Investing in New China

This year alone, he has made six trips to China, keeping up with his regular meetings with business owners of companies that he has already invested in, or getting to know prospects better.

Throughout his decades of investing in China, Wong has seen numerous market cycles. He has also seen plenty of companies grow in line with China’s economy, scaling up and becoming significant players in the industry segments they are in. 

That is why Wong is pleasantly surprised that many of these companies’ founders — already very successful businessmen in their own right — are happy to spare the time and meet him on his visits over a nice meal, where conversations flow more easily. “They are giving me a lot of ‘face’. I don’t manage US$100 billion,” says Wong, whose firm’s AUM stands at US$1.4 billion ($1.9 billion), somewhat self-deprecatingly.

Rather, what Wong has is more than four decades of investing experience — first at GIC, and, since 1995, from his roles as chief investment officer and CEO at APS, which he founded. On the one hand, Wong would hear about the opportunities and challenges of China as a market from the business owners. On the other hand, he shares his knowledge of geopolitics, and advises the business owners on what they can do to improve their companies’ attractiveness in the eyes of the capital markets. 

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One, for example, was vexed over how his shares were changing hands at just 3 times earnings. Wong’s advice is to use the company’s excess cash to do buybacks. In another instance, an overly eager owner wanted to pay out dividends four times a year. Wong told him that would create too much work for his staff and suggested that twice a year should do fine.

From his most recent conversations, Wong observes that the mood among Chinese business owners is not the rosiest recently. The post-pandemic surge that everyone had been expecting after the end of the lockdowns at the start of the year did not manifest right away. A quarter, then another, and yet another quarter passed by. The huge “big bang” government stimulus some had expected did not happen as well. As the year draws to an end, business conditions remain challenging. The contrast was especially big compared to many other economies where life is back to normal and business activities have rebounded.

The damage is being felt. Wong reasons that many people are still suffering from the post-pandemic blues no thanks to stringent lockdown measures, which left an impact on their psyche. Consumption at the individual level and business investment decisions by companies have been curbed. “They want to see more evidence that the economy, not just the Chinese economy, but the world economy, is improving,” says Wong in an interview with The Edge Singapore on Nov 30.

See also: Time to rethink traditional thinking in emerging markets

Judging from the most recently available October trade data, imports unexpectedly grew, while exports contracted at a lower rate. Wong cautions that just one month’s data is too scant to form a trend, although improvements would be seen in a matter of time. 

Meanwhile, there is a growing wave of cautious, or even negative sentiment on the part of international investors. On Dec 5,  Moody’s Investors Service cut its outlook for Chinese sovereign bonds to negative. While the rating agency kept its long-term A1 rating on China’s sovereign debt, it cited fiscal stimulus to support debt-laden local governments, as well as the property sector which is under stress, as risks.

Amid the tough conditions of past few years, the firm’s flagship APS All China Alpha Fund reported a three-year return of negative 4.76%. In contrast, the MSCI China All Shares NTR Index, used as the reference, was down 13.92% over the same period. “Even in a bear market such as today, one can always unearth gems amongst compelling, deep-value stocks,” says Wong.

Policies, context
A key theme of China’s economy in recent years was the tough regulatory stance on the previously high-flying Internet and property sectors. Alibaba Group Holding founder Jack Ma famously criticised banking regulators just ahead of Ant Group’s widely-anticipated IPO. After the listing was pulled, he has stayed out of the public eye.

Wong points out that Alibaba was specifically penalised by the regulators for anti-trust business behaviour. For years, leveraging on its scale and reach in the e-commerce space, Alibaba was found to have shown anti-competitive behaviour and was fined US$2.8 billion in 2021 — an amount equal to 4% of its revenue.

According to Wong, the financial penalty, although a record in China, has to be seen in the context of anti-trust actions taken by Western authorities. The likes of Google, Microsoft and Facebook have, at varying points in time, been slapped by financial penalties amounting to billions of dollars as well by various European jurisdictions. “The media did not play them up. But in China, such moves have been characterised as a move against capitalism,” says Wong.

In the same vein, President Xi Jinping’s “Common Prosperity” policy goal has been interpreted as a Robin Hood move against the rich and to reintegrate the whole society back into the same class. Wong says that if that is indeed the goal, China could have just increased the taxes on the rich but did not. The policy aim of Common Prosperity is to increase the size of the economic pie so that business owners, their senior managers, and the rank-and-file workers can all enjoy more wealth, he explains.

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For critics of China, a favourite whipping boy is how the country came down hard on the property sector, imposing tough credit limits on developers and forcing them to deleverage within what was basically an untenable time frame. “The property slump is policy-induced. It is not the result of market forces,” says Wong. He agrees that the implementation was too draconian in an overzealous attempt to burst the speculative bubble, hurting property firms and their shareholders very badly along the way. “It is short-term pain for long-term gain,” he maintains. 

However, the slump in the property market has the inevitable effect of hurting home buyers’ confidence and the sentiment has spilled over to lower levels of consumption, resulting in a negative wealth effect. “The Chinese are spending less not because they have no money, but because they are saving more,” says Wong.

Nonetheless, in recent months, there has been a steady stream of policy moves that can be seen as positive for the property market, although a full-fledged return is far off, says Wong.

With several huge listed property companies potentially defaulting on their loans, the woes have unfortunately weighed down on the wider Chinese stock market, sending valuations down even lower. As a cumulation of various broader trends, China’s economy cannot grow at 10% anymore — that was in the previous era of rapid industrialisation and rising home ownership. Investors, says Wong, have to make do with growth rates of 5%.

See also: China does not share Japan's obsession with golfing, nor a 'balance sheet recession'
 
Trade ties
Despite the efforts to stimulate domestic consumption, export remains a key driver of China’s economy. The ongoing trade war with the US, amid a wider global slowdown, clearly is not helping.

Last month, Presidents Xi and Joe Biden met in San Francisco. While the atmosphere was cordial, fundamental differences remain even though the temperature may drop one or two degrees from previously. “I will not read too much into it,” Wong warns.

The trigger point for today’s contest between the two largest economies in the world was ignited by Biden’s predecessor Donald Trump. As Biden maintained the same posture despite the domestic political differences from Trump, China’s own internal differences have been accentuated as a result. 

According to Wong, there is the globalist camp, which is keen to maintain cordial ties and promote trade as a way for the economy to grow; there’s also the nationalist camp, which is adopting a hardliner stance, and if they feel that China has been taken advantage of, the country should respond accordingly.

Even though the two presidents met, Wong observes that anecdotally, there has been a somewhat stronger response from China in recent months. For example, the curbs on the export of rare earth — critical metals used in electronics — to Western countries. 

Nonetheless, China is still a net beneficiary of the US, as seen from the trade imbalance and because China is still producing plenty of products that American consumers want to buy even with tariffs slapped on. As such, China will be careful not to over-react, says Wong.

Meanwhile, as a result of the trade war, many manufacturers have been forced to set up alternative manufacturing sites in other countries such as Mexico and Vietnam. By doing so, companies need to incur additional costs to buy and install new equipment and train their new local teams to operate the new lines — a process that takes months, if not years.

Apple, which relies heavily on Foxconn for its production activities, has in recent years outsourced some of its manufacturing to factories in India. Wong points out that Foxconn is still an employer of around a million workers in China and it will be years before India’s production volume can rise above the current level of low-single digits, amid recent reports of teething problems, both cultural and mechanical, in the Indian plants.

Besides the costs incurred by manufacturers in setting up new plants, there is also the need to upgrade the supporting infrastructure of power supply, roads, ports and so on — something China spent some US$10 trillion in the last 10 years alone, says Wong.

Despite bottomlines getting weighed down because of additional capex needs for new locations, Wong sees this trend continuing, given how the broader geopolitical environment is staying put. 

Along the way, previously high-flying, fast-growing stocks have slowed. Alibaba, at its peak, was trading a multiple of up to 50 times or more — it is now at just 10 times. As the growth of e-commerce slows as the nature of this market matures and as the competition gains ground, the slowdown has become more distinct. “We are seeing a massive de-rating of the stocks of these companies,” says Wong.

Nonetheless, Wong believes that China remains an interesting market to invest in. His portfolio is divided into two distinct groups. The first is a basket of value stocks with forward earnings of just around 5 times, and a dividend yield of around 6%, and which can grow at single-digit rates in the coming years, along with ROE in the double-digits. “They are profitable companies that are still growing and we are getting them at such a cheap valuation,” he says.

The second group is a basket of growth stocks that can grow over the medium term while holding a valuation multiple of 18 times or so, plus some yield. The ROEs of such stocks are not a priority given how many of these companies are still in the investment phase. “We want to invest in the new China, its new economy. China has grown very strongly,” says Wong.

New China’s growth 
Several sectors in this “New China” have caught Wong’s eye. First, electric vehicles (EVs). China is already the largest maker of EVs and by the end of the year, if internal combustion engine cars are included, it will be the world’s largest car exporter as well, overtaking Japan and Germany. 

Next, as a direct result of US sanctions, China has been forced to be more self-reliant in growing its capabilities in the critical space of semiconductors. Wong holds a long-time position in the partly state-owned Semiconductor Manufacturing International Corp, which recently made a breakthrough in its 7-nanometer (nm) manufacturing processes. While not as cutting edge as the 5nm or even 3nm technology that industry leader Taiwan Semiconductor Manufacturing Corp is capable of, Wong points out that 7nm is already good enough to make chips that can be used in 95% of the electronics devices requiring such chips to run.

Another company Wong has invested in is Geovis Technology. Founded in 2006, the company is in the niche area of satellite topography, using AI and big data to analyse the images captured from space and predict weather patterns or prevent spread of fires. Its clients come from both public and private sectors. 

Factory automation is another sector of interest. With labour not readily available, the only way to be more productive is to do more with less. Providers of factory automation, plugged into a market projected to grow at 25% a year for the coming five years, is one such rider on this trend.

Cybersecurity is a growing market too, given how governments and companies have to step up on cybersecurity defence as bigger parts of the economy gets digitalised, resulting in a market growing at 15% a year. Wong’s pick in this sector is Venustech Group, which has a customer base of more than 30,000 including over 80% of Chinese banks and more than three out of every five large state-owned enterprises (SOEs).

New China’s value
An interesting recent chapter in China’s markets was when a regulator proclaimed that the valuations of China’s publicly listed SOEs are too low and wanted them to be lifted, causing a brief spike in interest in SOEs that has since dissipated.

Wong believes that the rhetoric could be put across slightly differently — that SOE stocks have been neglected by investors for a long time to the point that they have been mispriced by the market and that therefore, they are offering very good value.

He maintains that many of the SOE stocks are indeed undervalued, prompting him to increase his position in some of these counters more than a couple of years back, when APS started switching from some higher-growth stocks to these value stocks.

One of his key holdings, China Mobile, the country’s largest mobile operator, is not a high-flying, fast-growing tech stock. Despite the utility characteristics, there is still steady growth. China Mobile now trades at just four times earnings and gives a yield of 9%. “It is a really undervalued stock that has done very well in the last few years, up 30 or 40% since we bought it,” says Wong.

He believes there are many similarly undervalued counters, which remain unloved because they are “boring” with steady, predictable cash flows. After all, many investors have gotten used to high-growth counters of 30% or more, which he cautions against chasing.

A decade ago, due to a liquidity-driven rally, Wong was not too hot about China’s banks. He has a different view today. The Big Four state-owned banks, listed in descending market cap, are Industrial and Commercial Bank of China; Agricultural Bank Of China; Bank of China and China Construction Bank. They are trading at a third or so of their book values; P/Es of between 3 and 3.5 times and giving yields ranging between 8% and 9%. Another plus point to receiving dividends is that the renminbi is relatively undervalued and thus there’s room for appreciation. “They were cheap, but they are now cheaper,” says Wong of the banks.

He acknowledges the worries over the potential jump in non-performing loans and the need for the banks to maintain credit to certain other SOEs. Nonetheless, drawing on his years in this market, Wong points out that worry over credit quality has been flagged since more than a decade ago. “I’ve never seen this kind of value in China in the last few years. I am bullish not because I expect very high growth rates; I am bullish because the market has more than discounted the bad news out there. Even with a growth rate of 4%–5%, China is very, very cheap,” says Wong.