While China’s services sector is expanding, consumer confidence remains mixed. Moreover, the broader recovery has assumed a K-shape, with some segments doing well while others are slowing. However, the Fidelity global investment team’s recent research trip to Shanghai and Hefei revealed a multi-faceted economic picture.
Catherine Yeung, Investment Director, and Marty Dropkin, Head of Equities, Asia Pacific, met with Portfolio Managers Dale Nicholls and Hyomi Jie to gain their on-the-ground insights. They also received feedback from Research Associate Eric Zhu and Investment Analyst Eric Tse.
A key takeaway from the visit was that sentiment in China had exceeded the team’s expectations. “As always, we found new and interesting companies. And given the extent to which stocks have corrected, the investment backdrop certainly looks healthy,” says Nicholls. Using Hefei as an example, Jie notes, “Even though it's a relatively small third-tier city, the local economy is booming with support coming from an influx of technology companies – particularly those operating in the electric vehicle (EV) sector.”
In addition, the city government has also removed a series of restrictions on home ownership, which will play a vital role in restoring consumer confidence. Hefei was also cited as a case study in urbanisation, given that its population is growing, with a notable percentage in well-paid employment. “Higher-value work is going to be one of the longer-term drivers of consumption in China,” adds Jie.
Freedom of value
The team also dispelled the idea that China has become a value trap, whereby investors see attractively valued stocks that deliver limited growth. “It's such a huge economy, and many well-managed companies are expanding or consolidating,” observes Nicholls.
Jie continues by explaining that the value trap concept may be exaggerated given China’s corporate dynamics. She elaborates by using gold jewellery retailers as an example. Here, the lower-end segment has gained market share through consolidation. “Even when the economy is slow, people are still willing to spend on gold to preserve their capital.”
Discount retailers were also cited as a market sector still creating value. “Despite the shift to online shopping, as long as the discount stores continue executing their business models well, there will be opportunities for investors,” says Jie. “In China, it's about finding the right consumer niche, communicating well and providing people with real value,” explains Nicholls. “That's why stock-picking opportunities in the consumption space are becoming far more interesting.”
Sector analysis – uncovering specific themes
Nicholls is also researching travel-related names that should be boosted by post-reopening activity, as well as the domestic substitution theme within the industrials sector. Here, Chinese businesses are becoming less reliant on foreign suppliers by improving their products and moving up the value chain.
Elsewhere, financial stocks are on the team’s radar. Insurance companies were singled out as having low levels of market penetration. “The recovery may have slowed, but the consumer is becoming more affluent and requires more protection,” adds Nicholls. And among the banks, China’s state-owned enterprise (SOE) reforms have been in the headlines, with the team observing that many domestic banks would be affected by this dynamic. In terms of opportunities, Nicholls is looking beyond the large institutions and focusing instead on mid-sized banks that are relatively inexpensive and have an improving outlook as capital returns to the system in the form of dividends and buybacks.
For the automobile sector, Tse explained that at the start of 2023, people had high expectations for an upturn in the car market. However, the overall pace was slower than expected, as robust pricing competition triggered a wait-and-see attitude among consumers. Each manufacturer is adopting a different strategy, with some maintaining their brand status by rationing discounts. Alternatively, there are different pricing strategies for traditional cars versus EVs.
For EVs, Tse thinks that China’s competitors will require time to develop their platforms. “I think many overseas original equipment manufacturers (OEMs) are learning from China’s electrification process, but it will take time to introduce better products.” Tse also predicts that China’s domestic OEM market will become more competitive, so he concentrates instead on the upstream supply chain, where many stock prices have corrected. These businesses include battery-component suppliers.
A presence in the IPO market
Lastly, the team touched on initial public offering (IPO) activity. Nicholls explained that Fidelity’s analysts see a potentially positive backdrop, “In 2020 and 2021, a lot of money was raised in the private sector, but that's starting to run out.” He also suggested there's generally less competition among investors exploring the IPO space. “There are certainly investment opportunities for stock pickers with a firmly established local presence.”