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July 6, 2015

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Home » Business » Finance Special

Green cars, online-offline buying and digital education are sectors to watch

By Clive McDonnell | July 6, 2015, Monday | Print Edition

Trading on 700 times trailing earnings, ChiNext-listed Qtone Education is symbolic of the bubble-like characteristics that have recently emerged in China’s domestic equity markets. We at Standard Chartered would caution against chasing stocks with similar eye-watering valuations.

Nevertheless, companies like Qtone Education are at the forefront of a structural pivot of the Chinese economy towards consumption and services and away from investment and manufacturing.

While this pivot is taking place at a slow pace from an economic perspective, investors have been quick to switch their attention toward companies with exposure to the sectors that are expected to drive future growth.

Standard Chartered sees three key consumption themes emerging:

• Electric vehicles

• Online education

• Online to offline consumption

Electric vehicles

Electric vehicles are viewed as one answer to China’s pollution problems.

China has a target of 5 million of the vehicles on the road by 2020, with 40 new launches expected this year. The market is currently dominated by local manufacturers such as BYD, which has a 35 percent market share. Foreign brands have struggled to gain traction in the market due to price differentials with local brands related to subsidies that can reduce prices of the latter by up to 60 percent.

There are challenges to expanding the electrical vehicle market in China, but this is where investment possibilities exist. Charging stations and high powertrain costs are cited as two key obstacles. The ratio of charging stations to electric vehicles in China is 180-to-1, compared to 30-to-1 in the US. If China is to achieve its 5 million target and assuming it aims for a ratio of 50-to-1, it will need to build 100,000 charging stations. Clearly, it will need private sector help to do this, which represents a potentially attractive investment opportunity.

High powertrain costs are one of the key drivers of Tesla’s decision to build the Gigafactory in Nevada. China faces the same challenge to bring down powertrain costs, but does not yet have plans for its own gigafactory. Companies such as BYD have the experience in batteries to consider such an investment, and, with Warren Buffett’s Mid-America Energy owning 25 percent of the company, it may have the ability to raise the capital required for such an investment

Online education

Chinese mainland parents have embraced online tutors as a solution to the fiercely competitive exams Chinese students face for entry to universities. This is in line with trends observed in places including Hong Kong, Taiwan and Singapore, where parents are similarly willing to spend considerable sums on tutors to give their children an edge. From an investment perspective, the difference in China’s mainland is the numbers involved, combined with the low marginal cost of adding additional students. Whether this justifies the eye-watering valuations following a 10-fold rise in Qtone education is debatable, but other opportunities related to this theme do exist.

The low marginal cost of adding students to online tutorial classes is a key differentiator with the same offline business. High rental costs for centrally located classrooms, high wages to attract star tutors and rising advertising costs are factors that have combined to undermine the attractiveness of traditional classroom-based tutorial schools as an investment opportunity. Online education has the potential for significantly high margins as star tutors can now be in two places at one time, rental costs are no longer an issue and advertising is targeted via social media and peer reviews.

Online to offline consumption

Alibaba, the biggest retail marketplace in China, was one of the first to pioneer this trend when it acquired a stake in Hong Kong-listed Intime department store in 2014. Online-to-offline consumption is viewed as the answer to the challenges posed by consumers who browse in physical stores only to place orders with a different retailer online.

Forecasts that this trend will mark the end of the shopping mall are greatly exaggerated. In Singapore, Q0010.com, which has a similar business model to Alibaba, is in negotiations with local mall operators to set up a physical presence. Alibaba is believed to be in discussions with Dalian Wanda, which operates a chain of 100 department stores in China, to create a similar presence at Wanda’s malls.

Many investors cite the doubling of the ChiNext and CSI300 indices over the past 12 months as a reason for avoiding the Chinese equity market. While we agree that markets such as ChiNext do have bubble-like characteristics, overseas-listed Chinese stocks, such as H shares in Hong Kong, are trading on reasonable valuations. H shares trade on 10 times consensus earnings for 2015, compared to 20 times for the CSI300 and 96 times for ChiNext.

Banks dominate the H share index, with a weight of 40 percent. Given this concentration, we believe fund managers have the potential to add value by investing in a more diversified manner in order to reduce portfolio risks. The themes we have identified are multi-year trends that are expected to deliver above average returns and are independent of short-term fluctuations in economic growth.

Finance Special


 

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