This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Diamond Lee, manager of the Ignis International China fund, highlights the future outperformers.
There is a parallel universe whereby large state-owned behemoths continue to dominate traditional sectors such as energy, telecom, and banking. At the same time, the most exciting and fastest growing companies often operate in service and consumer sectors.
In contrast to the state-owned giants, this new breed of companies are privately owned, motivated, and have management teams which have the ability to plan and execute growth strategies
Tencent
Tencent is the largest internet company in China, as measured by profits and the number of active users. Tencent provides a suite of internet services including social media, mobile games, and electronic payments. The internet industry requires a large user base to justify costly research and development projects, and the Chinese market is ideal from that perspective. Its development is also encouraged by a government which does not want to rely on Western internet providers for national security reasons.
Tencent has the financial resource to run multiple projects costing hundreds of millions US dollar at a time, which is key in an industry known for fast paced progress. For example, user profile analytics is complex but vital in providing advertisers with information about their target audience. Tencent is currently the largest holding at over 8% of the fund.
51job
Another example of the developing technology theme in China is 51job, an online recruitment platform targeting the growing number of white collar workers. There used to be many competing websites but 51job emerged from a fierce war to become the number one player in a now consolidated market.
Great Wall Motor
Great Wall Motor is a domestic auto brand specialising in sport utility vehicles (SUVs). A few years ago an emerging urban middle class grew rich enough to buy their first cars, which were small, low cost and low quality. These car owners are now upgrading to their second car and want a higher quality product but one which they can still afford. Being a local player, Great Wall has positioned its products well to reflect this demand profile.
Brilliance China
In contrast to Great Wall, Brilliance operates at the highest end of the auto sector as BMW’s joint venture partner in China. It produces 3 and 5-series cars and the X1. Margins are rising along with production standards, as more and more key components are made within China instead of being imported from Germany.
AIA
AIA is unique in having a broad collection of full life insurance licences across Asia, from Malaysia to South Korea. Demand for more sophisticated financial products is rising as wealth builds. AIA’s new business value in China is growing more than 25% a year, and even in more developed economies in Asia such as Singapore, new business value is still growing at 13%.
Key risks to Chinese economic growth
Although there is huge potential in certain segments, the country as a whole needs to face up to a number of challenges. For example, there has been wasteful investment, particularly at the local government level. In addition, overcapacity has been built up in some low value added industrial sectors (such as steel) as a result of low interest rates and loose monetary policy. The banking sector – which financed these investments – needs better regulation to ensure stability for the financial system.
The economy needs to continue to shift from a central command economy to a more free-market model. And a one-party political system is not one which fosters creativity and open debate is essential in building knowledge and extending the country’s long term capability.
Finally, the one child policy in China will become a negative as the working population is peaking. However, it is very likely this policy will be gradually relaxed over the next few years.
China is entering a period of reform which is potentially very good news if executed well, for it will mean more efficient allocation of resources and a more robust financial system. However, reform is seldom without pain. There will be casualties in the reform process, as well as emerging winners which will give rise to investment opportunities. There are many things which can be done better in China, and good companies have lots of room to add value and make good returns in the process.
