Investing in China

Frederick Jiang, CFA

Ways to Play China

ADRs

Local Shares in Hong Kong

Index ETF

Mutual Funds (Asia, China, Emerging Market)

Multi-National Companies with Big China Exposure

Not for Faint Heart

Volatility Can be Very High in Down Turn

Less Transparency and Different Accouting

Stick to Mid to Large Cap Names

Be Patient

High Return, High Volatility

Consistent Earnings Growth

Hang Seng China Enterprises Index - EPS

Buy Low, Sell High

Hang Seng China Index – Price/Earnings Multiple

Opinions Diverged

China will overtake the U.S. to become the world’s largest economy. ---- Jim O’Neil, Goldman Sachs

Opinions Diverged

The real estate bubble in China, looks like Dubai times 1000 – or worse.

---- Jim Chanos

Looking Back – GDP in US$

CAGR 10.2%

CAGR 2.9%

Looking Back – Stock Market

What drives China’s Growth?

• Reform and Restructuring• Urbanization and Industrialization• Demography Dividend and Education• Savings and Capital Formation• Globalization

Reform and Restructuring

From Communist to Socialist with Chinese CharacteristicsFrom Central Planning to Market Driven EconomyFrom Closed-Door policy to Open-Door PolicyFrom Dictatorship to “Centralized Democratic” Decision MakingPrivatization

What Drives China’s Growth?

• Reform and Restructuring• Urbanization and Industrialization• Demography Dividend and Education• Savings and Capital Formation• Globalization

What Drive China’s Growth?

Urbanization

-- 1.5 million per month

Industrialization

-- Raise productivity

-- Monetize economic activities

Urban / Total Population

(%) 2000 2005 2010 2015 2020 2025 2030

Australia 87.2 88.2 89.1 89.9 90.6 91.3 91.9

China 35.8 40.4 44.9 49.2 53.2 56.9 60.3

Hong Kong 100 100 100 100 100 100 100

India 27.7 28.7 30.1 31.9 34.3 37.2 40.6

Indonesia 42.0 48.1 53.7 58.5 62.6 65.9 68.9

Japan 65.2 66.0 66.8 68.0 69.4 71.1 73

Korea 79.6 80.8 81.9 83.1 84.2 85.2 86.3

Malaysia 62.0 67.6 72.2 75.7 78.5 80.5 82.2

Pakistan 33.2 34.9 37.0 39.7 42.8 46.3 49.8

Philippines 58.5 62.7 66.4 69.6 72.3 74.6 76.7

Singapore 100 100 100 100 100 100 100

Thailand 31.1 32.3 34.0 36.2 38.9 42.2 45.8

Vietnam 24.3 26.4 28.8 31.6 34.7 38.1 41.8

Asia 37.1 39.7 42.5 45.3 48.1 51.1 54.1

US 79.1 80.8 82.3 83.7 84.9 86.0 87.0

Latin America 75.3 77.5 79.4 80.9 82.3 83.5 84.6

Western Europe 75.3 76.1 77.0 78.0 79.1 80.4 81.7

Source: United Nations, CLSA Asia-Pacific Markets

What Drives China’s Growth?

• Reform and Restructuring• Urbanization and Industrialization• Demography Dividend and Education• Savings and Capital Formation• Globalization

Demography and Education

Demography Dividend

China’s Baby-boomer Generation

Young and Educated

With money, Will spend

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

New ly enrolled Fresh graduates

mnCollege Enrollment

Brain power: US vs China

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

1999 2000 2001 2002 2003 2004 2005 2006 2007

USA China

(No.) Science and engineering PhDs

Source: National Science Foundation, China National Bureau of Statistics, CLSA Asia-Pacific Markets

What Drives China’s Growth?

• Reform and Restructuring• Urbanization and Industrialization• Demography Dividend and Education• Savings and Capital Formation• Globalization

Saving is Virtue!

Waiting to make deposit

Total Deposit

Total Household Deposit in China US$5.13 Trillion

Household Savings / Disposable Income

0 10 20 30 40

USA

Philippines

J apan

Taiwan

Australia

Thailand

Indonesia

South Korea

Malaysia

India

Hong Kong

Singapore

China

(% )

Source: Euromonitor, CLSA Asia-Pacific Markets

Higher Savings Ratio,

Higher Capital Formation,

Higher Growth Rate

What Drives China’s Growth?

• Reform and Restructuring• Urbanization and Industrialization• Demography Dividend and Education• Savings and Capital Formation• Globalization

Globalization

China Accounts for 10% of Global Trade

Drivers for the Growth in Next Decade?

• Reform and Restructuring should continue,

but no more low hanging fruits• Urbanization and Industrialization

another two decades to go• Demography Dividend and Education

no more labor growth, productivity to go higher• Savings and Capital Formation

need less savings to drive domestic consumption• Globalization

slower export growth, trade balance

No More Double Digit Growth

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1980

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2022

2024

2026

GDP grow th

%

Power of Compounding

0

5000

10000

15000

20000

25000

30000

US

$ B

illi

on

Year

GDP Comparison

China

US

India

Key Assumption China India U.S.

Real GDP 7% 6% 2%

Inflation 3% 4% 2%

Currency Appreciation 2% 1%

Myth 1: Massive Real Estate Bubble

• “A reported 64 million empty apartments in China’s Ghost Towns” – Financial Times Blog

• “30 billion sf of office under construction, a 5-foot by 5-foot cubicle for every Chinese” – Jim Chanos

• “It costs you $1 million to buy an apartment in Beijing or Shanghai”

“Housing Bubble” in China

Supply and Demand in Last 10 Years

(in millions)Empty Complex

“Housing Bubble” in China

0

100

200

300

400

500

600

70019

95

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

0

5

10

15

20

25

30

35

40

45

New homes (floor space, LHS) New homes/new urban population (RHS)

sqm, mn sqm per person

Source: National Statistic Bureau

“Office Bubble” in China

Myth: “30 billion square feet of office under-construction”

Facts: 18 billion square feet all together, residential, office, commercial.

0

20

40

60

80

100

120

140

1995 1998 2001 2004 2007 2010under Construction: Office Completed: Office

square meter, mn

Facts: office under-construction is 1.3 billion square feet, not 30 billion.

“Housing Price Bubble” in China

0

5

10

15

20

25

30

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

NationalBeijingShanghai

thousand RMB per sqm

Source: Merrill Lynch Economic Research

Myth: $1 million apartment in Shanghai and BeijingFact: Average price is 300K-400K in BJ and SH, and nation wide average price is less than $80,000 in urban area.

Chinese Cities are Quite “Small”

0.0

5.0

10.0

15.0

20.0

25.0

Beijing Shanghai New

York

City

Tokyo Mexico

City

Moscow Bangkok London Seoul

% of city population to national population

Another Angle: Mortgage Loan Size

0.0

5.0

10.0

15.0

20.0

25.0

2002 2003 2004 2005 2006 2007 2008 2009 2010

Mortgage loan to GDP Mortgage loan to total household bank deposits

%

Mortgage to GDP: China 15%, US 82%

Source: Merrill Lynch Economic Research

Myth 2: China is Export Driven

0

10

20

30

4019

80

1982

1984

1986

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1990

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1996

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2000

2002

2004

2006

2008

2010

Ratio of ex ports to GDP

%

Gross Export vs. Net Value-Added

Average Selling Price $400

Ex-Factory Cost: $200

(reported in China’s export)

Value added in China: $6

(reported in GDP)

True Export Share

Source: UBS Economic Research and Waddell & Reed Estimate

GDP Composition

Source: Waddell & Reed Estimate

Myth 3: China is Investing Too Much

Chinese Consumption as % of World Total - 2010

Source: BNP Paribas Research

China’s Capital Stock

0

50,000

100,000

150,000

200,000

250,000

US

Russ

ia

China Ind

ia

Germ

any

Fran

ce

Braz

il

Japa

n UK

Kore

a

KM

-1,000

1,000

3,000

5,000

7,000

9,000

11,000

13,000

15,000

US

Braz

il

Russ

ia

Germ

any UK

China

Fran

ce India

Japa

n

Kore

a

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

US

China India

Braz

il

Japa

n

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ce

Russ

ia

Germ

any UK

Kore

aKM

0

100200

300400

500600

700800

900

US

Fran

ce

Japa

n

Germ

any UK

Kore

a

Russ

ia

Braz

il

China India

Total Length of Railway Total Number of Airports

Total Length of Paved Roads Number of Vehicles per 1000 People

Per Capita Steel Production

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

China Japan Korea US

Ton

Capital Formation as % of GDP

40%

41%

42%

43%

44%

45%

46%

2005 2006 2007 2008 2009F

Investment % of GDP

Source: CEIC

Where does the investment go?

Investment Breakdown by Sector

36%

29%

24%

11%

Manufacturing/Mining

Infrastructure Build-out

Property Development

Other Services

Source: China National Bureau of Statistic

What support investment growth?

Gross Saving Ratio

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

2005 2006 2007 2008 2009F

Source: CEIC

Myth 4: China’s Debt Bomb

“As the world watches the Greek credit crisis unfold, a Sino-debt disaster is brewing halfway around the world.”

Fortune Magazine, June 2011

Real Picture

Estimated Government Liability and Asset (% of 2010 GDP)

Assets     Liabilities  

Market Value of Listed SOEs 35%  Central Government Debt 17%

Value of Other SOE Assets 15%  Local Government Debt 27%

Land Use Rights 30%  Legacy Bad Loans 7%

  Total Gross Public Debt 51%

 

 Under-funded Pension/Healthcare  25%

 New Social Security Coverage 5%

 

Total Saleable Assets 80%  Total Liabilities 81%

Source: CEIC, UBS and Waddell & Reed Estimates

Public Debt -- U.S. vs China

Public Debt – U.S. vs China

U.S. China

Federal Government 93% 24% (17%+7%)

State Government 7% 10%

Local Government 11% 17%

Gross Public Debt 111% 51%

Medicare Shortfall 166% 25%

Social Security shortfall 37% 5%

Total Government Liabilities 314% 81%

Note: Chinese data does not include debt owned by State Owned Enterprises. U.S. data does not include agency bonds.

Private Debt – China vs U.S.

Mortgage to GDP: China 15%, US 82%

Household Debt % of GDP

0%

20%

40%

60%

80%

100%

120%

China India Taiwan Korea US UK

Not Without Road Blocks

• Less Favorable Demography• Structural Inflation• High Environment Protection Cost• Imbalanced Economic Structure• Widening Wealth Gap• Difficulties in Political Reform• Wide-Spread Corruption• Instable Corporate Profit Margin • No Equity Culture• Many More…

Less Favorable Demography

50

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350

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009Age 0-14 Age 65 and abov e

mn

200

300

400

500

600

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Age 20-44 20-39 20-34

million person

Aging Population

Less number of young workers

Structure Inflation

Food Price Inflation: the side-effect of urbanization

Major driving force behind high CPI inflation

Lack of Natural Resources:

60% of Oil Imported

50% of Iron Ore Imported

60% of Copper Concentrate

30% Soy Bean

5% of Corn

………

High Environmental Cost

Pollutions Cost China as Much as 2-3% of GDP

Imbalanced Economic Structure

U.S. China

Personal Consumption 70% 34%

Government Spending 19% 21%

Investment 15% 33%

Net Export -3% 12%

Total 100% 100%

Investment Implication

China Offers Long Term Growth Opportunities

Different Ways to Play China

Not for Faint Heart

Investment Implication

0

5000

10000

15000

20000

25000

30000

US

$ B

illi

on

Year

GDP Comparison

China

US

India

Key Assumption China India U.S.

Real GDP 7% 6% 2%

Inflation 3% 4% 2%

Currency Appreciation 2% 1%

$10,000 Growth at Different Rate

Assuming: 1. Chinese EPS grows at nominal GDP rate, US grows at 1.5X of GDP rate; 2. PE multiple and profit margin Stay the Same Over 10 Years.

Q & A