The heroic age of building in China which stretched from 1980 up to 2015 and even today, may be coming to an end. China today is a modern consumer economy similar to European countries (or Japan or Korea), with a large middle class, and consumption representing 60%+ of the economy compared to 40% a few years ago. Exports have fallen from 37% of GDP in 2006 to about 17% today, so the impact of potential trade tariffs is less than it was a decade ago.
Recently during a visit to Beijing, I learnt from many meetings with senior policy makers in Bank of China, State Administration of Foreign Exchange (SAFE) and China Investment Corporation (CIC), that the senior leadership is very confident that a compromise will be reached with President Trump in the next few weeks and that a trade war will be averted. This could indeed lead to a big rally in share prices both in New York and in Shanghai.
One fascinating area of research (and for us of long term investment) is the medical or healthcare field. Joseph Needham in his great work ‘Science and Civilisation in China’ established that almost every medical breakthrough occurred in China 500 years before Europe. Today, we have the uniquely positive set of circumstances whereby many Chinese PhDs from Stanford, Yale and Harvard are returning home and establishing new biotechnology businesses with world class standards, and scientists, involved. Among the companies we have already identified are Jiangsu Hengrui, CSPC and Wuxi Biologics, a major contractor with 240 drugs in the pipeline. Last week, we also visited BeiGene in the Life Science Park 20km north of central Beijing. It already has a capitalisation of US$11 billion with the promise that 3 important oncology products will be approved by the end of 2018. This is a Nasdaq listed company with important US shareholders, such as the Baker Brothers and Hillhouse Capital, other hedge funds, and even Merck. There is no doubt of its quality and of its potential, but to us it is a sign of the future trend in China. More and more biotech companies are coming to market, especially now in Hong Kong where the stock exchange has eased its listing rules to allow start-up biotech companies to list.
In the expectation that the trade talks will be settled, we are also optimistic about the technology sector in China. The news that Trump has relented on ZTE is important because it enables Chinese companies in the field of telecommunications and computer software to forge ahead even though China is still woefully short in its own national semiconductor manufacturing production.
Another key area of growth in China is domestic tourism. In the first quarter of 2018, 127 million domestic flights took place in China, a growth of about 11.5% from 2017. The expectation is that 550 million people will take flights in China this year, growing to 720 million by 2020. Including train travel, the figure rises to 1.3 billion. There are now 140 airports in China, accounting for most of the cities with over 1 million population. This is one reason we have focused on the hotel sector in our investment portfolio. By contrast, we have avoided the airlines where the advent of low-cost carriers will put pressure on profit margins.
The digital payment industry in China has also grown at an extraordinary pace since 2011, rising from US$15 billion that year to US$9 trillion today, or 80 times more than the USA, with the expectation that total mobile payments in China will reach US$47 trillion by 2020. Of course, this means that with the demise of cash, Chinese authorities, with the assistance of AI and big data technology, can track every payment and every e-mail that each citizen makes on a daily basis. Already 4 million Chinese individuals have been either denied travel permits or other benefits because of their low “civic score.”
I was also interested to discover that at very senior levels, there is a strong focus on Blockchain, and financial technology, in part because of the size of e-commerce and the on-line payment industry. There is a strong emphasis on security among the Beijing leadership; and even though there are very high transaction volumes, it is quite “transparent.” The leadership is also confident about the gradual resolution of the trade issue with GDP growth maintained at 6.5%, money supply at about 12%; and the debt ratio slowing down. Savings are still 45% of GDP, and most Chinese people like to own their own apartments, generally without large mortgages. (One major change could be a property tax, which has been widely discussed.) The government policy is, to open up to foreign ownership, most of the financial sector, including banks, insurance, and fund management; but there is no big rush on the part of foreign banks. The A Share market is generally undervalued, with banking shares under 1 times book, and many technology companies, growing at higher compound rates than their P/E multiples. The Hong Kong-Shanghai Connect has been a successful experience bringing in more capital into China. Now the authorities would like to see many of the big companies, such as Alibaba, which have New York listings, return to China, with the development of China depository receipts (CDRs instead of ADRs).
With the growth of this e-commerce market, I had expected to see physical retail spaces deserted or declining. In fact, some of the more up-market (up-scale) glitzy shopping centers in Beijing still maintain a high foot traffic, with not only international brand names, but also many new Chinese fashion brands restaurant chains. Dining out is now the most popular activity among young Chinese. Many of the millennial generation are less interested in accumulating material goods than having “experiences.”
It seems unlikely that Trump’s trade pressure on China will do much to break its rapid progress. In the 10 key sectors highlighted by the government in “Made in China 2025” – IT, robotics, aerospace, ocean engineering, railway equipment, electric vehicles, power equipment, advanced agricultural machinery, new metals and materials, and biotechnology – China is already making rapid progress; and much of the research is now taking place in laboratories in the major coastal cities, attracting some of the top Chinese scientists back from the US to work in good conditions with good salaries.
Robert Lloyd George
1 June 2018