China’s Market Enters the Era of Increasing Shareholder Returns

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During the recently concluded mid-year earnings season, China’s internet companies generally reported stable growth, with their shares reacting positively. However, the fastest-growing company in the e-commerce sector took an unusual approach. Despite its second-quarter financial report showing an 86% year-on-year revenue growth—impressive enough to satisfy the investment market—the company delivered a major disappointment during its earnings call. First, it stated that, due to intensified competition, its long-term profitability might decrease. More significantly, the company announced that it would not engage in any stock buybacks or dividends for the coming years.

It’s no secret that competition in the Chinese consumer sector is increasing, and many companies have offered pessimistic outlooks to temper investor expectations. Therefore, the subdued outlook did not cause the biggest shock. What really triggered a backlash was the company’s clear declaration that it would not pursue buybacks or dividends.

According to the Financial Times, the company has a staggering $38 billion in cash on hand, the largest cash pile of any listed company that does not pay dividends or buy back shares. This $38 billion is more than twice the size of the nearest contender, Tesla. Given these factors, it is no surprise that this company’s stock price plummeted by 30% within a week.

Stock Buybacks Gain Popularity Among Chinese Firms

Investors familiar with China’s market trends may have noticed that actions aimed at increasing shareholder returns, such as dividends and stock buybacks, are no longer exclusive to traditional industries. Internet giants like Tencent, Alibaba, Xiaomi, and Meituan have all carried out massive buybacks in the Hong Kong stock market this year. These companies, whose stock prices have dropped significantly from their peaks, are signaling to the market that their shares are undervalued, and they are confident about their future development.

It’s not just internet companies—there has been a wave of buybacks across the Hong Kong stock market this year. According to Wind data, as of the end of August, 223 companies had executed buybacks, 83 more than the same period last year. The total buyback amount reached 180.4 billion RMB, a 174% increase from the previous year[1].

Companies that conduct buybacks often see better stock performance. The S&P 500 Buyback Index, which tracks the top 100 US companies with the highest buyback ratios, outperformed the broader S&P 500 in 16 of the 20 years leading up to 2019, with an average annual outperformance of 5.5% over the period.

Reforms Resolve around Increasing Dividends

In addition to stock buybacks, the number of companies paying dividends in both the Hong Kong and A-share markets has reached record highs. According to the China Association for Public Companies, as of the end of August, 677 A-share listed companies had announced plans for first-quarter or semi-annual cash dividends, nearly 500 more than in the same period last year. Additionally, 480 companies are distributing interim/quarterly dividends for the first time in five years. In the Shanghai Stock Exchange STAR Market (Sci-Tech Innovation Board), 80 companies paid interim dividends, five times the number from last year.

In terms of dividend size, state-owned banks, energy companies, and utilities lead the way. State-owned enterprises (SOEs) generally have higher dividend payouts than private companies, and they have significantly increased their payout ratios over the past 15-20 years. For instance, in the 2002 fiscal year, China Mobile and CNOOC distributed 20% and 25% of their profits as dividends, respectively. By the 2022 fiscal year, these payout ratios had increased to 67% and 43%. The latest round of SOE reform, which began in January last year, also revolves around increasing shareholder returns.

Similar to companies that aggressively repurchase shares, firms that are generous with dividends also tend to have better stock performance. The CSI Dividend Index, which tracks 100 large and medium-sized companies with stable dividend payouts, outperformed the CSI 300 Index by more than 10% in 2023 and recorded a smaller year-to-date decline in 2024[2].

China’s Dividend Theme Is Still in Its Early Stages

Although dividend payout ratios of Chinese companies are generally on the rise, they still have substantial room for improvement compared to global markets.

Over the past five years, Chinese companies’ dividend payout ratios have averaged 30%, compared to the global average of 48% and Europe’s 64%. Chinese companies’ payout ratios are not only lower than those in developed countries but also below other Asian markets such as Singapore, Malaysia, Thailand, Indonesia, and India. In fact, Chinese companies’ balance sheets are strong—excluding the financial sector, Chinese listed companies hold 18 trillion RMB in cash, accounting for 23% of their market value, indicating room for higher dividends.

Goldman Sachs believes that China’s high-dividend theme is still in its infancy. With policy support, increased free cash flow, and interest rate cuts as catalysts, dividend-paying assets could become a long-term structural trend.

From a supply perspective, the transformation of China’s economic growth sets the stage for dividend stocks. As China’s economic development enters the next phase, the quality of growth will outweigh the quantity. With growth slowing down, growth stocks’ valuation expansion becomes harder to achieve. Oversupply and overcapacity in many industries also make aggressive expansion less advisable, so more profits can be used to increase returns for investors.

From a demand perspective, as China’s population continues to age, there will be growing demand for stable, reliable dividend stocks. Coupled with policy support and improved market mechanisms, the theme of increasing shareholder returns appears promising for the future.

[1] Source: Wind, as of August 31 2024

[2] Source: Bloomberg, as of August 31 2024

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.

What is China Considering by Re-emphasizing the Attraction of Foreign Investments?

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At this year’s Third Plenum, much attention was drawn to the frequent mention of “security” in the post-meeting communiqué, leading some to believe that the government is shifting its focus from economic growth to national security. However, the words “reform” and “opening up” appeared far more frequently than “security.” Additionally, the communiqué revived a long-absent term—”foreign investment.” The 18th and 19th Third Plenums did not mention foreign investment, so its re-emergence is a noteworthy signal for investors.

Over the past year, the central government has introduced a series of measures aimed at re-attracting foreign investment. In August 2023, the State Council issued “Opinions on Further Optimizing the Environment for Foreign Investment and Increasing Efforts to Attract Foreign Investment,” outlining multiple approaches to make it easier for foreign investors to do business and invest in China. In October 2023, at the Third Belt and Road Forum, the government also announced the removal of restrictions on foreign investment in manufacturing, effectively opening all sectors to foreign investors (previously, there were still significant restrictions in areas such as publishing and traditional Chinese medicine). Furthermore, to make it easier for foreign businesspeople to enter the country, the Ministry of Foreign Affairs announced visa-free entry for citizens of six countries, including France, Germany, and Italy, in November last year, along with a general relaxation of visa application and transit visa policies for other passport holders. It is clear that the re-emphasis on foreign investment at this year’s Third Plenum is not an isolated event; the government had laid considerable groundwork beforehand. Against the backdrop of sluggish economic growth and weak private investment, the importance of retaining and attracting foreign capital has significantly increased.

Foreign investment has played an indispensable role in China’s rapid development over the past half-century.

In the early stages of China’s opening up, foreign investment represented the most advanced technology. Foreign companies brought to China their advanced experience in building factories, production, management, and new business models while investing in the country. For foreign investors, China offered not only cheap labor and a vast market but also tax incentives from both central and local governments eager to attract foreign capital. Initially, the influx of foreign investment was concentrated in manufacturing, gradually expanding to consumer goods industries such as food, beverages, home appliances, and automobiles. For a long time, China held a leading position globally in receiving foreign direct investment (FDI).

Before 2000, the average annual growth rate of foreign investment in China exceeded 20%. From 2000 to 2010, this growth rate slowed to around 10% annually, but considering the base effect, this was still rapid growth. After 2010, the growth rate of foreign investment slowed to single digits. By 2023, China’s net outflow of FDI reached $152.5 billion, and the actual use of foreign capital nationwide fell by 8% compared to 2022.

In fact, the exodus of foreign capital began before the pandemic, but the sharp decline in 2023 brought it to widespread attention. Before the pandemic, foreign investment shifts were primarily driven by cost considerations—as labor and land costs in China increased, global supply chains began to shift towards more affordable regions in Southeast Asia, Latin America, and Africa. After the pandemic, the outflow of foreign capital accelerated, driven more by strategic reasons such as geopolitical tensions and concerns over supply chain security.

Foreign investment relocations motivated by cost considerations are a natural outcome of economic development. This type of foreign capital, typically in labor- and resource-intensive industries, may help accelerate China’s industrial upgrading as low-end manufacturing relocates abroad. However, China does not wish to see an overly rapid exodus of manufacturing, as the supply chain is interconnected, and the rapid departure of low-end manufacturing could also impact the Chinese economy.

Strategic relocations of supply chains, on the other hand, stem from many Western countries’ reflections during the pandemic. They began to rearrange their global supply chains, with key segments even being repatriated. Additionally, the US has imposed restrictions on investments involving China amid China-US tensions, prompting some foreign investors to partially withdraw to mitigate risks. This type of foreign capital exodus poses a more significant challenge to the Chinese economy.

Why is the Chinese government reviving the focus on foreign investment?

As China’s economic growth slows, the government is seeking various engines to drive the economy, and foreign investment is one of the crucial forces. In 2022, foreign companies accounted for 33% of China’s total imports and exports. They also contributed one-sixth of tax revenue and 10% of urban employment. Furthermore, employees of foreign companies generally earn higher incomes than the national average, meaning this population also has relatively stronger consumption power.

Moreover, China’s industrial upgrading cannot occur without the technology and management expertise brought by foreign companies. A typical example is Tesla’s entry into China, establishing a Gigafactory in Shanghai, which spurred industry competition. China’s electric vehicle companies have made continuous breakthroughs in areas like autonomous driving, range, and smart features, partly due to the “catfish effect” of Tesla.

At the same time, we believe China remains attractive to foreign investors. Although the cost advantage has diminished, China still boasts the world’s most complete, mature, and responsive industrial supply chain, along with a large pool of high-quality labor. China’s market is highly competitive, requiring foreign companies to excel not only in R&D and quality compared to domestic competitors but also in speed. However, China’s market is also vibrant, with advanced industries offering more growth opportunities than most overseas markets.

While economic slowdown and geopolitical factors will continue to influence foreign companies’ decisions regarding their presence in China, we believe that when the Chinese government demonstrates sincerity and makes concerted efforts to attract foreign investment, there is a greater chance for positive changes to occur.

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.