Chinese new year of the dog

Dale Nicholls
Dale Nicholls
Portfolio Manager, Fidelity China Special Situations PLC22 February 2018

As we enter the Chinese new year of the dog, here are three themes to consider when investing in the region - you could call these my ‘top dogs’, ‘pups’ and ‘strays’ for the year ahead.

Top dog (long-term winner)

Investments related to the rise of China’s middle-class consumer remain a core focus for me. These consumers are demanding more from products and services - and some companies are responding with strong offerings on both of these fronts.

China Meidong Auto is a long term holding that has done very well over the last couple of years, but I still think it has much more potential. It is a car dealership based in the Guangdong region that continues to grow its network while its excellent management team is highly successful in taking over weaker dealerships and turning them around.

Selling cars is core to its business, and its approach has led to partnerships with high quality brands such as Porsche and Lexus. But what sets China Meidong Auto apart from competition, and how it has been able to turnaround the failed businesses it has purchased, is its approach to services. Buying a vehicle from them is an experience and the management team focuses heavily on offering the best after sales services.

It is well diversified and other services, such as financing, are important revenue opportunities that the company is capitalising on. There is scope for more growth as it expands its dealership network across the region and even nationally, which means lots of future potential value in the business.

Pup (emerging idea)

I am constantly looking for investment opportunities in health care given the strong mid-term growth prospects, and pharmaceutical distributors have emerged as an interesting area.

The industry has been consolidating for the past decade, but will accelerate following the recent ‘two-invoice’ reform. This policy cuts out layers of middle-men so there are now only a maximum of two invoices for drugs sales - one from manufacturer to distributor; another from distributor to hospital. The impact has been significant consolidation within the provinces this reform has been trialed in.

This is also a capital intensive business in China as distributors extend credit to hospitals ranging from 1-6 months, and the receivable days are increasing as distributors look for new opportunities in more remote cities. As a result, the biggest and best run are growing market share.

I own Sinopharm, China Resources Pharmaceutical and Shanghai Pharmaceutical in this space due to their extensive distribution network and comparatively deeper pockets. Given the regulatory changes and subsequent change in industry structure, this area has been neglected by the market and thus valuations look relatively attractive.

Stray (area of concern)

Property developers face a tougher environment going forward. After a few years of favourable policy and a general pick-up in demand we have seen a strong residential property market. However, all cycles end and after seeing prices more than double in some cities the government is clearly tightening policy, whether through tougher mortgage rules or restrictions around people buying additional properties.

This is starting to hit the property market through lower transactions and higher inventories, which will impact developers. The developers have seen their share prices rise significantly over the last two years, but they are now at relatively high valuations, while leveraged balance sheets may make it a rocky period for the smaller and less disciplined players. I must stress that I do not think this will have a meaningful impact on the consumer story as much of the incremental demand for property units has been coming from investors rather than property owners - and if policies do start to bite, then the government will look to reverse them.

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