China is refocusing its economy towards consumption and services, away from investment and manufacturing.
While this pivot is happening slowly from an economic perspective, investors in the Chinese stock market have been quick to switch their exposure accordingly.
Chinese stock valuations have risen sharply and become increasingly stretched, but we see three key themes emerging – business sectors that still offer good opportunities for long-term investment.
These are seen as one answer to China’s pollution problem. The government aims to have 5 million electric vehicles on the road by 2020. To reach this target, it will need to build 100,000 new charging stations and bring down the high costs of electric vehicle engines, or ‘powertrains’.
Clearly, it will need the private sector help to do this, which represents a potentially attractive investment opportunity.
Chinese parents have embraced on-line tutors as a means of dealing with the fiercely competitive university entrance exams, faced by Chinese students. The same is happening in Hong Kong, Taiwan and Singapore, where parents are also willing to spend considerable sums on tutors to give their children an edge.
Compared to traditional methods of teaching, on-line education has the potential for significantly higher margins as star tutors can teach significant numbers of students at one time, high rental costs for premises are avoided, and advertising happens via social media and peer reviews.
China currently spends 4 per cent of its GDP on education, compared to the OECD average of 6.2 per cent. But the percentage is likely to increase as urbanisation continues and the Chinese economy shifts further away from manufacturing towards services.
Online to offline commerce (O2O)
O2O is an important emerging trend within China. It gives consumers the convenience of browsing in a bricks-and-mortar store, placing the order online, and then collecting the goods from the store, as opposed to waiting for delivery. Forecasts that O2O mark the end of the shopping mall are greatly exaggerated.
Many investors cite the doubling of China’s ChiNext and CSI 300 stock indices over the past twelve months as a reason for avoiding the Chinese equity market altogether.
While we agree that markets such as Shenzhen’s ChiNext have bubble-like characteristics, overseas-listed Chinese stocks such as H-shares listed in Hong Kong, are still trading on reasonable valuations.
The three themes we have identified – electric vehicles, on-line education and O2O – are multi-year trends, which are independent of short term fluctuations in economic growth and expected to deliver above average returns.
A version of this article was first published in The Business Times (Wealth Supplement) on 02 June 2015
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