The Chinese economy continues to recover from the Covid-19 hit. With many countries easing lockdown measures and restarting their economies, now is a good time for investors to examine which sectors and companies are well placed to weather future market turmoil. 
In Chinese equities, two trends have caught our eye of late. The first pertains to companies that can successfully straddle both the growing Chinese domestic market and the choppy waters of the international economy. Although care is needed with companies exposed to diplomatic fluctuations, especially the ongoing tension between China and the US, we should not ignore companies engaged in exporting. This is because there are some interesting opportunities in companies that have made the transition from exporters to catering for the Chinese domestic market, while maintaining exposure to the vagaries of global demand. Two such examples are Man Wah and Midea.
Sofa designer and manufacturer Man Wah is a good example of how an ‘Original Design Manufacture’ (ODM) business, originally dependent on overseas markets, can develop into a strong domestic franchise. This is a trend we have seen across the better Asian manufacturers for decades. Man Wah started as a pure exporter of recliner sofas. It first ventured into domestic branded business in Hong Kong at the end of the 1990s and saw good uptake despite small apartments. This gave the company confidence in the mainland market’s future demand, so it cultivated the market and its brand much earlier than competitors. In 2011, China made up about 30 per cent of the company’s total revenue and profit; today it is around 50 per cent of revenue and 70 per cent of profit. As the largest producer of motion sofas in the world, with rising brand power and domestic distributing power, we expect Man Wah’s China franchise to be stronger in the future.
Midea is China’s largest home appliances company in terms of revenue size, with a slightly different story to Man Wah’s. The company started as a domestic home appliances maker but also began an overseas business as an ‘Original Equipment Manufacturer’ (OEM) producer to global brands. Thanks to its leading position in the Chinese home appliances market, Midea grew to achieve significant scale in revenue that enabled the company to invest around $1-1.5bn per year in research & development (R&D). With improving product development, the company successfully grew its own brand sales overseas instead of just being an OEM supplier. Its overseas business now accounts for 47 per cent of total revenue, of which one-third is from their in-house brands.
Both Midea and Man Wah have successfully diversified from their original business model, leveraging the growth of the Chinese domestic market while maintaining a presence in the export market. As such they’ve turned into resilient companies with scale and brand power.
The second of the two trends is China’s continuing growth as an innovation and R&D hub. Indeed, when investing in Chinese companies, considerations should be made for those with strong intellectual property or scale to protect market position, as these can make a significant difference in the long-term horizon.
In the field of healthcare, the Chinese government has been reforming their regulatory framework. A novel drug approval process has been sped up dramatically and drug distribution and government bidding has been made more transparent. Commercial insurance has also been growing fast. As a result, companies are strongly encouraged to develop innovative drugs to meet the large growth in demand in high-quality drugs. There is little direct subsidy from the government but some tax incentives are offered for high R&D spenders.
Two companies taking advantage of this trend are 3SBio and Shandong Weigao. 3SBio is a leading Chinese biopharmaceutical company founded by a Chinese scientist returned from the US. 3SBio maintains dominant market share in three biosimilars. It has been consistently investing in R&D and drug acquisition as well as forging alliances with global leading biologics players including AstraZeneca, Samsung Biologics and Eli Lilly. In the fast-growing biosimilar drug demand, leaders like 3Sbio should enjoy high growth in the long term.
Shandong Weigao is another domestic leader, specifically in single-use consumables and orthopedic implanted devices. It has been using mergers & acquisitions to speed up R&D activities. A joint venture with Medtronic in early 2000 was a good stepping-stone to start its orthopaedics business. Their latest acquisition, Argon Medical in the US, has helped Weigao grow its presence in biopsy products, vascular clot management devices, drainage catheters and guidewires. The company currently enjoys steady and strong growth. They benefit from their scale and a strong distribution network, in addition to an extensive product offering.
The entry barrier in the healthcare industry today is increasingly driven by innovation (as opposed to local relationships), and it is an industry which China wants to grow, both to aid its transition to a high-income country and to improve the quality of life of its citizens. This is a sector increasingly offering the high-entry barriers that long-term quality investors look for.
The transition from an investment-driven to an innovation, service and consumer-driven growth model is the crucial step for China to become a high-income country. Asia already represents half of the global middle class in 2020 and the path to higher income has been a long and sticky process. That is why we like domestic leaders from China. While the market might focus on the short-term economic cycle in China, investors should focus on the long-term structural trends of China’s innovation and development instead.
Jasmine Kang is portfolio manager of the Comgest China Growth fund. The views expressed above are her own and should not be taken as investment advice.