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China's Leapfroggers Shape the Investing Landscape

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China's Leapfroggers Shape the Investing Landscape AB IQ INSTITUTIONAL INSIGHTS AUTHOR China’s Leapfroggers Sammy Suzuki John Lin Stuart Rae Shape the Investing Brad Gibson Landscape In our many travels through China to explore the changing market CONSUMPTION: CHINESE CONSUMERS COME landscape, we’ve discovered countless companies and industries WITHOUT THE BAGGAGE that are jumping ahead of the West. These leapfroggers are creating CLICKS VS. BRICKS exciting opportunities for investors as China’s equity and debt markets Mobile trends are at the heart of China’s technological prowess. open to the world. China’s landline telephony infrastructure never developed as much as that in the US or Europe. Yet mobile phone penetration in China Global investors are starting to gain access to trillions of dollars’ worth has almost caught up with that in the West. Meanwhile, brick-and- of new securities in China. In June, index provider MSCI began to mortar retail is very underdeveloped in China. This difference in include domestic Chinese stocks, known as A-shares, in its emerg- infrastructure is the source of China’s edge. ing-market indices for the first time. Chinese authorities are adding For developed countries, the shift to e-commerce is often painful. capacity to trading programs that allow international investors to buy It requires the retail sector to unwind huge networks of stores and onshore stocks, which have an aggregate market cap of approximately strike the right balance between physical and digital sales. For US$7.0 trillion. And next April, Chinese government bonds will be China, it’s much easier, since companies don’t have to dismantle added to the Bloomberg Barclays Global Aggregate Bond Index, nearly as much physical store space to take the digital leap. For a move that could shift an estimated US$300 billion in allocations example, the Alibaba Group has been building out its Hema to China’s fixed-income markets once other index providers follow supermarket chain, in which the stores are optimized for online Bloomberg Barclays’s lead. Foreign investor inflows into China’s bond delivery. In contrast, Amazon recently purchased Whole Foods market are already exceeding US$7 billion per month this year. Market and will likely need to retrofit the stores meaningfully. For international investors, the appeal isn’t just about the sheer size of What’s really going on here? Instead of reconfiguring brick-and- China’s market. The Chinese equity and bond markets add significant mortar infrastructures, Chinese companies can spend their time diversification benefits to global funds. And Chinese companies are building efficient e-commerce platforms designed for a digital leading the way for global peers in industries ranging from e-commerce world. As a result, Chinese e-commerce now accounts for about to advertising and electric cars to clean energy. Investors who can 15% of retail sales, nearly as much as in the UK and well ahead find the strongest candidates stand to benefit from powerful return of the US (Display 1, left). Given the vast size of the market, this potential at a time when equity markets in the developed world may translates into massive consumer power. Alibaba reported annual lose steam. gross merchandise value of US$768 billion in its fiscal year ending March 2018—more than three times greater than Amazon’s over the same period. AB IQ | INSTITUTIONAL INSIGHTS | JUNE 2018 Display 1: China Is Ahead in Digital Retail and Mobile Payments E-commerce as Percent of Retail Sales2016 Consumer Payments: Breakdown by Value (Percent) 2 1 1 3 16.3 15.0 33 75 71 33 8.3 8.9 4.8 3.7 34 23 25 UK US China UK US*China 2011 2017 Cash Mobile Card Other Left display as of December 31, 2017; right display as of December 31, 2016. Historical analysis does not guarantee future results. *US cash value includes checks. Source: British Retail Consortium, iResearch Consulting, National Bureau of Statistics of China, Nilson Report, Office for National Statistics (UK), People’s Bank of China, US Department of Commerce, Wind Tre and AllianceBernstein (AB) Alibaba isn’t alone, though. Competitors include companies like measured more directly. And new players, equipped with more JD (Jingdong), with its business-to-consumer platform that has accurate data, are disrupting the way advertisers reach consumers. become the e-commerce partner of Tencent, a leading Chinese Through its lead in digital advertising, China is at the forefront of Internet group. JD built up its muscle by acquiring Walmart Stores’ using consumer data as a new currency. online business in China in 2016. The deal allowed JD to leverage Walmart’s supply chains, increase product selection and improve TECHNOLOGY: NEW WAYS TO SOLVE TOMORROW’S logistics efficiency. PROBLEMS EDUCATION Vipshop, China’s leading online discount retailer, has also been Some Chinese companies are testing new technologies in bold growing rapidly. By selling non-standardized clothing lines, ways. TAL Education uses distance learning to teach some of its including off-season and overstocked products of other brands, students and is experimenting with artificial intelligence technology Vipshop has been able to generate higher gross profit margins than in its classrooms as well. Results from early tests suggest that its peers. these programs can keep kids more focused than real teachers. The company is also developing facial-recognition technologies to MOBILE PAYMENTS gauge the level of concentration of the students. If a student isn’t The Chinese e-commerce boom is fueled in part by a payment focused, parents will be automatically notified. revolution. Chinese consumers are far ahead of American and UK consumers in adopting mobile payment (Display 1, right). Here, too, Megvii Technology, a Chinese facial-recognition company, is Chinese consumers and companies have leapfrogged their world applying its technology in areas ranging from retail to security. peers. And again, it’s all about infrastructures. Facial recognition is used to identify a VIP when he or she enters the store. Police applications include security cameras in shopping China has 16.3 bank branches per 100,000 adults, compared with malls to catch criminals on the run. China is quickly turning science more than 32 in the US and almost 24 in Europe. Similarly, credit fiction into reality. cards never made it into as many Chinese wallets. This explains why Chinese consumers have embraced mobile payments for ENVIRONMENTAL CHALLENGES everything from clothing to fast food. At the same time, the day-to-day reality in a country of 1.4 billion people is far from simple. Rapid industrialization has created dire KFC (formerly known as Kentucky Fried Chicken) is a case in point. environmental challenges that, until recently, were not high on the By the end of 2017, 53% of its sales in China were made with country’s agenda. mobile payments. In fact, one premium KFC store in Hangzhou That’s now changing. Since 2016, when the government signed the allows customers to pay using facial recognition. Paris climate accord, China has stepped up its efforts to shift its Mobile payment is even popular among street vendors. For economy onto a more sustainable growth path. Dangerous levels of example, we’ve even seen fruit vendors on city streets with QR pollution in industrialized areas have prompted the government to codes on their carts allowing payment via WeChat Pay, a popular act, and China’s middle class is growing increasingly intolerant. mobile payment system operated by Tencent. Solar and wind power is still a relatively small piece of China’s DIGITAL ADVERTISING IS BOOMING energy market, but growth is rapidly accelerating (Display 2). Similar trends are evolving in media consumption. In China, the Against this backdrop, China has become a world leader in the rapid shift toward mobile devices has powered a digital advertising production of solar panels, led by component makers such as boom. About two-thirds of all advertising spend in China is GCL-Poly and LONGi, which manufacture products that match up dedicated to digital platforms, compared with 40% in the US. favorably with their Canadian and European competitors. Many Chinese companies that have emerged to fulfill the country’s new Televisions are no longer the centerpiece of media consumption. appetite for clean-tech and alternative energy are fast-growing, Today, smartphones provide advertisers with mountains of data well-run operations, amply funded by both government and private about consumers. Returns on advertising investments can be sector investors. AB IQ | INSTITUTIONAL INSIGHTS | JUNE 2018 Display 2: Renewable Energy Is Growing Rapidly in China Solar and Wind Market Share (Percent) Solar and Wind Growth Share (Percent) 3 45 2 30 1 15 0 0 05 06 07 08 09 10 11 12 13 14 15 16 17 05 06 07 08 09 10 11 12 13 14 15 16 17 Through December 31, 2017 Source: Bernstein Research and BP TRANSPORTATION HEALTHCARE: GETTING INTO SHAPE Alongside the push for renewable energy, China has embarked China lags the West in some areas. For example, the country’s upon an ambitious plan to promote electric vehicles (EVs). The healthcare system is still far behind the US and Europe. Yet reforms government sees EVs as an important component of combating its are under way that we believe will ultimately lead to major changes— energy security problem by helping to limit oil imports and reduce and investing opportunities. pollution. Market demand for healthcare in China is constantly growing In recent years, the government has spent billions of renminbi (Display 3), owing to its large aging population. The government’s subsidizing EV purchases and chargers, while tightening regulation keynote reform plan—Healthy China 2030—represents a of traditional fossil fuel–powered cars. Companies to watch include commitment to improve healthcare access and quality, raise life BYD, the world’s largest maker of electric cars and EV batteries, expectancy to 79, and support the expansion of the healthcare as well as the Chinese state-owned automaker, SAIC Motor, which industry.
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