Is it time to reconsider investing in China?
3 Jul, 2024

 

Philipp Wörz, Fund Manager at PSG Asset Management

 

There has been a lot of noise emanating from China over the past year. Slowing economic growth, fears around property values, regulatory interventions and an uneasy geopolitical environment, among other factors, have contributed to Chinese and Hong Kong stock markets losing some of their luster. As a result, many global investors have already jumped ship and are showing little interest in the region, and valuations are attractive. While geopolitical tensions and the property market downturn are real risks, good investment opportunities are often found in an environment of fear and uncertainty.

 

Sources: PSG Asset Management and Bloomberg, 24 June 2024

 

In previous years when Chinese stocks – especially the large tech platform companies –could do no wrong, our funds did not have exposure to this space as we did not believe lofty valuations reflected the various risks, especially governance, geopolitics and unsustainable economic policy. However, we have since seen a 52% sell-off in the Hang Seng Index from its peak in 2021 until January this year, at a time when US stock markets have been posting record highs day after day. Consequently, our investment team has increasingly viewed China-focused stocks and the Hong Kong market generally as a potential hunting ground for companies the market may be underappreciating. As a result, we have introduced several Hong Kong listed holdings into our global funds in recent months.

 

Diverging fortunes

 

Sources: PSG Asset Management and Bloomberg, data in USD based to 100 in June 2004

 

With this in mind, we believed the time was ripe for gathering some first-hand learnings as we consider the emerging opportunity set and carefully weigh the risks. And so, some of our team members recently travelled to the region to meet with local experts, investors and industry analysts. We also visited an electronics factory and an e-commerce distribution centre in Shenzen and stores and luxury goods malls in Shanghai and attended the UBS Asian Investment Conference in Hong Kong, meeting with several investee companies and their competitors both at the conference and at their Hong Kong offices.

 

Learnings from looking East

 

While China’s political and macroeconomic landscape is best summarised as complex, we wanted to share five key learnings from our trip, which we believe will have longer lasting implications.

 

The Chinese make pretty (fast) cars and NEVs are everywhere

 

The ubiquity of new-energy vehicles (NEVs) was apparent as we drove around Shanghai and Shenzen. Official market share data support our observation, as new-energy vehicles accounted for a record 47% (29% battery powered, 18% hybrid) of new car sales in May. During our trip, we had the opportunity to get up close to the fully electric Xiaomi SU7, with acceleration that roughly matches a Porsche 911 Turbo (at 0-100km/h in 2.7 seconds), has an 800km range on a single charge and costs less than US$40 000 – far more affordable than other similar models.

 

Car exports are already booming (see the graph below),but looking forward a few years we are likely to see Chinese car brands become even more mainstream across many markets, with significant implications for established carmakers’ growth ambitions.

 

China vehicle exports (units per month)

Sources: PSG Asset Management and Bloomberg, 31 May 2024

 

China’s excess capacity is being exported across many industries

 

A tough domestic economy, declining industrial capacity utilisation and growth in fixed asset investment by manufacturers continue to put downward pressures on domestic and export prices and margins of manufacturers. We are increasingly seeing this excess capacity being exported, which can benefit consumers and select companies (via cheaper product and/or input prices), but it comes at the expense of competitors’ margins and existing jobs. In light of this, the ongoing political debate about tariffs is not surprising.

 

Being a foreign brand in China doesn’t guarantee success

 

Expert insights and consumer data suggest Chinese locals are increasingly indifferent between buying a foreign or local brand across various categories – e.g. skincare (Estée Lauder vs Proya), footwear (Nike vs Anta) and autos (Tesla vs Xiaomi) – as the quality of local brands has improved over time and consumers increasingly favour a combination of quality and value.

 

Share of sportswear market in China: Chinese companies Anta Sports and Li Ning vs global competitors

Source: Euromonitor, Bernstein analysis

 

Shutting China out of supply chains will be a long process

 

Many Western politicians are anti-China and are increasingly trying to exclude the country from global supply chains. However, this is likely to be a long process with many unintended consequences, given China’s scale and importance to existing supply chains. It will take a long time to materially reduce the West’s reliance on the country and will require a significant increase in capital investment to have a material impact over the next decade.

 

Structural improvements hinge on property markets

 

China’s real estate market has been the source of significant excess, and more recently of pain. While recent measures may yet stabilise the market, there remains significant excess real estate inventory that will likely take several years to be absorbed. The government needs to walk a fine line between sufficiently supporting the sector and avoiding moral hazard and another speculative frenzy. Stability and improvements in China’s property market will likely have outsized impacts on consumer confidence and longer lasting structural improvements to China’s economy.

 

Seize the opportunities, remain conscious of the risks

 

Many investors believe that global funds can only be managed successfully by enterprises with headquarters in places like New York, London or Boston. And yet, PSG Asset Management’s track record of delivering award-winning performance* for investors in its global feeder funds hints that this perception deserves to be questioned. Technology, regular reporting and strict information dissemination rules have levelled the playing field when investing globally. In fact, we’d argue that being located at the tip of Africa allows for an independent perspective, away from the noise of consensus opinion, and that this aids us in constructing high conviction, differentiated portfolios.

 

Currently, we are finding attractive opportunities for our clients in Chinese and Hong Kong markets, while bearing the risks in mind.

 

ENDS

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@Philipp Wörz, PSG Asset Management
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