Tuesday, December 12, 2017

Games, trains and electricity

As China’s Communist Party prepares for its 19th National Congress next week, investors are watching closely for hints about what may emerge. There are expectations that this could include broad structural reforms and a reshuffle of the party’s top leaders.

But some analysts are doubtful. Xi Jinping will be reappointed for another five-year term, of course, and sweeping reforms are “unlikely”, says Magdalene Miller, China equities portfolio manager, Aberdeen Standard Investments.

“Still, in Xi’s new term, there may be some breakthroughs in reforms that have stalled or been set aside over the past five years around state-owned enterprises, urbanisation, land rights and financial services,” she adds. “As global investors, we remain cautiously hopeful.”

Whether that could mean allowing greater participation by foreign insurers remains to be seen, but looking forward to the next five years there may at least be some investment opportunities. Miller sees potential for upside in power generation, transport infrastructure and online gaming.

The government has already said that it is (kinda maybe) planning to phase out gasoline and diesel vehicles, perhaps by 2040. This is obviously positive for the country’s biggest makers of electric vehicles, such as BYD and BAIC, and their component suppliers. But the burning issue (so to speak) with electric vehicles is where the electricity comes from. And in China the answer is coal — 90% of the country’s power is generated by burning the black stuff.

In other words, electric vehicles in China will help to reduce pollution in the cities by transferring it to power plants away from urban centres.

“So while there are increasing opportunities for investors to put their money into cleaner energy in China, I still see value in the good ol’ school industries,” says Miller, who points to Huaneng Power International as an obvious beneficiary of China’s continued dependence on coal, even as the country moves to control the expansion of coal-fired capacity.

There is also another type of electric vehicle that investors are interested in: trains. The railway industry is a key part of Xi’s One Belt, One Road initiative and spending in the industry could rebound from its recent trough as a result.

“Although some investors are sceptical about the sustainability of a rebound in Chinese railway spending, growing rail investment and maintenance, an ever-expanding urban subway network, non-rail business options and potential overseas ventures are all positive trends,” says Miller, who singles out Zhuzhou CRRC Times Electric as a company that is under-valued by the market.

For investors who aren’t excited by the growth dynamics of railways or coal-fired power stations, online gaming might be more appealing. It is hard to overstate the popularity of gaming in China — revenues are forecast to reach US$27.5 billion this year.

Companies such as Netease and Kingsoft are developing stronger platforms to further increase the penetration of gaming among Chinese consumers, including the evolution of a new generation of games aimed at younger players. As with any popular trend in China, of course, there is always a risk that the Communist Party may step in to regulate it more tightly if gaming is deemed to be offensive to Chinese values. But it is hard to imagine any successful effort to curtail the popularity of gaming in China.

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