China’s post-Covid reopening has revived investor interest in the world’s second-largest economy. As the recovery continues to take shape, we prefer to take a long-term view on Chinese equities.
Despite the recent headwinds, we expect China’s growth path to continue over the longer term. The structural drivers underpinning this growth remain intact, and we expect Chinese companies to benefit from trends such as rising incomes and wealth, increasing demand for premium goods and services, and burgeoning sophistication in technology and manufacturing. We believe there will also be opportunities for companies to innovate and move up the value curve. This, coupled with China’s increasing role in global trade, should bode well for exports as well as domestic consumption.
Below, we highlight three sectors that are likely beneficiaries.
Industrial automation aims to offset a shrinking workforce
The impact of China’s earlier one-child policy will continue to be felt in the coming decades. Its working age population, or people between 15 and 64, will contract by 22% or 217 million people. To counter the anticipated labour shortages, the government seeks to improve manufacturing through automation and robotics, which means China’s automation market will see strong secular tailwinds. For example, the country set a record of 243,300 industrial robots in 2021, a 44 per cent increase from the previous year.
Shenzhen Inovance is an industrial automation company with leading positions in inverters, servomotors and new energy vehicle (NEV) controllers. It has repeatedly proven its capability in developing new products and entering new markets, where it can compete with multinational peers. By March 2022, the company had generated 28% per annum shareholder returns since its IPO in 2010, with 40% compound annual growth rate (CAGR) in sales and 35% net profit CAGR*. Despite its size, our view is that Inovance can continue to generate attractive growth over the next 5-10 years as it gains market share and continues to innovate.
Healthcare companies stand to gain market share
Healthcare spending, while much lower than in developed countries, is expected to grow as China’s population ages. The population over 65 will increase from 14% of the total population in 2022 to 30% in 2050.
Shenzhen Mindray is China’s largest domestic medical devices company and a market leader in patient monitors and life support systems. Growth across categories has picked up in recent years, and Mindray’s market position for each category has been improving as well. It has gained market share from global leaders as it expands its presence overseas and has more than 40% of its sales through exports*.
In the domestic market, we expect increased hospital spending on medical equipment to contribute significantly to its revenue. There are also growth opportunities ahead, as the penetration level of medical devices in China is still low and there is a growing preference for import substitutions.
Domestic brands may benefit from premium consumption
Structural growth is expected to return to domestic spending with the recovery of consumer confidence. Amid weaker consumer demand resulting from the pandemic in the last two years, we focused on high-quality franchises and market leaders – those companies with above-average margins and returns, and which can increase selling prices.
One sector we looked at was China’s beer market, which is different from most other countries. It is highly consolidated with the top three companies, China Resources Beer (CR Beer), Tsingtao and Anheuser-Busch InBev, sharing 75% of the market as per our research in 2022*. Despite beer volumes declining since 2014, the improving economy and a growing middle class has seen some brands looking to develop more premium products, improving unit economics. Sales and profitability have also improved as beer companies consolidated their breweries.
CR Beer’s share of premium sales has grown with the help from a 2019 merger with Heineken China, resulting in higher average selling prices. Although the company is a state-owned enterprise, China Resources businesses have typically been well run, with returns comparable to private enterprises. Additionally, while investors were worried about higher prices of inputs like aluminium cans, historically beer companies have been able to pass on costs, while the gross profit margin of circa 40% should limit the impact on profits.
Conclusion
While China has changed significantly over the last three decades we have been investing there, our investment process has remained the same. We believe the key driver of share prices over the long term is companies’ ability to generate value, by growing their earnings or net asset value. Therefore, we use bottom-up analysis and focus on quality companies, with capable leaders who are aligned with shareholders. As the China market is likely to remain volatile, we also seek to maintain discipline around valuations and not get carried away by market sentiment.
*Source: FSSA Investment Managers, company data retrieved from company annual reports or other such investor reports. Financial metrics and valuations are from FactSet and Bloomberg. As at February 2023 or otherwise noted.
Martin Lau, a portfolio manager and managing partner at FSSA Investment Managers, part of First Sentier Investors
About FSSA Investment Managers
FSSA Investment Managers is an autonomous team within First Sentier Investors with dedicated investment professionals in Hong Kong, Singapore, Tokyo and Edinburgh. FSSA IM are bottom-up investors, using fundamental research and analysis to construct high-conviction portfolios. They conduct more than a thousand direct company meetings a year, seeking to identify high quality companies that they can invest in for the long term. As responsible, long-term shareholders, FSSA IM have integrated ESG analysis into their investment process and engage extensively on environmental, labour and governance issues. As at 31 December 2022, FSSA IM manages US$30.3 billion on behalf of clients globally.
About First Sentier Investors
First Sentier Investors manages more than USD $146.2 billion in assets, as at 31 December 2022, on behalf of institutional investors, pension funds, wholesale distributors, investment platforms, financial advisers and their clients worldwide.
The firm operates as a standalone global investment management business with offices across Europe, the Americas, and Asia Pacific. First Sentier Investors’ expertise spans a range of asset classes and specialist investment sectors focused on delivering sustainable investment success based on responsible investment principles.
Formerly First State Investments, the firm was acquired from the Commonwealth Bank of Australia in August 2019 by Mitsubishi UFJ Trust and Banking Corporation, a wholly-owned subsidiary of Mitsubishi UFJ Financial Group, Inc.
Important Information
This document has been prepared for general informational purposes only and is only intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of issue and may change over time. This is not an offer document and does not constitute an offer or invitation or investment recommendation to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any material contained in this document.
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For illustrative purposes only. Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy and First Sentier Investors does not necessarily maintain positions in such companies. Any fund or stock mentioned in this presentation does not constitute any offer or inducement to enter into any investment activity nor is it a recommendation to purchase or sell any security.
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