China is embracing the green revolution
With potential for a solid earnings rebound, Asia appears to be at the forefront of the post-pandemic recovery. But the evolving long-term growth story is also producing great opportunities to add value – as well as avoid pitfalls - via ESG, according to James Thom, manager of the Aberdeen New Dawn Investment Trust.
Despite some local pockets of resurgence for the virus, the economic picture for Asia looks very favourable compared to the West, Thom said. ‘For the big markets, especially China, the situation looks relatively under control. In India, the cumulative numbers are high but look to have peaked and are progressively heading downward,’ he says.
Consensus forecasts now are for a 25% rebound in earnings for the Asia Pacific ex Japan market, he points out, and China remains the only major global economy to show growth for 2020, with a figure of 2.3% despite the shutdowns.
Currently, China’s hugely ambitious plans for a green revolution is throwing up several potential investment ideas for Thom and his team. ‘This is an area where we’re doing a lot of work at the moment: within our pipeline of ideas, quite a bit is focused on renewables, and China renewables in particular,’ he says.
This reflects the bigger picture: China plans to reach peak carbon by 2030, as part of the goal to become carbon neutral by 2060. ‘A huge amount of investment is going into this, which is inevitably driving opportunities for investors,’ Thom says.
A direct play within Aberdeen New Dawn is LONGI Green Energy, a new addition to the portfolio. ‘It’s a relatively small position but is already performing very well. The company is the largest solar wafer manufacturer not just in China but globally, and a very compelling business. It’s a good example of the type of stock we look for: not only is there a tailwind of growth at industry level, but it has great economies of scale and a market leading position in what is already quite a mature market,’ Thom says.
Another green play is Korean electric vehicle battery component manufacturer LG Chem. ‘There are two parts to this company: the legacy business is petrochemicals which is a solid business in its own right, but they are also among the global market leaders in EV battery manufacture. Their customers for this latter include a lot of the big European auto-makers and they have grown astonishingly fast on the back of this.’
While LG Chem is more focused on Europe, another Aberdeen New Dawn holding, the China A-Share listed Yunnan Energy New Material, is an electric vehicle (EV) battery play focused on the domestic China market. ‘They make a key component within the battery, and are the market leader at what they do,’ Thom says.
China has been leading the world in terms of EV take-up, accounting for roughly 50% of global sales, Thom notes. ‘It’s not just the sheer size of the market, there is also an extremely favourable policy framework for EVs. The government is really pushing this area forward, so we think Yunnan is well positioned.’
Another ESG-related theme within the portfolio is healthcare, with a number of companies in the region now focused on providing cheaper and better access to medicines. Among these Thom highlights WuXi Biologics, one of Aberdeen New Dawn’s best performers in 2020. In the second half of last year the team also added China’s Hangzhou Tigermed Consulting, and Korea’s Samsung Biologics, part of the broader Samsung Group. All three are contract service providers to the biologics industry, which is one of the key growth segments within the global pharmaceutical industry, Thom says.
‘Biologics are essentially drugs derived from living organisms, and as a huge growth area this is capturing a lot of the research and development spend from the big pharma companies: this covers both innovative new treatments, as well as biosimilars, which are the generic version of drugs whose patents have expired,’ he explains.
The service providers offer a play on the growth of biologics that is in line with Aberdeen New Dawn’s focus on stable, cash-generative companies, he notes.
‘Drug companies themselves are fairly binary as an investment: the product either makes it through clinical trials and becomes approved, or it fails and never generates any revenue. These contract service providers allow us to tap into the broader growth story, without taking on that level of risk,’ he says.
But perhaps one of the most essential applications for ESG investing in Asia remains a focus on governance. ‘From a structural standpoint, we think Asia is now looking very attractive, given the backdrop of economic growth, and these secular growth areas like renewables, healthcare and others. But it’s important to remember that risks remain, in particular in the area of corporate governance,’ Thom says.
He points to the case of Luckin Coffee, the Chinese equivalent of Starbucks, and one of last year’s hot IPOs. Soon after going public, the share price suffered massive value disruption as fraud was uncovered. ‘They had been fabricating sales figures, using related parties to falsify transactions - a classic fraud. It wasn’t one we had invested in, but a lot of investors were seduced, and lost an enormous amount of money.’
There were a number of classic red flags involved in the Luckin case, Thom notes. ‘A lack of transparency in the accounts, high levels of related party transactions, and a management team that were largely unknown to the market. As quality investors with a strong focus on corporate governance, these would all be major deterrents for us, he says.
Aberdeen New Dawn focuses on understanding the management, the major shareholders, the track record of dealing with minority shareholders, the numbers of related party transactions, and the complexity of the corporate structure, he says.
‘The biggest question in our minds is, can we really follow the cash? These are the sorts of things that have been fundamental to our process for years, and we think remain critical to investing in the region. A lot of these issues will be particularly acute in China, partly because there are so many new IPOs there and partly because it is still at a phase of capital market development where standards do lag more developed markets, and so due diligence remains absolutely vital.’
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