Back in Q4 2018 when the sabre rattling started over US/Sino trade, a number of investors believed this would be negative for China. As far as sentiment was concerned they were right…. for a short time. You may remember how we highlighted in a series of notes (“China through the US looking glass I-IV”) that the Chinese consumer seemed little affected by the trade war and this was showing up in buoyant sales for US consumer companies selling their products into the country (Kimberley Clark, Nike, Apple, Skechers, Estee Lauder).
The fact is that China progressed from the position of a low cost manufacturing centre many years ago. Although Chinese products are increasingly competing in the global export markets, it is the domestic service economy that is the most important driver of future growth. The “Made in China 2025” policy, launched by Xi Jinping in 2015, is clearly designed to support the development of domestic champions and create self-sufficient industries which will play to the consumption theme in which Aubrey invests. It highlighted ten core industries where China wanted to be a global competitive player, and these included robotics, semiconductor chips, and automotive technology. Although not directly consumer facing (which as you know is our focus), the development of these industries will further impact consumption trends within the country.
Whilst Chinese companies have been accused of ‘reverse engineering’ in areas of industrial development they have also invested heavily in R&D and seen significant success within the broad IT equipment and software industries, consumer electronics, and electric vehicle batteries to name a few. Despite the political arguments over the adoption of Huawei equipment in Europe or the threat to the US, the company has produced competitive product and taken market share in many regions of the world.
We have highlighted the success of Alibaba and Tencent previously as they expanded within the Asian region and invested heavily in new opportunities in those markets. The success of Haier may be less known but the Euromonitor Consumer group recently ranked the company as the largest global electrical appliance brand by volume sales in each of last 10 years, with their product range extending from refrigerators, washing machines and now including wine coolers.
International objections towards China’s ambition vary but the blueprint is similar to that adopted by other Asian countries in recent decades as they sought to develop their value proposition and progress beyond low technology industries. The ambition to develop industry that raises employment skills and creates intellectual property is seen in the car industry, and future growth is expected to bring more to the economy than gleaming new cars on the extensive motorway networks. China is now the largest car market in the world with over 21m cars registered in 2019 ahead of the US with almost 17m and the ambition is to develop leading positions in EV cars but also battery technology expertise which can be sold to other manufacturers.
Although Mr. Musk grabs the headlines with Tesla, the International Energy Agency has stated that the 2.3m electric cars in China account for 45% of the global fleet in 2018 and it forecasts that the global fleet will be 70m by 2025 with China continuing to be the largest player. Contemporary Amperex Technology Co. Ltd may not be a household name but it is China’s largest and the world’s second largest EV battery manufacturer. They currently supply German and Japanese manufacturers and are building a $2bn plant factory in Germany which is clearly a similar commitment to that shown by German auto manufacturers building cars in China to sell into that market.
The ambition of industrial development is not limited to the manufacturing and export opportunities. The Infant Milk Formula (IMF) market has seen a resurgence in the position of the domestic manufacturers led by China Feihe. The historic one child policy and the natural parental desire to ensure the best product for their infants resulted in a clear preference for the international brands. This was exacerbated by a couple of scandals over the quality of locally produced formula. As a result the Government encouraged the domestic players to reach a 60% market share by 2022 and Feihe has successfully developed their product portfolio to achieve a leading position in the premium IMF category. Key to this has been the important relationships with the Mother and Baby Store distribution channel to support their brand position which has been developed over several years. A recent discussion with the company highlighted their ambition to deliver over 20% revenue growth for the coming 3 years and the expectation of a 30% market share.
The development of the wider healthcare industry has also been another key dynamic of Government policy. It should not be a surprise that half the Covid-19 vaccines in clinical trials have been developed in China. The growth of the affluent middle class in China has led to increased demand for better national healthcare by consumers. Policy changes to regulation and reimbursement policy are intended to increase the adoption rate of generic medicine in China but will also reward innovative drug development in a similar model to that seen in developed markets. Domestic drug companies now account for more than half of the top 20 players and Aubrey is an investor in CSPC Pharma. The group has a history of generic drug production but has successfully developed an innovative portfolio of drugs addressing stroke treatment, hypertension and oncology amongst others. A recent discussion with management highlighted the planned launch of more than 50 generic drugs and 10 further innovative drugs in the coming 3 years.
The success of domestic China has not happened overnight. Education has been a priority for parents for decades and over 8.3m students graduated in the summer of 2019. We have invested in the education theme over the tenure of our GEM strategy and currently own New Oriental Education, the leading provider of independent educational services in China which currently operates over 1200 after school learning centres. But the development of the national educational system is only part of the story: the return of Chinese students with international education and, critically, work experience in top class foreign companies will also add to the impetus of “Made in China 2025”. They will also swell the ranks of the burgeoning professional and middle classes who are enjoying increasing salaries. Some of these will buy foreign brands (see the first paragraph above) but in our view this misses the much bigger opportunity amongst the local champions producing high quality domestically designed products and services.
The “Made in China 2025” initiative will clearly impact the consumption theme on which we focus. It is our goal to identify the winners and losers in this process for the benefit of our investors.
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