Why growth investors can't ignore China

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Capital at risk

China matters. It’s the world’s second-largest economy, an important source of global demand and has rising diplomatic influence, particularly in Asia.

“As a global investor, even if you choose not to invest directly in Chinese companies, you can’t ignore the country because you can’t understand the world without understanding China,” says investment manager Helen Xiong on our Short Briefings on Long Term Thinking podcast.

“Global supply chains depend on it, it’s home to some of the leading technology companies, and the green energy transition will only be possible if China plays a leading role.”

Yet until recent stimulus measures, the markets had focused on China’s relatively weak GDP figures, construction industry troubles and lacklustre consumer spending.

Xiong acknowledges that China has not shared the post-Covid recovery enjoyed by many of its Western counterparts. But as an investor on the Global Alpha Team and joint deputy manager of The Monks Investment Trust, she sees an opportunity in a sector that is one of China’s government’s highest priorities.

“China is laying the foundations for advanced manufacturing,” Xiong says. “It’s trying to move away from low-value sectors like property building into what’s a higher-value and ultimately higher-return activity.”

This favours firms involved in cleantech – including solar panels – robotics, advanced medicine and agricultural technologies. But it’s perhaps most apparent in how China leads the world in new energy vehicles (NEVs), a category including electric cars and, to a lesser extent, those powered by hydrogen fuel cells.

Overcoming overcapacity

Domestic sales of NEVs overtook conventional auto models for the first time in July, and an industry body has forecast that total production will reach 11.5 million vehicles this year. That’s a 20 per cent gain over 2023. No other country comes close.

The Chinese government has provided support via tax breaks and subsidies, and the installation of more than 10 million charging points has further helped.

Yet despite rapid growth, fears about overcapacity have deterred some from investing in the companies involved. But Xiong suggests that is a short-term issue.

“We know as companies scale production, their manufacturing costs fall, which means their prices can come down, creating further demand,” she explains, expanding on a point first discussed in her paper China: finding the new shoots of growth.

“Initially, all these new companies get a lot of state support, but eventually, the poor ones will be outcompeted by the more efficient, innovative players, and you’ll get market consolidation. In the meantime, all the learnings and intellectual property these Chinese companies gain should build up their competitive advantage.”

If only the best survive, investors need to be picky. In Xiong’s case, that means investing in Li Auto, one of only three global firms currently making electric vehicles at a profit.

“Li Auto has pioneered a solution to ‘range anxiety’ by putting a small combustion engine in its cars, whose sole purpose is to charge the battery when depleted,” says Xiong. “Its EREVs [extended-range electric vehicles] use little or no petrol on most daily commutes but are cheaper to make than other electric vehicles as they don’t need as much battery storage for long journeys.”

That means Li Auto can provide customers with other premium experiences without an excessive price tag, as Xiong experienced in Beijing.

“The whole vehicle is voice-controlled. When I asked it to turn on my back massage, it understood where the sound came from and only activated my seat. There are also hand-gesture-controlled entertainment screens and a mini-fridge in the back.

“People in China talk about these cars being to the automotive sector what iPhones were to mobiles. I don’t think I fully internalised it until I test-drove one for myself.”

Trade barriers

CATL also features in the portfolios Xiong manages. The Chinese company made 37 per cent of the world’s electric vehicle batteries last year, more than double its nearest rival. There is also growing demand for its other products, including equipment to store renewables-generated energy.

Xiong is mindful that the EU and US have increased tariffs against some of China’s advanced manufacturers. However, the risk is relatively contained in these cases.

“Li Auto is mostly a domestic story,” she says. “CATL does sell to Europe but manufactures there, with plants in Hungary and Germany, so a lot of the restrictions won’t apply.

“But ultimately, it costs 40 per cent more to make a car in Europe than it does in China, and we as a society have to decide whether we’re happy to pay that cost and risk delaying our green energy transition or whether we accept that China has a role to play.”

The potential for retaliatory Chinese trade restrictions has, however, influenced Global Alpha’s decision to reduce its exposure to some Western companies whose investment case depended on continued sales to China.

“Rising trade barriers are an inevitability,” says Xiong. “So we’ve reduced or sold out of companies including cosmetics maker Estée Lauder, sportswear firm Adidas and drinks producer Pernod Ricard. We now favour instead companies that are ‘local-for-local’.”

Stimulus

Recent stimulus from China’s central bank, government agencies and regulators – and rumours of more to come – has boosted Chinese share prices and sentiment. However, Xiong says her focus on five-year-plus time frames means she’s looking for signals of enduring change.

“The announcements I’m most interested in are about encouraging mergers and acquisitions and companies to pay back more cash to shareholders,” she explains.

“I wonder if policymakers are trying to learn from Japan’s reforms, which encouraged firms to raise corporate governance standards and care more about shareholder returns.

“That’s led to many Japanese companies’ valuations increasing significantly. But it will take time to know.”

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You can read more about investment opportunities in China in Helen's article: China: finding the new shoots of growth.

Words by Leo Kelion

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