In this interview with Citywire, Hong Kong-based Catherine Yeung, Investment Director, Fidelity China Special Situations PLC, gives a snapshot of a recovering China and what the latest earnings season tells us about businesses moving forward.
1. If we look at how the Chinese share market performed during past global downturns, is this time different?
During the 2008 global financial crisis, China unleashed a huge stimulus package and was very much deemed to be leading the global economy out of the situation. But that led to some inflationary issues, and obviously a marked rise in outstanding debt, which the Chinese government still needs to address today. This time around, we can look at the situation facing each country through three drivers. One of them being the flattening of the Covid curve, second the pace and sustainability of economic recovery and finally policy implementation.
China has really been able to contain the virus and subsequent breakouts with strict tracking and monitoring.
In terms of the economic recovery, manufacturing was the first sector to pick-up again and the consumer is looking relatively healthy with support from the government. Notably, the Chinese government wants the domestic demand story to be sustainable so there’s a push to ensure that the labour market is healthy and people spend again. If we look at domestic air travel for example, it’s recovered by 95%.1
Elsewhere, because of the disruption to supply chains, some of the exports previously coming from ASEAN countries have shifted back to China. This is likely a short-term trend, but it does highlight the issues facing a number of economies across the globe which are not as far advanced on the recovery curve as China. For this reason, we are closely watching export data for an insight into the health of the global economy - just because we’ve seen domestic demand pick-up in China, it doesn’t mean that the rest of the world will follow the same trend.
In terms of fiscal policy, as is usual for the Chinese government when it is concerned about growth, it tends to use infrastructure investment as a buffer. It is no different this time, apart from it’s a very targeted infrastructure investment. Take all this together, we do think that China is probably going to come out of the situation, both from an absolute and a relative point of view, better than others.
1. Source - South China Morning Post, September 2020.
2. What type of companies in China benefited or suffered the most from the pandemic?
It was a better than expected Q2 earnings season. Now, some of that was because we had a very weak first-quarter season, but we have recently seen positive revisions. The key area where you’ve seen upward trends is in new China names in areas like biotech and e-commerce. Meanwhile, Banks were the area where we saw weaker results, with the banking sector reporting the first year-on-year decline in net profits since the listed in the early 2000’s.
What’s been a really fascinating phenomenon in the market both this year and last year, is the narrow rally that has emerged - of note, investors have tended to gravitate towards biotech and big tech consumer-related names, which has aided Fidelity China Special Situations PLC due to its exposure to a number of consumer and tech-related names. On the flip side, value sectors and ‘old China’ names have significantly underperformed.
Some of the leading companies in the new China space like Alibaba will continue to gain market share. Internet companies have posted high margins quarter-on-quarter as well as year-on-year. Even when we were in lockdown in China, which occurred earlier than in the UK, companies were talking to us about the further acceleration of e-commerce, particularly in areas like online groceries where it is likely that habits will stick post Covid-19.
3. What kind of disruption have we seen in business models?
Within the consumer space, companies that a strong online and offline presence are being viewed as winners that are expected to gain further market share. Obviously, those companies with very strong brands where it’s very hard even in normal times to erode their market share continue to be market leaders, whether it’s Alibaba or Tencent or other non-ecommerce brands.
There’s a company in the portfolio called China Meidong, which is an auto company. It’s an auto distributor and has various brands such as BMW. Its business model is really intriguing because it doesn’t exist in the top-tier cities. During the big lockdown in March in the first earnings season, management were saying to us that pent-up demand was a likely scenario to play out, i.e. people needed to go and look at the car and test drive the car before they bought it. There was this expectation that those brands that had good brand recognition would only see a short-term earnings decline and this is now coming through with the likes of Meidong as people are spending again.
Online education companies continue to do quite well too with people spending more time at home. In fact they were doing well anyway as education has long been a key priority for Chinese families. This year we have seen more activity move online as offline services were forced to close down. Some companies have been unable to respond and the clear winners have been those operators with an integrated online and offline offering.
4. Let’s talk a bit about some unquoted firms in the trust. Why the interest and what’s the outlook for these firms?
The trust can invest up to 10% in unlisted companies which is a great advantage as we see companies generally coming to market later, not only in China but elsewhere across the globe.
Some of the names in the portfolio haven’t yet come to market because of various issues relating to market dynamics last year, but in general, this space is really untapped.
More recently, we’ve seen very strong initial public offering (IPO) issuance. Shanghai, for example, saw US$15.4bn in IPO proceeds over the first half of the year, which is way up on US$4.9bn in the same period last year.2 This trend is also evident in Hong Kong and Shenzhen and it is notable that these markets collectively saw the top three IPOs globally in the first half of 2020. There has been strong demand from both on retail and institutional investors, with some IPOs being oversubscribed multiple times.
In public markets, there has been a big shift towards growth and momentum in China, driven both by foreigners and domestic Chinese investors. This is likely to continue, but it is a concentrated trade and valuations look extended in certain areas. So, by investing in the trust you can diversify your exposure to China outside of the relatively small number of stocks that have been driving markets so far this year.
2 Source: Bloomberg, September 2020
5. We’ve seen A-shares opening up the market to international investors. Is that enough?
It’s gone unnoticed because of Covid, but the regulators have continued to focus on liberalising China’s domestic markets. The Stock Connect programme that links Hong Kong with China’s mainland markets has been around for a few years and has helped attract more international investors. We’ve also seen other initiatives include removing quota limits for qualified foreign institutional investors and relaxing equity financing rules for A-share companies.
The Star Board, or the Star Exchange, also opened last year to much fanfare. It’s only been around for just over a year and we’ve already seen over 190 companies either having listed or are in the process of listing. Star is a science and technology innovation board, the Chinese equivalent of Nasdaq.
While we’re still seeing Chinese companies list in the US, rising regulatory amid US-China tensions is making both primary and secondary overseas listings less attractive for Chinese firms. On the flip side, Chinese capital markets have grown tremendously over recent years and offer strong liquidity and a solid investor base for companies seeking to list.
As the make-up of the market continues to evolve, I think you’ll see an increasing number of both domestic Chinese and international investors look to Chinese asset markets to tap into China’s long-term growth story.
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