After China reopened its borders in early 2023, our investment team traveled to the country in May to meet with management teams face-to-face for the first time in more than three years. The investment team took full advantage of the opportunity, visiting 15 cities and more than 50 companies over the course of two weeks. Below are some of our team’s key observations and findings from the trip and insights from a few of our most interesting meetings.
CHINA’S REOPENING IS IN FULL SWING
Heading into the trip, we read mixed reports about how quickly China was moving past the pandemic. While it’s true that some reopening data have been below market expectations, we witnessed bustling restaurants, airports and train stations. Tourist attractions were hitting maximum capacity from domestic travelers. People appeared cautious but generally positive. And as another sign that China has put the pandemic in the rearview mirror, most citizens weren’t wearing facemasks.
AT THE SAME TIME, THREE YEARS OF LOCKDOWNS HAVE LEFT SCARS AND ALTERED SPENDING HABITS
While Chinese consumers are out and about, the loss of freedoms, and often incomes, has made them more cautious about spending. An interesting data point reflects the dichotomy between society reopening and consumers spending less: Domestic travel for China’s May Day holiday break was up 19% from the same holiday before the pandemic, but tourist spending was roughly flat from 2019. The lack of discretionary spending is also evident in China’s malls, which seemed relatively empty.
Across China, we noticed “consumption downgrading” by middle-class consumers who appeared hesitant to spend on aspirational items. Overall, we remain optimistic about the reopening trajectory. However, we think it will be a gradual process and likely bumpy. We continue to look past near-term expectations in our investment horizon.
CHINA’S INFRASTRUCTURE IS SECOND TO NONE
During our visit, we traveled over a 35-kilometers bridge connecting Shanghai and Ningbo and rode on quiet, electric buses on streets free of potholes. We also visited nine airports, all of which were built in the last 10 to 20 years and arguably operate more efficiently than those in the U.S. And it appears that even more impressive infrastructure projects are yet to come—testing is underway on a vacuum-tube train that will combine aerospace and railway technologies to commute passengers from Shanghai to Hangzhou (a distance of 150 kilometers) in just 15 minutes. The train will be tested at speeds of up to 1,000 km/h. Impressively, the country’s existing high-speed rail system has about 42,000 kilometers of track, already the longest high-speed railway in the world.
TECHNOLOGICAL ADVANCEMENT REMAINS IMPRESSIVE
Examples of China’s innovation were abundant. Throughout China’s major cities, highly developed camera networks and facial-recognition systems detect and deter crime. At a robotics company we visited, a fully automated factory floor used robots to make robots. And China’s delivery system is extremely efficient—a member of our team left a swim cap and goggles at a Shanghai hotel but was able to have it delivered to our next destination 1,200 kilometers away in less than a day and at a cost of just $4.
DIGITAL PAYMENTS DOMINATE, WHILE CASH APPEARS TABOO
From taxi drivers to coffee shops and restaurants, merchants shunned cash payments. As digital payments have become ubiquitous in Chinese society, so too has digital shopping. WeChat and Alipay dominate. One of our analysts visited his parents, who are in their 80s, and found them using a Meituan app for grocery shopping. The app aggregates all orders from their community of several high-rise buildings, delivers those items in bulk, and then sends a WeChat message to the parents when their individual order has been separated.
THE SEMICONDUCTOR INDUSTRY COULD SEE MORE SHAKEUP
We met with eight Chinese semiconductor-related companies during our trip. Companies confirmed that less capital is going into the chip-design industry, which should shake out weaker competitors in the next several years. It will also increase the availability of talent for remaining firms. Regarding the current semiconductor cycle, inventories appear to have peaked in some verticals. However, semiconductor buyers remain uncertain about demand for their own end products, implying the recovery may be softer or take longer than some forecasters expect.
From our meetings, we also got a clearer picture of the capabilities of the different management teams. We remain constructive on the industry, as our semiconductor holdings largely continue to focus on stable end-markets, expand into new verticals, ramp up new research and development, and execute tailored designs to meet customer needs.
AMERICA AND CHINA STILL DO A LOT OF BUSINESS TOGETHER … SO DO CHINA AND TAIWAN
Geopolitical tensions are undeniably ratcheted up. But our research trip served as a reminder of the deep economic ties among the U.S., China and Taiwan. Our own holdings illustrate the complex relationships. For example, Ford is licensing technology from China’s Contemporary Amperex Technology Co. Ltd. to design the batteries that will power generations of U.S. electric vehicles. Elsewhere, we learned Shenzhen Mindray Bio-Medical Electronics Co. Ltd. recently won a large deal to provide medical-diagnostic equipment to a group of U.S. community hospitals. As an example of how Chinese businesses can work constructively with the U.S. government, Wuxi Biologics Cayman, Inc., a Chinese contract development and manufacturing company, worked closely with the U.S. Department of Commerce to get itself removed from a regulatory watch list.
Our research trip also reinforced the existence of close relationships among some Chinese and Taiwanese businesses. For example, Airtac International Group, an industrial component manufacturer, is headquartered in Taiwan but has factories in mainland China. The factories are run by Chinese management teams that have fully integrated a Taiwanese corporate culture.
INVESTORS MUST PICK THEIR OPPORTUNITIES CAREFULLY IN CHINA
The innovation taking place in the country, the infrastructure supporting businesses and the sheer size of China’s domestic market create compelling investment opportunities within the country. At the same time, there has been and continues to be an abundance of capital available to most Chinese businesses. This has led to fierce competition in some industries and, ultimately, low returns for investors. The abundance of capital means historically productive uses of it may not bear as much fruit. For example, investments in infrastructure and property may have lower marginal returns ahead and be less impactful growth engines going forward. For us, this reinforces the need to dig deep to understand the competitive moats of a business and the industry market structure in order to identify potential winners and losers. It also underscores the imperative of doing on-the-ground research to visit companies, factories, suppliers, customers and competitors.
China may be the ultimate stock-picker’s market in that sense, a place where more selective compounders overcome competitive intensity to generate outsized returns. Though the past three years have been a tough environment for compounding earnings because of lockdowns, geopolitical tensions and a volatile macroeconomic backdrop, we remain optimistic that our high-quality, long-duration investment style will be rewarded in China. Positively, our current holdings in China have continued to invest in growth—opening new plants and expanding into new geographies domestically and internationally. Below we highlight three of our favorite company visits.
CONTEMPORARY AMPEREX TECHNOLOGY COMPANY CO. LTD. (CATL)
We met with Wasatch holding CATL and toured the factory at its Ningde, Fujian headquarters. CATL develops and manufactures lithium-ion batteries that power many electric vehicles (EVs), putting the company at the forefront of one of the most promising growth trends in China and globally.
Associate Portfolio Manager Kevin Unger with an EV powertrain and battery bed. Source: Wasatch Global Investors
China’s rapid uptake of EVs was evident as we wound through the country’s largest cities, where roads were lined with sharp-looking electric vehicles and buses that made the streets noticeably quieter than large Western cities. Our experience on the roads verified what the data was telling us: China’s leadership in EV technology and adoption is substantial. The country accounted for nearly 59% of the world’s EV sales in 2022. Within China, electric passenger vehicle sales grew 87% in 2022 and accounted for a quarter of new auto sales. Build Your Dream (BYD) appears to be the most popular brand, underscoring its 33% market share of new-car sales.
Importantly, under the hood of many EVs is a CATL battery. CATL is the global leader in the EV battery market, with 50% market share in China and 37% share across the world. The company’s participation in China’s early EV growth has given it a tremendous scale and first-mover advantage relative to competitors. As CATL grows its battery business, the unit economics for its batteries continue to improve, making it ever more competitive on the global stage. EV adoption is the key revenue driver for CATL, and we continue to see revenue estimates get upgraded due to faster-than-expected EV adoption.
Along with its strong competitive position, we’re excited about CATL for its ongoing innovation and new opportunities that lie ahead. Strong revenue growth has allowed the company to invest heavily in research and development, spending $2.3 billion in 2022 alone. A recent deal with Ford highlights CATL’s technological edge. Instead of trying to build its own EV batteries, Ford struck a deal with CATL to license its innovative technology. CATL’s heavy research focus has helped it stay ahead of major technology shifts in the industry and tap new potential verticals, such as energy storage, which grew 230% year over year and accounted for 14% of total sales in 2022. CATL is the global market leader in the booming energy-storage market with 45% global market share.
SHENZHEN MINDRAY BIO-MEDICAL ELECTRONICS CO. LTD.
We met with Wasatch holding Mindray, a medical-equipment company, at its Shenzhen headquarters. The opportunity to talk with management and see Mindray’s cutting-edge equipment firsthand gave us a better understanding of how this Chinese company has punched above its weight, competing and taking share from global players such as Siemens, Philips and GE.
Mindray operating theater display. Source: Wasatch Global Investors
The meeting gave us more confidence in Mindray’s business trajectory and reinforced our conviction in the management team. That conviction was already high, given how well the firm managed pandemic-related dislocations over the last three years. Many medical-equipment and diagnostic companies experienced a dip in demand during the pandemic as consumers delayed certain procedures. But Mindray’s revenue growth was remarkably consistent, with growth rates above 20%. At the height of the pandemic, Mindray’s patient monitoring and ventilator sales jumped, while in-vitro diagnostics (IVD) and ultrasound sales slowed. As Covid-19 waned, patient monitoring revenue normalized, while demand for IVD and ultrasound equipment carried the day.
Geographic diversification also provided steadier revenue growth. In the initial phase of the pandemic, Mindray’s overseas revenue jumped while revenue from China slowed. Then, in the latter phases of the pandemic, international growth normalized while revenue from China picked up. Mindray’s earnings were also helped by wide profit margins, as gross margins remained stable near 70% and operating profit margins hovered over 35%.
We also came away from our Mindray meeting more impressed with the company’s commitment to innovation. Management told us they typically spend 10% of revenue on research and development. That spending is bearing fruit: The company’s engineers have received more than 1,800 patent approvals and are averaging a 24% increase in approvals each year. Mindray’s management team also shed light on its nimbleness relative to larger peers, estimating that the company’s product development times are, in some cases, five times faster than competitors.
Mindray’s innovative nature has helped it defy the stereotype that Chinese medical products are less expensive but of lower quality than equipment from developed markets. To wit, its patient monitoring systems command a premium price relative to their multinational competitors because of their high quality. The innovative culture and high-quality nature of its technology give us confidence Mindray will continue to gain share globally with its existing products and successfully branch into new segments such as minimally invasive surgical devices and animal care.
AIRTAC INTERNATIONAL GROUP
We toured an Airtac factory on mainland China in Ningbo, Zhejiang and came away impressed with the sophistication of the production line, the corporate culture and the opportunity for growth ahead. Headquartered in Taiwan but with much of its operations in mainland China, the company manufactures industrial automation components that convert the energy of compressed air or gas into a mechanical motion inside machines. With much of China’s workforce aging, the country is looking increasingly to factory automation, and we think Airtac is an attractive player for both domestic China and international industrial markets.
Airtac production floor. Source: Wasatch Global Investors
What struck us most on our visit was Airtac’s clean, modern, sophisticated and vertically integrated production process. The company has developed high-end, efficient production lines for relatively simple products, allowing it to create very high-quality, low-cost components. Impressively, Airtac’s vertical-integration model now allows a whopping 80% or more of its parts to be manufactured in-house.
We also learned more about Airtac’s corporate culture, which is focused on cost efficiency, continuous production improvement and the chairman’s belief that employee satisfaction leads to higher productivity. Reflecting that belief, Airtac’s worksites feature green spaces, recreation areas, in-house restaurants, and even dormitories where employees can stay. The company also pays its workers high wages and offers better benefits relative to many other industrial companies. This has translated into a highly productive workforce that participates in 5.5-day work weeks.
We believe Airtac’s sophisticated production lines, corporate culture and vertical integration are competitive advantages for the company. Airtac is already the second-largest brand in China and is now focused on becoming one of the three largest global competitors. We believe Airtac is well-positioned for future growth as demand for automation increases, the company cross-sells into new verticals and it utilizes its operational prowess to improve margins.
RISKS AND DISCLOSURES
Mutual-fund investing involves risks, and the loss of principal is possible. Investing in small-cap funds will be more volatile, and the loss of principal could be greater, than investing in large-cap or more diversified funds. Investing in foreign securities, especially in emerging markets, entails special risks, such as unstable currencies, highly volatile securities markets, and political and social instability, which are described in more detail in the prospectus. Being non-diversified, the Fund can invest a larger portion of its assets in the stocks of a limited number of companies than a diversified fund. Non-diversification increases the risk of loss to the Fund if the values of these securities decline.
The Wasatch Greater China Fund is subject to risks associated with investments in China and countries in the greater China region that could affect the value of your investment in the Fund, including government control over currencies, economic conditions, industries and specific issuers, as well as continued strained international relations, uncertainty regarding taxes, and limits on credible corporate governance and accounting standards. Because of its exposure to greater China, including mainland China and China’s special administrative regions, such as Hong Kong, the Fund is subject to greater risk of loss as a result of volatile securities markets, adverse exchange rates and social, political, military, regulatory, economic or environmental developments, or natural disasters that may occur in the China region. The imposition of tariffs or other trade barriers by the U.S. or foreign governments on exports from China may also have an adverse impact on Chinese issuers. The Fund may invest in the securities of Chinese issuers through the China Stock Connect program. Trading through the Stock Connect Programs is currently subject to a daily quota, which limits the maximum net purchases by all purchasers using the Stock Connect Programs each day. While the daily quotas are relatively large, there is the possibility that the quotas could be reduced or exceeded, meaning buy orders for China A-shares would be rejected, affecting the Fund’s ability to efficiently execute its investment strategy.
An investor should consider investment objectives, risks, charges and expenses carefully before investing. To obtain a prospectus, containing this and other information, visit wasatchglobal.com or call 800.551.1700. Please read the prospectus carefully before investing.
Information in this document regarding market or economic trends, or the factors influencing historical or future performance, reflects the opinions of management as of the date of this document. These statements should not be relied upon for any other purpose. Past performance is no guarantee of future results, and there is no guarantee that the market forecasts discussed will be realized.
Portfolio holdings are subject to change at any time. References to individual companies should not be construed as recommendations to buy or sell shares in those companies. Current and future holdings are subject to change and risk.
As of March 31, 2023, the Wasatch Greater China Fund had 4.0% of its net assets invested in Airtac International Group, 3.8% of its net assets invested in Shenzhen Mindray Bio-Medical Electronics Co. Ltd., 3.2% of its net assets in Wuxi Biologics Cayman, Inc., 2.9% of its net assets in Meituan, Class B and 2.8% of its net assets invested in Contemporary Amperex Technology Company Co. Ltd.
The representative account for the Wasatch Greater China strategy is the Wasatch Greater China Fund. The primary investment objective of the Wasatch Greater China Fund is long-term growth of capital.
Wasatch Advisors LP, trading as Wasatch Global Investors, ARBN 605 031 909 is regulated by the U.S. Securities and Exchange Commission under U.S. laws which differ from Australian laws. Wasatch Global Investors is exempt from the requirement to hold an Australian financial services licence in accordance with class order 03/1100 in respect of the provision of financial services to wholesale clients in Australia. Wasatch Advisors LP, doing business as Wasatch Global Investors, is the investment advisor to Wasatch Funds.
Wasatch Advisors LP, doing business as Wasatch Global Investors, is the investment advisor to Wasatch Funds.
Wasatch Funds are distributed by ALPS Distributors, Inc. (ADI). ADI is not affiliated with Wasatch Global Investors.
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Revenue growth is the increase in a company’s revenues over a specified period of time, not necessarily one year.