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This document is intended for professional investors as defined in the MIFID
Demystifying the Dragon:
Myths and Realities of Investing in China
Fabrice Jacob, CEO, JK Capital Management Ltd.
European Pensions & Investments Summit 2012
Grand Hotel Huis ter Duin, Noordwijk aan Zee, The Netherlands, May 15, 2012
This document is intended for professional investors as defined in the MIFID
China: A model that raises suspicions and fears The fastest growing economy in the world
Between 1990 and 2011 – China has grown faster than any other economy to become the 2nd largest in the world
2
Source: Bloomberg , World Bank, IMF – April 2012
3x
20x
5x
USD 357 Billion
1.6% of the world USD 7.3 Trillion
10.4% of the world
USD 317 Billion
1.4% of the world USD 1.7 Trillion
2.5% of the world
GDP 1990 GDP 2011
USD
22 Trillion USD 70.2 Trillion World
China
India
This document is intended for professional investors as defined in the MIFID
China: A model that raises suspicions and fears An unprecedented economic recipe
Chinese growth model is unique
Five-year plans dictate the growth paths
Foreign players are kept on a tight leash. Many of them are forced to partner with local companies
Trade barriers are everywhere
Local companies in strategic sectors are heavily subsidized, especially those that invest overseas
Building infrastructures became a top priority 30 years ago, well ahead of any other Asian country
Any form of political opposition to the ruling party is systematically crushed
Yet, China received 10x more foreign direct investments than India in the past 15 years
3
China’s economic growth model is not unique in the principles it uses.
It is unique as it should have collapsed long ago.
This document is intended for professional investors as defined in the MIFID
The biased prism of Western observers GDP growth under excessive scrutiny
At the beginning of each year the NPC gives its growth target for the year. In 2012, it raised concerns and took the
market down…
4
0
2
4
6
8
10
12
14
16
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
China’s annual GDP growth target
Official GDP Growth Target
Source: National Bureau of Statistics, Capital Economics - February 2012
%
This document is intended for professional investors as defined in the MIFID
The biased prism of Western observers GDP growth under excessive scrutiny
…. and yet it has never been a good proxy for Chinese growth
5
0
2
4
6
8
10
12
14
16
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E
%
China’s GDP growth vs official target
China GDP Constant Price Cumulative YoY
Official GDP Growth Target
Source: National Bureau of Statistics, Capital Economics - February 2012
This document is intended for professional investors as defined in the MIFID
CPI was once a big subject in China. It no longer is but appears to have remained for many the indicator of
China’s health, with any spike raising the ghost of a “hard landing”
-5
0
5
10
15
20
25
Jan-05 Jun-06 Oct-07 Mar-09 Jul-10 Dec-11
Consumer Prices (% Change YoY)
FOOD NON FOOD OFFICIAL CPI
Source: National Bureau of Statistics, Capital Economics February 2012
The biased prism of Western observers CPI as the barometer of Chinese health
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“Chinese inflation is up again [...] putting
China back in an old bind: How to support
growth without unleashing the dragon of
inflation?”
Financial Times 10/04/12
China’s GDP growth has become so important in western minds that every single macro data is
scrutinized by analysts who look eager to find signs of impending doom
An exceptionally cold month of March caused a spike, not mentioned by any Western newspaper
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False Ideas about China “China is highly dependent on exports”
Net Exports contribution to GDP
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China 26%
India 18%
South Korea 50%
Taiwan 66%
Thailand 66%
Malaysia 81% 0%
20%
40%
60%
80%
100%
2005 2006 2007 2008 2009 2010 2011(Est)
China GDP Breakdown (Expenditure Approach) (2005 - 2011E)
Net exports Capital Formation
Government Consumption Private Consumption
Note: National Bureau of Statistics, Capital Economics – March 2012
Source: Bloomberg data - April 2012
Gross Exports as a share of GDP 2011
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False Ideas about China “China is highly dependent on exports”
And gross exports figures often do not reflect the true nature of Chinese exports
8
In China’s exports numbers, an iPhone accounts for $196, not for the $19 local added value
Imported Components from Taiwan, Korea, Japan
and the US: $177
China Components:
$11
China Assembly cost: $8
Apple’s profit: $404
Retail price breakdown of a $600 iPhone 4S
Source: KGI estimates – April 2012
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False Ideas about China “China is the United States’ largest banker”
US Treasuries outstanding: US$ 15 trillion
China total FX reserves: US$ 3.3 trillion
China’s reserves invested in US Treasuries: US$ 1.1 trillion
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US Treasury Ownership
US Institutions and Individuals 42.3%
Social Security Trust 15.8%
US Civil Service Retirement Fund 7.1%
Other Public Funds 2.2%
Foreign Ownership 32.6%
of which China 7.6%
67.4%
Source: US Federal Reserve Bank as at December 2011
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False Ideas about China “Property prices in China have become unaffordable”
Property prices have risen in China, but salaries have risen even faster with the emergence of a large middle class
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4% of sales are in Tier 1 cities, 69% are in Tier 3 where prices are 68% below Tier 1 (source: CLSA – April 2012)
50.0
60.0
70.0
80.0
90.0
100.0
110.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 E
Property Price to Wage Ratio (index 100 in 2000)
Source: National Bureau of Statistics, Bloomberg, Capital Economics - April 2012; Note: CE 2012 Estimates based on Q1 2012 data Note: CE 2012 Estimates based on Q1 2012 data
This document is intended for professional investors as defined in the MIFID
False Ideas about China “There is no genuine demand for property in China, it’s all speculation”
The number of flats built every year in China often leads to the assertion that no matter how big the population is,
such demand has to be speculation. It is forgetting the unique combination of 3 factors:
Property ownership only exists since 1993
In most cities and because of the gender imbalance, a young man will find it very difficult to get married if he
doesn’t own a flat
Confucianism: A cornerstone of Chinese culture is “filial piety" (xiao [孝] in Mandarin Chinese), the attitude of
obedience, devotion and care toward one’s parents.
11
An urban couple with one child and two sets of parents has an ultimate objective to own 3, if not 4 flats.
The real issue is they are often not allowed to.
This document is intended for professional investors as defined in the MIFID
False Ideas about China “There is no genuine demand for property in China, it’s all speculation”
Property ownership in China remains low, first time buyers drive the market while investors account for a marginal part
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59%
34%
7%
0%
20%
40%
60%
80%
100%
Sep
-07
Ma
r-08
2Q
09
3Q
09
4Q
09
1Q
10
2Q
10
3Q
10
Oct-
10
Nov-1
0
Dec-1
0
Ja
n-1
1
Fe
b-1
1
Ma
r-11
Apr-
11
Ma
y-1
1
Ju
n-1
1
Ju
l-1
1
Aug
-11
Sep
-11
Nov-1
1
Dec-1
1
Ja
n-1
2
Fe
b-1
2
Ma
r-12
Property buyers’ profiles
First Time Buyers Upgraders InvestorsSource: CLSA – April 2012
53.8% 48.9%
24.0%
30.0%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
Tier 1Cities
Tier 2Cities
Tier 3Cities
NationalAverage
Property Ownership in China - 2011
Source: CLSA – April 2012
This document is intended for professional investors as defined in the MIFID
China’s Challenges China is addicted to investments
Despite retail sales increasing by 15% year on year, China relies far too much on investments
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Such an imbalance is unsustainable in the long run…
0.0
20.0
40.0
60.0
80.0Consumption & Investment (% of Nominal GDP)
Household & Government Consumption Investment & Inventory Building
Source: National Bureau of Statistics, Capital Economics – March 2012
This document is intended for professional investors as defined in the MIFID
China’s Challenges China is addicted to investments
Investments in infrastructures are still in strong demand: the freight train network example
14
... but for another few years, a high level of infrastructure investments should not be a concern
30 319
0
5 000
10 000
15 000
20 000
25 000
30 000
35 000
USA Germany France UK Japan Russia China IndiaFre
igh
t T
raff
ic (
10
00
to
n-
kilo
me
tre
/kilo
me
tre
) Freight traffic by rail
Source: CICC Research – February 2012;
Note: 2010 data for China, 2007 data for other countries
This document is intended for professional investors as defined in the MIFID
Demography is a real challenge for China in the long run as the population is ageing and the gender imbalance is
not closing
- 200 400 600 800 1 000 1 200 1 400 1 600 1 800
-
100
200
300
400
500
2000 2010 2020 2030 2040 2050
China's Population
Population above 60 Years Old (in Million)
Total Population (in Million) - RHS
China’s Challenges After having been a strength, Chinese demography will become a burden
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China also faces other challenges along the road such as corruption and pollution
970
975
980
985
990
995
(m) China's labor force
Source: China Population and Development Research Center – March 2012 Source: US Census Bureau – March 2012
This document is intended for professional investors as defined in the MIFID
A Top-Down approach:
Never stand against the wind !
The wind from Beijing is always the strongest
A Bottom-Up approach:
1. Check all connected transactions
2. Beware of auditors outside the big four
3. Keep a close eye on inventory and receivables
4. Both large cash balance and large debt is never a good sign Parmalat syndrome
5. Go on site very often, don’t take anything for granted !
How to invest in China? A combination of two approaches
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China is not always easy to understand at close range, it becomes almost impossible from a distance.
The key to successful investments is proximity.
This document is intended for professional investors as defined in the MIFID
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