LTGG Reflections: Year of the Dragon

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The major change I detected was one of local sentiment. There were many more conversations about the travails of the property market, exports, the ageing population and lukewarm consumer confidence. This is unsurprising given an economy where the average growth rate has halved from the heady days of 8-10 per cent growth to a still respectable mid-single digit rate now. Perhaps most notable was the lack of confidence in the government to solve economic problems – a shift in the long-term bargain between the Chinese Communist Party’s legitimacy and its ability to provide ‘chuda’ – a better life.

The mood on regulation was more positive, with a sense of calm after the storm of the last few years. The recent sacking of an official who had tried to impose more gaming restrictions was cited as emblematic of a more market-friendly approach. However, we should keep in mind how quickly things can change in either direction.

Western bearish sentiment prevails, with several companies mentioning that we (Baillie Gifford) were the first foreign visitors they’d seen in a long time. The contrast with ‘standing room only’ at Indian conferences could hardly be starker. Many are hesitant to invest in China, it’s a lonely place to be an investor. Despite the prevalent pessimism, I found companies' progress exciting. We checked in with current holdings and met some wonderful companies not currently held in the portfolio.

PDD Holdings

Temu is PDD’s online marketplace that offers heavily discounted consumer goods shipped directly from China. Since its launch in September 2022, it has expanded to a staggering 50 countries and plans to hit 60-70 soon. Culturally, PDD is fascinating. The average employee is 26, and the idea for Temu bubbled up from its ranks.

The management thought Southeast Asia was a dull start for this new business, so went to the US, and demand exploded after the company’s Superbowl ad in 2023. PDD's ‘old’ business is progressing well, reaping the rewards of building traffic with a cost per transaction that is very hard to replicate. The Chinese ecommerce market is the world’s most difficult, but PDD has won here and is now taking on the competition globally.

NIO

It is well documented how difficult the electric vehicle (EV) market has been in China. NIO’s vaunted competitive advantages in brand and battery swap technology have failed to stem the wave of new entrants. It is worth noting that EVs now represent one-third of all new car sales in China. The industry has government backing, which has led to cut-throat competition. While NIO deliveries were up 30 per cent in 2023, the company is still a small player. As such, to capture share, it is pivoting its strategy, concentrating on fewer NIO branded models and spreading fixed costs across two mass-market brands – Alps and Firefly (codename) with a target blended margin of 20 per cent. I think the strategy of taking on BYD in the mid-market is an interesting one. I think a bit of patience is required to see what the company conjures up.

Meituan

Xing Wang, the chief executive, was subdued. He has clearly been affected by the company’s relentless share price decline despite decent operational progress. He perked up as we discussed Meituan’s growth prospects – the core food business is pretty settled with a majority market share, while management is excited about grocery delivery (there are no national supermarket competitors in China) and the new area of pharmacy delivery. These should all be positive for network efficiency. He was also upbeat on how well the company has been able to do in Hong Kong, taking market share from two sleepy incumbents.

As for the companies we don’t hold, I was able to meet with MiraclePlus, a start-up accelerator; Little Red Book, a social media and ecommerce platform; Luckin Coffee, China’s largest coffee chain; KuaiShou, an online video platform and LONGi, a solar solutions provider. These are intriguing companies that we will continue to monitor.

So, where does this leave my thinking? Our task is a relatively simple one – investing in stocks that go up. Carrying out this job is harder because of the pesky issue of valuation – what is in the price? An unknowable a priori question. For China, the current question is how much of a discount can we tolerate before mistrust spills over into pariah status? Of course, there is a non-zero risk that China becomes effectively uninvestable, and we are left with a gaggle of companies on 1x earnings growing at 20-30 per cent. This reductio ad absurdum illustrates the point. We are being asked to pay very low multiples for what appear to be solid growth opportunities. Some will be ephemeral because of the competitive jungle that China represents, but for the long-term winners, it appears that the rewards on offer to patient investors will be outsized and the risks worth taking.

It is conceivable that China de-rates further or just tracks sideways at Korean-like multiples. In this latter scenario, I think we still make patient money. One comment that stayed with me from the trip is, “The new China is only thirty years old and is only starting to enjoy its wealth rather than just creating it.” I remain comfortable having exposure to the Chinese companies in LTGG. Given the quality of growth and opportunity on offer, I feel more than compensated by valuation and will remain patiently bullish.

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