Searching for Scarce Chinese Investments

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In the late 1980s and 1990s, China began attracting significant foreign investment and developing its manufacturing industry, gradually emerging as the world’s factory for various low-cost manufactured goods. Today, after two to three decades, while low-end industry chains are shifting to countries with even lower production costs like Southeast Asia, Chinese manufacturing still dominates many light industry manufacturing sectors, with toys serving as a typical example.

More than 70% of the world’s toys are produced in China. Yet, can you name one or two Chinese toy brands or manufacturers? Most people probably cannot. If you can name any Chinese toy manufacturers, you are likely working in the procurement department of an international toy brand. The world’s most famous toy brands mostly hail from the United States, followed by Denmark, Japan, and others. It is believed that most of them have factories in China or source toys from China. To those who procure toys, it doesn’t matter whether the toy manufacturers are well-known; they care most about the products’ quality, price, safety, production capacity, reputation, and the workers’ working conditions. If these criteria are met, they are willing to purchase from the manufacturer. This indicates that many Chinese companies are excelling in these aspects, enabling China to become a toy powerhouse.

The export of manufacturing goods like toys has indeed created a large number of employment opportunities in China, greatly driving economic growth in the early stages of opening up. However, with changes in China’s socioeconomic and demographic structure, the Chinese manufacturing industry needs to continue transforming and upgrading to better adapt to the new environment. In fact, in some relatively complex industrial manufacturing sectors, China has already become one of the world’s best. Though due to the nature of these industries, China’s prevalence is not necessarily known to the general public.

One such area is engineering machinery. One Chinese company we’ve been following is the world’s leading manufacturer of excavators and concrete machinery. While most of China’s toy factories are original equipment manufacturers (OEM) for international brands, this engineering machinery company has become an international brand itself. Many years ago, when this company was founded, the domestic engineering machinery market was dominated by American and Japanese brands. However, as this company gradually produced products that were cheaper, of good quality, and fully functional compared to its competitors, coupled with its excellent customer service, its market share in China continued to rise until it became the industry leader. Since then, it has expanded beyond China and penetrated overseas markets. According to its 2022 annual report, the company’s products are exported to more than 50 countries and regions worldwide, with the fastest-growing regions being the United States and Europe. Overseas sales account for 27.2% of its total revenue, and the gross profit margin in overseas markets is higher than in China. This indicates that the company is not merely dumping its products overseas; its products have a considerable competitive edge to increase market share in foreign markets. For investors who are somewhat pessimistic about demand in China but find Hong Kong stocks attractive in terms of valuation, it may be worth paying attention to these companies that achieved certain success in expanding overseas. It’s not just the engineering machinery industry; there are also such companies in the medical equipment sector.

Overall, these companies that have successfully ventured abroad with their own brands undoubtedly have more investment value than toy factories that only engage in OEM manufacturing for others. Ordinary consumers won’t know which Chinese manufacturer produces the toys they own. Consumers only pay attention to toy brands, and brands can easily switch to another Chinese or even Vietnamese supplier without customers noticing, as long as the quality and price are maintained. However, those brands with the name of a Chinese company printed on engineering machinery and concrete machinery need to maintain product quality for many years to gradually gain the trust of industry professionals and then expand overseas. However, these brands are only recognized by industry insiders and may not yet be considered “internationally renowned brands.” Is China capable of nurturing such internationally renowned brands?

Recently, a fund manager representing a large asset management company in Ireland came to Hong Kong to search for Chinese fund managers. During our office conversation, we talked about how he was about to welcome a child, so he needed to buy a new car. Like many people, he mostly considered electric cars when buying a new car. After careful research on American, European, and Chinese brands sold locally in Ireland, he believed that Chinese cars offered the best value for money. At the same price point, Chinese cars had better endurance and were not inferior in appearance or other features. Although he eventually chose an American car due to considerations about rear trunk space, he now views Chinese cars in a different light.

Indeed, many consumers worldwide have invested real money in Chinese electric cars. Taking one company as an example, in its mid-year report for 2023, it revealed that its market had expanded to more than 50 countries and regions globally, with sales ranking among the top in some regions. For example, one of its models ranked first in sales for seven consecutive months among all models (not limited to electric cars) in Israel; in Thailand, this model’s market share reached 39% from January to May; in Australia, this model ranked third in national electric car sales in April 2023, only behind Tesla’s Model 3 and Model Y. In other regions such as Singapore and New Zealand, the brand also achieved good sales performance. As automobiles are one of the largest consumer expenditures for most people, purchases are usually made after detailed analysis, comparison, and collection of user feedback. Therefore, achieving such overseas performance is not easy.

In the past few decades, the development of the Chinese economy and Chinese companies can be described as unstoppable. However, companies with the potential to become international brands are still few and far between. Therefore, investors should pay more attention to finding these companies with unique capabilities and scarcity.

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

In respect of any discrepancy between the English and Chinese version, the English version shall prevail.

Prospects for the Chinese Economy

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The economic prospects of China have been a subject of extensive debate among global media outlets and economists. Opinions range from optimism to pessimism. Two months ago, Martin Wolf, a senior columnist at the Financial Times, presented a thought-provoking article titled “We Shouldn’t Call ‘Peak China’ Just Yet.” In this piece, he offers a well-rounded perspective on the challenges and potential advantages facing China.

Wolf’s argument can be neatly segmented into three key areas. First, he provides insights into China’s current GDP per capita. Remarkably, China’s GDP per capita stood at a mere 2% of the United States’ 42 years ago. After approximately quadrupling, it reached 28% of the US in 2022, equivalent to about half of Poland’s GDP per capita. Should China attain Poland’s level, its total GDP would surpass that of both the US and the European Union combined. To provide context, South Korea’s GDP per capita in 1988 was similar to where China stands today. It took South Korea 19 years to double its GDP, reaching Poland’s current level, with the challenge of the Asian financial crisis in between. If China follows a similar trajectory, doubling its GDP per capita within 19 years, it may match Poland’s level in the 2040s.

Second, he acknowledges the concerns of investors regarding China’s economic prospects. Historically, China’s economic growth has been heavily reliant on fixed asset investments, notably in the real estate sector. Any measures to curtail the real estate industry are bound to affect the broader economy and amplify the vulnerabilities in the financial system. When compounded with factors like an aging population, tense international relations, and other variables, these issues do raise valid short-term concerns.

Third, Wolf emphasizes that investors should not be overly pessimistic about China’s economic outlook. He draws parallels with South Korea, which navigated a debt crisis in 1982 and the Asian financial crisis in 1997. During these periods, many held bearish views on South Korea’s economy. However, post-crisis, South Korea’s economy continued to thrive.

At the end, Wolf also pointed out that it is worth remembering the strengths of China, such as the nearly 1.4 million engineer graduates each year, a strong entrepreneurial culture, and leadership in certain fields, like electric vehicles. Wolf believes that China’s technology sector has long been ahead of Europe.

Beyond Wolf’s well-reasoned arguments, there are additional economic advantages that China can leverage. As specialized fund managers in China, we’d like to underscore a few more strengths.

First, China’s current infrastructure surpasses that of many emerging countries and remains competitive even when compared to developed nations. This positions China as an attractive destination for foreign investment. Once foreign investors regain their confidence, China’s appeal will shine once more.

Second, on a global scale, only the Chinese market boasts a level of uniformity and scale comparable to the US. China’s single legal system, tax structure, consistent trade rules, and shared language across the nation make it favorable for businesses. This uniformity enables companies in China to enjoy economies of scale, resulting in higher returns on investments compared to smaller countries. Companies that excel in the Chinese market also gain a competitive edge in dominating other markets. This phenomenon is why the US hosts more large multinational corporations than any other country in the world. We firmly believe that China has the capability to nurture more multinational corporations in the future.

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

In respect of any discrepancy between the English and Chinese version, the English version shall prevail.