweichow Moutai Co LtdBeverages396,99710.313.314.6
MeituanE-commerce242,83817.7212.625.6
Pinduoduo IncE-commerce169,69297.429.828.9
Kuaishou TechnologySocial media145,63750.2NA32.9
JD.com IncE-commerce127,14829.377.437.2
China Tourism Group Duty Free Corp LtdDuty free goods93,087-3.114.322.5
Midea Group Co LtdHousehold appliances88,883-0.3-4.636.3
Foshan Haitian Flavouring & Food Co LtdFood seasoning manufacturer86,77515.120.64.0
Xiaomi CorpSmartphone manufacturer84,88919.4-8.816.3
Hangzhou Hikvision Digital Technology Co Ltd **Video surveillance82,0377.16.53.6
Baidu IncOnline search & advertising77,146-0.339.655.8
NetEase IncGaming71,44524.4-17.528.3
BYD Co LtdCar manufacturer (EV & ICE)71,17222.6173.539.0
KE Holdings IncHousing transaction platform66,40453.2NA30.6
NIO IncCar manufacturer (EV)61,068107.856.364.5
Gree Electric Appliances Inc of ZhuhaiAir conditioners56,805-17.1-36.027.6
Nongfu Spring Co LtdBeverages55,951-4.87.519.1
WuXi AppTec Co LtdDrug manufacturing technology54,33928.529.028.3
ANTA Sports Products LtdSports apparel46,9854.7-1.67.2
JD Health International IncOnline healthcare platform46,38078.8NA35.8
Haier Smart Home Co LtdHousehold appliances44,0284.5135.720.9
Foxconn Industrial Internet Co LtdNetworking equipment43,5685.6-3.734.0
Will Semiconductor Co Ltd ShanghaiSemiconductors & image sensory39,42639.78388.519.5
Semiconductor Manufacturing International Corp **Semiconductor foundry37,19325.4206.5-7.7
Luxshare Precision Industry Co LtdConnectivity manufacturer36,38363.359.966.8
SAIC Motor Corp LtdCar manufacturer (EV & ICE)36,263-12.0-19.928.0
Haidilao International Holding LtdRestaurant chain35,3617.8-91.419.1
BOE Technology Group Co LtdDisplay panels manufacturer34,12016.5108.8NA
Tencent Music Entertainment GroupMusic streaming33,25914.627.353.7
Shenzhou International Group Holdings LtdTextile manufacturing33,0251.6-0.73.6
XPeng IncCar manufacturer (EV)26,912151.8NA52.9
Sunny Optical Technology Group Co LtdOptical instruments25,8320.419.427.3
Yum China Holdings IncRestaurant chain25,124-5.8-15.913.5
Trip.com Group LtdOnline travel agency23,328-48.6NA14.9
Focus Media Information Technology Co LtdOffline advertising solutions21,513-11.713.751.0
ZTE Corp5G & telecommunication18,94511.869.247.7
Oppein Home Group IncHousehold furniture manufacturer15,4016.96.81.8
Topsports International Holdings LtdSports retailer9,247-5.6NA23.8
Aggregate / median4,040,44313.216.827.6

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 risks

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.

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