15 Sep 2020
Asia Pacific ex Japan 14/08/2020
Innovation has transformed the world and impacted everything from the way we travel, communicate and work. Although historically been viewed as an imitator, China is now at the forefront of the next wave of innovation. Our team outline three themes set to define China’s future dominance and where the investment opportunities lie.
We are living in a golden age of innovation and the pace of change is intensifying. For example, it took 70 years for the washing machine to reach full penetration, 20 years for colour television but only five years for social media. We expect the next innovation waves to drive exponential growth in companies that develop, enable and adopt these disruptive forces.
From a geographical perspective, China is at the forefront of the next wave of innovation, partly due to its significant structural advantages. As the so-called godfather of Artificial Intelligence Kai-Fu Lee once said, “Data is the new oil, and China is the new Saudi Arabia”.
Data creation, access and analysis are paramount to the development of the next generation of innovations. China has created more data than any other country and continues to outgrow global data growth. Additionally, the country is uniquely positioned at the crossroads of innovations - both as a source and a destination for the most innovative companies.
Domestically, government policy and regulations have long been supportive of innovation, an effect that is now materialising. As such, we believe China’s structural advantages make it a fertile ground to develop innovative products and services.
Waves of Innovation drives growth in productivity, population and economy
Source: www.oxfordre.com
This in turn will have significant implications for the shape of future returns from Chinese equity markets. Indeed, from an investment perspective, we have identified technology, environmental and lifestyle innovation as the three key themes that will be significant drivers of change and growth for at least the next few decades.
It is estimated that the ‘technology innovation’ theme will see the total addressable market increase from US$738bn in 2019 to US$2.2trn by 2025, led by the growth in AI software, autonomous vehicles and the internet of things.
The enormous breadth of use cases for technological innovation mean that this theme will have a long duration. AI and automation have the potential to disrupt almost every sector to varying degrees, much the same way as the internet has. Since the introduction of the iPhone, the global internet sector has hugely outperformed global equities and continues to do so. We see potential for AI and automation-related stocks and sectors to follow suit over the next decade.
Global internet sector has outperformed since the introduction of the iPhone
Source: Fidelity International, Bloomberg: OGIGXT Index (G347), July 2020Past performance is not a reliable indicator of future returns. |
Glodon is a leading AI enhanced software provider for the construction industry in China. Its software helps construction companies digitise the cost estimation, quantity surveying and project management functions of a project. Digitising processes both reduces the customers costs as simplify the processes, with their dominant market share a testament to the quality of their solution.
Earnings growth will be driven the transition to a Cloud software-as-a-service model and the increasing penetration of construction management software which is currently nascent. Additionally, developed market peers have shown that the increased visibility of recurring earnings from the transition to the SaaS model can lead to a significant valuation re-rating.
Cloud revenue growth and contribution forecast
This is the theme linked to development and application of products and processes that contribute to sustainable environmental protection and ecological improvements. Key areas here include electrical vehicle (EV) makers and supply chain, waste treatment and alternative energy.
From an investment perspective, one of the main opportunities we have identified is in electric vehicles. As battery prices continue to decline driven by advances in technology and scale, they will become more economically competitive with traditional combustible engines, leading to exponential growth in battery demand over the next 10 years.
China has the largest battery manufacturing capacity in the world with potentially 65% market share by 2023. Leading players will benefit from the soaring electric vehicle demand.
Battery manufacturing capacity global breakdown
2019: 365GWh
2023: 1,237GWh
CATL is the world’s largest electric vehicle (EV) battery supplier with 24% global market share and over 50% market share in China. It supplies most of the major Chinese auto manufacturers and some major global players like Daimler, BMW and VW. Its leadership has been underpinned by technical superiority and upstream integration.
With EV penetration still nascent but nearing the inflexion point, as battery costs decline and regulatory pressure on fossil fuel cars intensifies, the total addressable market will grow rapidly.
Projected global EV penetration
This theme is based around transforming and improving our lives through innovative solutions.
China’s per capita spend on healthcare is a fraction of that of their developed peers. However, as incomes grow, and the population urbanises, we are likely to see growth in China outstrip other markets.
Per capita health expenditure
With foreign companies currently dominating innovation, patent-protected pharmaceuticals, innovative Chinese biotech companies with world class R&D capabilities have huge scope to develop their own drugs and tap this underpenetrated market.
Recently, the Chinese government completely transformed the drug approval review process. It is now faster, more transparent and with higher assurance of quality. Meanwhile, China’s drug development is increasingly integrated with the rest of the world which encourages those with the know-how to utilise the large Chinese patient pool for fast clinical trials. The R&D talent pool in the China is also improving attracted by the opportunities in China. As a result, China will steadily deliver more and faster drug innovations.
Wuxi AppTec is one of the largest pharmaceutical outsourcing service providers in Asia. Established in 2000, the company provides pharmaceutical, biotech, and medical device R&D and manufacturing services to global customers in terms of advance medical discoveries and treatments for patients. Wuxi AppTec’s innovative and industry leading capabilities in areas such as R&D and manufacturing for molecule drugs to cell and gene therapies is accessed by customers through its open-access platform, which has seen partnerships for close to 4,000 collaborators from over 30 countries.
We believe Wuxi Apptec is a long-term earnings compounder that is expected to benefit from increasing Chinese and global demand for CRO (contract research organisation). Being a first mover in this segment, we don’t see any meaningful competition both from global and Chinese domestic players. The company’s strong entry barriers are a result of a solid track record, its innovative strategy, its ability to attract and retain talent and focus on next generation cell/gene therapy where it is a leading player.
Strong client demand for outsourcing continues to underpin Wuxi AppTec’s business, especially as more global clients opt to outsource laboratory work given disruptions seen in their US or European operations due to the outbreak of Covid-19. With Covid-19 becoming a global pandemic, unmet medical needs are strongly required; the Chinese regulator has given Covid-19 related drugs and vaccines work priority when reviewing any clinical trial data although the actual trials process has not been shortened.
China is a fertile ground for innovation and its huge market provides companies with the potential to quickly scale up successful innovation. Although the types of innovations will evolve over time, we believe the innovation theme and China’s leadership is perpetual in nature.
Innovation is not confined to the technology sector but is increasingly encompassing areas such as lifestyle and environmental. Through our fundamental bottom-up research and local insight, we can invest in the leading areas and companies that offer “innovations by China and innovations for China”.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Investments in small and emerging markets can be more volatile than other more developed markets. Changes in currency exchange rates may affect the value of investments in overseas markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.