Analysts across Wall-Street expect China’s economy to grow about 5% in 2023. According to the IMF, this would represent approximately 1/3 of global economic growth. Additionally, equity analysts for Goldman Sachs are predicting 9% growth in Q2 and 7% growth in Q3. Economic expansion will be closely tied to rebound and recovery from relaxation of the “zero-covid” policy. An area that will likely experience a significant surge in the short-term is the service sector, which is performing well below pre-pandemic levels. Quarantined Chinese households accumulated an excess of $437B in savings in 2022. As consumers return to work and travel, spending will invigorate the Chinese market. Increased consumer spending will lead to some short term increases in the stock market. At the beginning of this week, Goldman set an expectation of a 24% increase in the MSCI China index this year.
As a long-term investor in the Chinese markets, I am looking towards 2023 as an opportunity to realize strong returns. My investment thesis in China stems from the rapidly growing middle class, extreme upside potential, and an ongoing transition from manufacturing to tech. Over half of the Chinese population is currently considered middle class, opposed to ~3% of the population in 2000. China has a population of more than 1.45B. This means the existing middle class is more than double the population of the United States. However, average per capita GDP is still lower than the world average. This metric suggests that growth isn’t over. China has experienced 4 decades of enormous economic growth and posted its worst period on record in 2022. Historic growth has been largely related to China’s cheap and abundant labor force. This labor force helped to make China into a manufacturing superpower as the world’s largest exporter. I am convinced that this narrative is destined to change. More promising areas of the Chinese economy are emerging with an emphasis on technology and IT-services. This is evidenced by the recent decline in manufacturing as a percentage of GDP and the increased allocation towards services. (See Figure 1 below) Figure 1:Chinese Distribution of GDP by Economic Sector (Statista 2023)
Overview of Chinese Portfolio Performance and Growth Prospects
Yadea Group Holdings Ltd (1585.HK): ~4.7% of Portfolio, ~21.2% Return Yadea is the market leader in 2 wheeled electric vehicles in China with $4.16B in TTM revenue. In the first half of 2022, the company demonstrated its profitability by increasing net profit margins by 52.6% over 2021. Additionally, management prioritizes returning capital to shareholders evidenced by ~37% historical ROE. Yadea markets its products in over 100 countries and regions, but 98% of sales occur in mainland China. The company is currently rolling out a more international focus: Yadea increased exports 104% in the first half of 2022. As the company shifts to a more diversified customer base, sales growth will continue, and the stock price will continue to move upward.
China Taiping Insurance Holdings (00966.HK): ~3.4% of Portfolio, ~ (24.5%) Return China Taiping Insurance Holdings sells primarily life insurance in the Peoples Republic of China. The Chinese insurance market will grow along with the quickly growing middle class. Additionally, the Chinese market is projected to overtake the US and become the world’s largest insurance market. China Taiping trades at a P/E of 6.82x while large competitor China Life Insurance (SHG: 601628) is trading at a P/E of 27.25x. The disparity between product quality is small. Thus, the market should correct by increasing the per share price of China Taiping Insurance Holdings.
Baidu, Inc – ADR (NASDAQ: BIDU): ~2.7% of Portfolio, ~ (10.7%) Return Baidu is the largest search engine in China with 84% of the search engine market. The company is closely comparable to Alphabet in the United States. Baidu focuses its key growth initiatives on artificial intelligence, video streaming, voice recognition tech, and autonomous driving. Baidu management rolled out a $5B share repurchase plan on February 22nd signaling conviction that the stock is currently undervalued. Additionally, the company’s 4Q22 earnings revealed that net profit has doubled over 4Q21. Baidu is a particularly exciting example of an undervalued Chinese tech stock that is poised to have strong success. We are currently awaiting the rollout of Baidu’s ChatGPT style artificial intelligence chatbot. If this product is successful, Baidu could make itself the leader of this emerging market.
60 DigiTech, Inc – ADR (NASDAQ: QFIN): ~1.83% of Portfolio, ~ 10.3%) Return 360 Digitech is a leading consumer credit Fintech in China with $2.2B in TTM sales. The firm helps financial institutions to evaluate consumer credit worthiness by using data driven insights. 360 Digitech stands to benefit from the growth of the Chinese consumer credit market. The consumer lending market is dominated by home-loans and then credit card loans. The total consumer loan market is projected to grow at a 9.1% CAGR from 2021-2025. QFIN is the leading provider of this service in China; as the market grows QFIN earnings will follow. Additionally, this service is uniquely high margin QFIN is earning ~32% in Net Profit.
Final Thoughts High tech companies catering towards the Chinese domestic market will benefit from strong macroeconomic tailwinds in China. These companies are positioned to become key players in the new age Chinese economy. For investors willing to withstand short-term turmoil, the potential for outsized gains is incredibly attractive.