Collectives commentary

China: A long way to grow

Mark Williams, Head of Asia Equities, Liontrust

Conversations about investing in Asia often start with China. There is good reason for this. It already has the largest economy in the world.

This is certainly true when measured in purchasing power parity (PPP) GDP terms, ahead of the US and greater than the combined EU members.

Its ascent to this position has led it to be the regional growth engine for a number of years. Forecasts in the IMF’s April edition of its World Economic Outlook show that China is this year expected to be responsible for over half of Asia’s growth. In fact, it alone is expected to contribute almost a third of the expansion in the world economy in 2018.

And China’s economic power is only going to get bigger. On a per capita basis, its GDP is only just over a quarter that of the US. If it follows any previously observed development curve, then this per capita wealth will increase substantially in the coming years and as a result there will be massive growth in China’s middle class.

So although China is already huge, we all need to get used to the idea that the bulk of its growth is still to come. This means there is massive investment opportunity in the country. We run a portfolio which invests throughout Asia (excluding Japan). Our approach to stock selection in the region is to target those providing a combination of growth in both earnings and dividends, whose shares are available on an attractive valuation. By applying these criteria to identify the very best companies in Asia, we have found that 40% of our selections come from China – a testament to the strength and depth of the Chinese equity investment universe.

By looking for stocks that are not only generating earnings growth but which are also increasing dividends, we are automatically looking at more conservative, well managed companies that generate strong cash flows.

One might think an income requirement would be restrictive when investing in Asia. This is simply not the case. We have screened the global equity universe for companies which are delivering attractive combinations of earnings growth and dividend yield and we have discovered that around 40% of these stocks are to be found in Asia Pacific ex-Japan, with 17% in China and Hong Kong.

This pool of potential investments is growing due to improvements in the dividend culture in Asia. While attitudes to paying dividends – and to the interests of minority shareholders in general – have historically been less progressive than those we are used to in the UK, they are maturing rapidly. We believe that companies in Asia will begin to show more inclination to return excess cash to shareholders.

One area that we see a long-term sustainable investment trend is in the expansion of personal consumption in China. In the decade, since 2007 Beijing’s minimum wages have almost trebled, and other parts of the country have matched the pace, stimulating enormous demand for discretionary goods. There are lots of ways for investors to access this trend. We have been able to invest in Anta Sports Products, the largest domestic sports brand in China in terms of market capitalisation and sales. With a market share of around 12%, Anta is a key beneficiary of aspirational discretionary consumption.

The potential for China’s longer-term consumption growth is easily illustrated by its penchant for internet shopping. Asia as a whole already has more internet users than Europe and North America combined, and Chinese e-retailing giant Alibaba has created the juggernaut of online consumerism known as ‘Singles Day’, which now dwarfs the sales seen in the US on ‘Cyber Monday’ or ‘Black Friday’. Despite already having reached such mammoth scale, we still believe that there is a long way to go before individuals in China are spending anything like their international peers. China’s current internet penetration rate is only 46.7%, compared with 80% in Europe and 88% in North America, and as it catches up, internet shopping will only increase. Goldman Sachs estimate that online sales will rise from 17% of the total in 2018 to 25% by 2020.

90% of China’s population still don’t own a passport.

It is clear that the growth of the Chinese middle class is generating significant opportunities for the companies which have been able to tap into the associated spending. But what is perhaps underappreciated is the extent to which this consumption growth story is in its infancy. For example, we are already seeing Chinese consumption power have a huge impact globally through the 122 million Chinese who travelled overseas (in 2016), but 90% of China’s population still don’t own a passport. Similarly, China is the world’s largest auto market, with car sales exceeding both Europe and the US, but there are still only estimated to be around 21 motor vehicles for every 100 people, compared to almost 80 in the US. As far as Chinese economic growth and the investment opportunity are concerned, we have only scratched the surface.

There are only around 21 motor vehicles for every 100 people, compared to almost 80 in the US.

While we have invested in a number of consumer stocks directly, the delivery and transportation of these goods naturally creates logistical demand. We have bought into this demand growth through Shanghai-based SITC online logistics, an Asia-focused provider of integrated logistics solutions which uses shipping and land freight forwarding services.

Sustainable growth in China also requires improving infrastructure. This is a need which has been identified by the Chinese government, resulting in investment on a grand scale. The ‘One Belt One Road’ project involves around US$900bn of infrastructure investment improving connections both within China and between China and the rest of Asia through the land-based ‘Silk Road Economic Belt’ and a

In order to reap the best returns from the substantial economic forces at work in China, investors need to look beyond a buy the market approach.

sea route termed the ‘21st Century Maritime Silk Road’. Again, there are ways to access this spending. China Machinery Engineering Corporation (CMEC), for example, should be a key beneficiary of the programme. It focuses on engineering, procurement and construction contracts.

In order to reap the best returns from the substantial economic forces at work in China, investors need to look beyond a ‘buy the market’ approach. There are a number of reasons to be very selective within China’s equity markets. One of the most compelling is the variation in prospects for different sectors of its economy. At the risk of over-simplification, the ‘old economy’ sectors are on the way out as the country develops, while a new age is dawning for those specialising in consumption and the service economy.

By maintaining a simple focus – selecting the areas which benefit from economic development and transition to a more sustainable long-term path, while avoiding those that suffer – we are confident of participating in China’s economic development for years to come.

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