Certain key structural trends were highlighted during the much anticipated 19th Party Congress last October 2017 and we view that they offer investment opportunities with incredible upside over the medium to long-term. We will focus on sectors that are set to benefit from these structural trends and avoid sectors that are likely to experience structural headwinds.
We are constructive on the consumption, environmental protection and information technology sectors but are cautious on real estate sector. While IT will offer medium and long-term structural solid growth, investors will have to be mindful of the valuations. We view any share price pullback in the IT sector as potential accumulation opportunities.
Meanwhile, we expect supportive policy measures to be gradually announced going into the next year. The emphasis on industry and economic reforms will continue to shape a new era for China in the coming years.
Quality of Growth vs Speed of Growth
The quality of China’s growth – instead of the speed of growth – was heavily emphasised by the new leadership team at the recent 19th Party Congress. An ambitious two-stage long-term development plan was tabled, which aims to transform China into one of the leading countries in innovation by 2035 with a sizeable middle-income population. By 2050, China will become an advanced socialist country with leading global influence.
Positive structural trends for consumer, environmental protection and IT sectors
President Xi outlined the importance for China to find new growth momentum in areas like medium and high-end consumption, and to facilitate the transition towards a consumption-based economy with a sizeable middle-income population. This could lend further support to domestic consumption growth. China’s domestic consumption has remained buoyant with consumer confidence index staying on its uptrend. In our view, this trend should be well supported by solid growth in income. The average income of urban and rural residents has been growing at a compound annual rate of 10% and 13% respectively over the past decade.
With this in mind, we prefer WH Group (288 HK) and YUM China (YUMC US) within the consumer sector. We also see opportunities to accumulate Ctrip (CTRP US), as the travel service company will be among the key beneficiaries of rising middle class income in China and a key player in the new economy.
Technological innovation has become one of the decisive factors for China’s growth and the quality of that growth going forward. There has been a heavy emphasis on the ability to innovate and to integrate internet, big data and artificial intelligence. As labour costs continue to rise, robotics revolution will also become important for industries upgrade. At the same time, financial technology has seen a rapid development, in response to China’s fast e-commerce penetration and under-served retail banking customers.
Environmental protection is another area of focus for the Chinese government, with priority on water conservation and the fight against air and soil pollution. Further clarity on policy support in addressing environmental issues would provide catalysts for this lagging sector to catch up with performance. We like China Longyuan (916 HK) and see a positive catalyst from further clarification on the mandatory green certificate requirement before the law kicks in next year. The stock is trading below replacement cost and book value with an improving return-on-equity. We also like Beijing Enterprise Water (371 HK), which is trading towards the low-end of valuation, and is a top player and key beneficiary in the sector. On-going improvements in cash flow and account receivables could be a positive performance catalyst.
Chinese real estate market
Amid rising home prices, the view that housing is for accommodation and not for speculation was reiterated at the 19th Party Congress. The government also vowed to set up a system with supply from various parties. We continue to be bullish on the sector although do not expect any loosening in property regulatory policies in in the near term. Real estate has been the best performing sector in 2017, having risen by 96% and substantially outperformed MSCI China. We see that the rising Chinese middle class will continue push the broad real estate market higher. Within the sector, investors should be selective and focus on beneficiaries of the governments promise for more affordable housing such as China Overseas Land (688 HK) and Country Garden (2007 HK).
Stocks in focus
We are keeping a watch on our teams best stock picks such as: Beijing Enterprise Water (371 HK), China Longyuan Power (916 HK), China Overseas Land (688 HK), CTRIP.COM (CTRP US), WH Group (288 HK), YUM China (YUMC US), and Country Garden (2007 HK.) These have seen substantial gains in the past months and unless macroeconomic factors change, they will continue to outperform the broader market given their competitive advantages in the Chinese market.