Where are the best investment opportunities in China?
China’s reopening after Covid lockdowns has attracted considerable investor attention, but there are longer-term trends to consider too.
Chinese shares have had a good run recently with gains spurred by the country’s reopening after the protracted period of Covid lockdowns. Government support for the property sector has also aided equity market returns, as has a stabilisation of the regulatory environment for internet stocks.
But even after the recent gains, we see several themes that could potentially drive longer-term gains for Chinese equities. As well as the ongoing economic re-opening, themes such as decarbonisation, technology self-sufficiency and healthcare spending offer growth potential for firms and investors.
Reopening theme is still playing out
The re-opening theme is not fully played out. After all, the re-opening has been swift and it takes time for corporates and consumers to adjust to such a significant change.
We expect that the fast-paced removal of the tight Covid-related restrictions in China will provide substantial support to the recovery in consumer spending, which in turn will support domestic earnings in many sectors.
Among those we see as the main beneficiaries is the food & beverage sector. Increased dining out as people start to socialise more will drive higher demand for food and drink products.
Advertising will be another winner, as the increased opportunities for consumption should lead to higher spending on advertising and marketing by corporates.
Possibly a less obvious reopening beneficiary is the insurance sector. We anticipate an uptick in policy sales as insurance sales agent can carry out face-to-face sales meetings again.
While the re-opening theme is still playing out for now, we will start to see normalisation of demand in these sectors in the coming months. But the attractions of Chinese equities extend beyond the near-term reopening opportunities.
The “regime shift” occurring across the globe in terms of de-carbonisation, investment in technology, and increased government spending is also taking place in China. These shifts will take place over the medium to long term and, in our view, can support significant growth for companies with exposure to these themes.
Three long-term themes to watch
1. Electric vehicle supply chain
As the effects of climate change become more evident, the de-carbonisation drive is increasingly important for countries around the world. The need to switch to electric vehicles (EVs) is an aspect of this, and an area where we think China offers particularly interesting exposure for investors.
China is a global leader when it comes to supplying the EV value chain, and also when it comes to demand for the finished vehicles. A staggering 57% of all EVs sold globally in 2022 were sold in China.
Within the EV supply chain, there are a number of companies who are building dominant positions in their respective niches. Take Sanhua Intelligent as an example. It’s a producer of key components for battery and motor temperature controls in EVs. It commands a c.60% global market share in the air conditioning valve industry, and a greater than 90% share in the EV valve industry. Clients include global EV specialists like Tesla as well as original equipment manufacturers (OEMs) like Ford and BMW. As EVs continue to take market share around the world – helped by regulations - there is good visibility on the company’s growth potential.
2. Technology self-sufficiency
Rising tensions between the US and China have manifested in the technology sector as a ban on US companies supplying potentially strategic semiconductor technology to China. The supply chain blockages caused by Covid lockdowns and logistical difficulties are a further impetus behind the move to localise production closer to end markets.
There are selected players in the Chinese technology sector that we see as beneficiaries of this accelerating localisation trend. ZW Soft is one. It is a leading domestic computer-aided design (CAD) software provider. China’s CAD market size is increasing steadily on the back of industrial digitalisation. We view ZW Software as a domestic leader with a strong technology advantage over its competitors.
3. Healthcare infrastructure
Part of the reason why China’s Covid-19 lockdowns were so strict and so lengthy was due to lack of hospital capacity and other healthcare infrastructure. Expanding this is a key government priority now. Meanwhile, the localisation theme also means that local healthcare equipment providers should reap the benefits, rather than foreign suppliers.
An example of the kind of company we see benefiting from this is iRay Technology. It is engaged in the research & development, production, and sales of digital X-ray detectors. As a market leader in its field, it is well positioned to benefit from both the foreign substitution trend and increasing government spending in China.
In short, we see this year as one of recovery for Chinese shares as the key overhangs of the past few years are removed. Lifting the Covid lockdowns, providing support for the property sector, and a more stable environment for internet/platform company regulation are factors that can aid near-term recovery. But China can also count on the longer-term growth themes mentioned above. The key for investors will be identifying the specific companies who will be the winners.
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