The Emergence of China's Consumers

Unlike the US peers, the Hong Kong/China equity markets have peaked in mid-February 2021 and stayed directionless since then, as evidenced by the shrinking newly issued mutual funds in April 2021 (RMB10.7billion versus RMB226.4 billion in March 2021 (Chart 1). However, China consumption sector defies gravity during the period and stands out as one of the biggest outperformers. 

Investors’ optimism on China consumer sectors is driven by :

i. Beijing government’s strong policy support and commitment to boost consumption growth, which is the key underlying driver for the “Internal Circulation” policy to revive China’s economic growth;

ii. Chinese consumer’s boycott on Western brands has created a golden chance for the emergence of China’s home-grown consumer brands, especially in the mid-/ high-end markets which have traditionally been dominated by the Western brands; and

iii. Rising industry concentration alongside liquidity easing post-COVID, which has made investors more willing to pay a valuation premium for consumer sector leaders with stable long-term earnings growth.

Solid earnings to support growth

As evidenced by the stronger-than-expected March 2021 purchasing managers’ index (PMI) figure, Chinese economy has revived rapidly post COVID-19 lows. In the current lukewarm market, we prefer to focus on sectors with high earnings recovery visibility.

China consumer sector is clearly one of the outperformers, which has just delivered solid 4Q20 earnings.  However, earnings estimate upgrades diverse - Consumer Discretionary topped 4Q20 EPS growth whereas Consumer Durables & Apparel, Software & Services, and Retailing ranked as the top three sectors on 4Q20 YoY net profit growth (Chart 2). We argue that there is still divergence in the earnings estimate trajectory of companies even within the same sector, and having exposure to the “earnings winners” is the right strategy.

Which sub-sectors do we prefer?

Consumer discretionary

We prefer those leveraging off the new consumer behaviors post-COVID, with support from policy tailwinds (e.g. short-term re-opening of long distance domestic traffic, dual circulation, and carbon neutral objective of Beijing).

Consumer staple

We prefer sustainable earnings winners with solid track record.

Based on 4Q20 results and 2021 outlook, we summarise the following key criteria of our stock selection:

i. Consumer discretionary & transportation:

- Policy-favored passenger electric vehicles majors (further details please see below); sportswear with strong traffic acceleration;

- Beneficiary sectors from the resumption of long-distance travel recovery in short-term (airlines, travels and duty free shops); and

- People’s transformed lifestyle post-pandemic (med tech, e.g. online pharma, hospital and consultation; smart property management; education with new economy-biased)

ii. Consumer staples with strong earnings track record:

- High-end spirits after share price correction;

- Skincare major which continues to capture pend-up demand; and

- Food & beverages and dairy product leaders

China auto – A new era has just begun

When it comes to China consumption sector, the auto sector is probably the most important pillar. Recent emergence of passenger new energy vehicle (NEV) has certainly been redefining China’s auto industry landscape.

China’s auto market has been recovering from the impact of the Covid-19 pandemic since 2H20. We expect a higher pace of recovery this year after the Chinese government implemented various measures to accelerate long-term NEV adoption. Last November, the State Council announced a development plan for the NEV industry for the 14th Five-Year Plan period (2021-2025), targeting a 20% share of NEVs in the country's total vehicles sales by 2025 (Chart 3).

According to Bloomberg (Chart 4), the market is expecting China's passenger NEV sales to rise 54% YoY in 2021, and by 50% YoY in 2022, fueled by automakers' aggressive and competitively priced NEV rollouts, as well as car buyers' front-loaded purchases, as they take advantage of NEV subsidies before their phase-out by year-end 2022.

Net-zero carbon target accelerates the NEV adaptation process

We believe policies advocating net-zero carbon emissions, such as new-energy vehicle credits and license restrictions for gasoline vehicles, will boost demand. Meanwhile, consumer choices have also widened significantly, as more luxury carmakers are successively launching more new NEV models.  Economy of scale, resulting from much higher sales, also helps to lower production costs, and hence showroom prices. As a result, higher profitability and stronger cash flows fuel a virtuous cycle, driving the innovation that powers growth, including the fast-charging solid-state batteries that make EVs more attractive to buyers, and more convenient to own.

Semiconductor shortage is hurting other countries more than on China

Last but not least, we note the auto industry is now facing a crisis in the form of semiconductor chips supply shortage. We believe the supply-demand dynamics would improve in the coming months, especially for China. This is because the US-China trade war has prompted the Chinese government to stockpile chips and find new sources for components. As a result, we see the Feb-to-date share price correction as good re-entry opportunities for China auto stocks.

Which stocks shall we consider to invest?

We prefer companies with passenger NEV focusing on hybrid over traditional ICE (internal combustion engine) manufacturers.

Within this segment, we prefer manufacturers with high-end focus, as they will be less impacted by the subsidy cut while also capturing the income-inflation trend in China.