Chinese property, internet and consumer discretionary are three sectors primed for growth, while investors in the structurally well-supported electric vehicle story should focus on less-competitive parts of the EV supply chain, according to Colin Liang, Head of China Research and Investment Committee member for the Redwheel Emerging & Frontier Markets Team, and Portfolio Manager of the China Equity Strategy.
Key takeaways:
Speaking to advisers in Sydney and Melbourne recently, Mr Liang said the Redwheel China Equity strategy is now ‘maximum bullish’ on China, with the country’s property, discretionary spending and electric vehicle markets of particular interest.
The strategy took a similarly bullish position in 2020 when the COVID pandemic was establishing itself across the rest of the world. Mr Liang said that being the first to endure the virus, China was tipped to be the first country to emerge from the other side. By the end of 2020, the country was producing and exporting goods while the rest of the world imposed lockdowns to curb the virus’ spread. Mr Liang and his team then took an aggressively bearish stance through 2021, fearing Chinese authorities would use aggressive taxes to cool off the domestic economy after this relative economic strength.
Although the strategy was relatively neutral in its outlook for China until the later part of 2022, Mr Liang believes recent regulatory and political changes both within China and in the broader global market create a strong case for three segments of the Chinese market, in particular:
For much of 2021 and 2022, China’s property market has been in what Mr Liang describes as a “crisis”.
“At the beginning of 2021, property sales were overheated and the government was looking at the metrics and understood it as an asset bubble,” he said.
“They wanted to deflate that bubble in an orderly way. They started with an engineered slow down, but it got out of control.
“Property sales dropped significantly, which is very different to previous cycles that we’ve seen in past decade because it was compounded by Covid.”
During the lockdowns, Chinese citizens could no longer travel to other regions to purchase homes. At the same time, the pandemic cast a shadow of uncertainty over many peoples’ job and income security, leaving fewer people confident enough to commit to 30-year mortgages.
Towards the end of 2022, Chinese authorities began to realise the gravity of the situation and responded with unprecedented levels of support.
This stimulus is already stabilising the market across China, Mr Liang said, with ‘top tier cities’ such as Shanghai already receiving an influx of potential buyers. Even so, Mr Liang said his attention has been directed towards businesses exposed to the property market rather than developers themselves.
Mr Liang noted that after the property crisis famously left numerous Chinese developers (most famously Evergrande) on the precipice of bankruptcy through 2020–2022, many are now in positions where their balance sheet cannot be repaired.
Although the Redwheel China Equity strategy does hold some developers Mr Liang expects will survive, he said the approach to the property market is through what he calls “property derivatives”.
“We own financial property management services firms, which align by providing things like gardeners and delivery collection services.
“There's no balance sheet involved and the cycle is a kind of cash cycle. We also own paint companies which sell into the supply chain after it recovers. We also own water-proofing companies.”
Backed by more than a billion consumers, China’s internet sector has blazed a trail of innovation and dynamism. Nevertheless, the rapid growth, size and disruptive presence of the internet sector has also invited the attention of regulators. In 2021, there was a pronounced crackdown on the industry, impacting several notable, home-grown companies in particular. As a result, investors grew extremely concerned about the growth outlook and profitability profile of the industry, sending the sector valuation to an historic low.
However, given the focus of the regulations was to create long-term stability in the sector, and that the economy faces growth challenges as a result of 2022 Covid lockdowns, the Chinese government is unlikely to introduce new regulations.
“We have seen peak regulation.” Mr Liang said. He added that internet companies make up a big portion of the economy, and that there could be more support around the sector as it helps to drive consumption in China.
With better growth expectations and attractive valuation, the internet sector is a proxy play on China’s reopening and further consumption recovery.
Mr Liang said he was bullish on the electric car trend as early as 2018, with the strategy making its first investments in 2019. At the time, Redwheel was buying cobalt stocks to capitalise on supply chain challenges (such as the closure of Glencore’s Mutanda mine in 2019).
In mid-2020, the strategy started purchasing original equipment manufacturers (OEMs) as demand for electric vehicles began to grow. At the time, Mr Liang said, OEMs simply needed to offer a unique electric vehicle model to do well in the market.
In the intervening years, competition in downstream OEM markets has increased, and companies like Tesla are now facing a tougher market.
In China, Mr Liang said, there are now 15 local OEM models vying for top spot, with many offering better pricing than Tesla.
These conditions have soured Mr Liang’s view on OEMs, but battery manufacturers and other mid-stream businesses provide an attractive alternative, he said.
“If we look at battery assembly, we're moving from three players to maybe five players today,” he said.
“Battery separators which are harder to make, we're talking about four players globally to five players. So the competition's very much muted in the middle part of the chain but way bigger on the two ends of it.”
Mr Liang said he was bullish on the electric car trend as early as 2018, with the strategy making its first investments in 2019. At the time, Redwheel was buying cobalt stocks to capitalise on supply chain challenges (such as the closure of Glencore’s Mutanda mine in 2019).
In mid-2020, the strategy started purchasing original equipment manufacturers (OEMs) as demand for electric vehicles began to grow. At the time, Mr Liang said, OEMs simply needed to offer a unique electric vehicle model to do well in the market.
In the intervening years, competition in downstream OEM markets has increased, and companies like Tesla are now facing a tougher market.
In China, Mr Liang said, there are now 15 local OEM models vying for top spot, with many offering better pricing than Tesla. These conditions have soured Mr Liang’s view on OEMs, but battery manufacturers and other mid-stream businesses provide an attractive alternative, he said.
“If we look at battery assembly, we're moving from three players to maybe five players today,” he said.
“Battery separators which are harder to make, we're talking about four players globally to five players. So the competition's very much muted in the middle part of the chain but way bigger on the two ends of it.”
Mr Liang flagged discretionary spending as another area of interest. In the wake of the Covid pandemic, he said, the People’s Bank of China sought to stimulate the economy by loosening fiscal policy and injecting liquidity back into markets.
Unfortunately, much of this additional capital found its way into savings accounts rather than storefronts – reflecting similar trends in Western markets.
Over the past three to four months however, many of the uncertainties which had plagued Chinese households during the pandemic have started to ease – which Mr Liang expects will translate into greater discretionary spending, especially in the travel sector.
Mr Liang pointed to the January consumer credit figures as evidence of this, noting that these numbers were incredibly strong even removing the Chinese New Year effect.
Looking to capitalise on this spending, which Mr Liang expects will take place over the next 12 to 18 months, the Redwheel China Equity strategy has taken positions in Chinese-based online travel agencies, Macau-based gaming companies, and duty-free providers.
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