After the Chinese stock market suffered a major correction last fall, domestic equities tumbled into more attractive territory, says Richard Pan, head of qualified foreign institutional investors (QFII), at Beijing-based China Asset Management Co. Ltd. (ChinaAMC).
"Stocks on the CSI 300 Index are trading around 12 to 13 times forward earnings, or one standard deviation below the historical mean," says Pan, who heads a six-person team that oversees about US$1.5 billion in assets for segregated accounts.
The CSI 300 Index is a cap-weighted index that replicates the performance of 300 so-called "A" stocks trading on the Shanghai and Shenzen stock exchanges. Through the QFII scheme, foreign investors have access to about 2,800 Chinese companies, which taken together have a market cap of about US$6 trillion, versus US$20 trillion for the U.S. But, Pan argues, China is catching up -- and fast.
The largest mutual-fund manager in China, with assets of about US$158 billion, ChinaAMC also manages Excel China, which is sold to Canadians and holds "H" shares listed in Hong Kong.
Current valuations represent one reason for Pan's optimism about his home country. "We think stocks are a bargain, especially blue-chip companies, such as automobiles, home appliances and large property developers," says Pan, a 19-year industry veteran who has a BSc in engineering from his home-town Wuhan University, in central China, and an MBA from Georgetown University.
Take, for example, Midea Group Co. Ltd. , the largest maker of home appliances. "It has US$10 billion in cash and no interest-bearing debt. Its enterprise value to EBITDA is less than five times," says Pan, adding that the stock pays a 5% dividend yield and EBITDA growth is expected to be around 12-15% for the next few years. "We think it's a decent company and very cheap."
The second reason for Pan's optimism is that overseas investors underestimate the growth potential for China's new economy. "The new economy will decouple from the old economy. I'm including e-commerce, mobile payments and entertainment. There's a consumption upgrade going on and information-based service companies are growing."
This is driven by a gradual growth in middle-income households that are gaining a larger share of the urban population. Data from ChinaAMC indicates that China has a long way to catch up to many developed countries in the consumption of consumer appliances, electronics and beauty and personal care products.
"GDP per capita is still at a low base," says Pan, adding that per-capita income is around US$8,000. "But the economy is much more balanced, versus most of the emerging markets. It does not rely on commodities. China has a lot of financial service and industrial companies, and Internet-based companies. If you break down the sectors in the CSI 300, it's very similar to the S&P 500."
Another source of optimism is the continuing modernization of China's industrial base. "China is the world centre of manufacturing. But it's mostly low-end. For the last three years we have been moving to high-end manufacturing, and the trend will continue for at least a decade," says Pan, adding that high-speed communications networks will help boost productivity improvements. "In the future, the slogan, 'Made in China,' will become known as 'Innovated in China.'"
Entrepreneurship represents another key positive driver. China has a reported 60 million small- to medium enterprises, which employ more than 70% of the workforce. "Almost every Internet company was founded by enthusiastic entrepreneurs," says Pan.
He points to Jack Ma, who founded e-commerce provider Alibaba Group (BABA), which has emerged as the world's largest online business-to-business trading platform. Another example is Pony Ma, founder of Tencent Holdings Ltd. (TCEHY), which has rapidly grown since 2004 to a market cap of US$200 billion thanks to interests in media, entertainment and mobile telephone services.
Pan admits that labour costs are higher than in many emerging markets. "But China has the economies of scale and a huge talent pool. Every year, six million people graduate from universities. We have a highly educated workforce," says Pan. "We are upgrading our manufacturing and will focus on the high-end, instead of low-end manufacturing."
From a top-down perspective Pan says that China's slower growth is healthier than the double-digit growth that existed in the 2000s. "We know that 10% growth is not sustainable. Instead, 5% growth is respectable, achievable and sustainable," he says. "And even if growth falls to 5%, we can find plenty of opportunities for investors."
Pan has split his portfolio of 50 to 60 names between so-called New China and Old China names. That is, about half of the portfolio is held in knowledge-based companies such as those involved in health care. The other half is in traditional companies such as automobile manufacturers.
"My fund combines value and growth," says Pan, noting that the traditional names in the fund are driven by value metrics. "Our strategy is benchmarked to the CSI Index," he adds. "But compared to the index, we are pro-growth."
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