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China on-site: property bubbles and internet growth

China on-site: property bubbles and internet growth

01-12-2017 | Insight

In our bi-monthly publication on China we discuss a key concern and a key opportunity. In this edition, we examine whether property is in bubble territory and discuss the phenomenal growth in China’s internet industry.

  • Victoria  Mio
    Victoria
    Mio
    CIO China, co-Head Asia Pacific Equities, Fund Manager Robeco Chinese Equities
  • Hauke Ris
    Hauke
    Ris
    Client Portfolio Manager Asia-Pacific Equity
  • Jie Lu
    Jie
    Lu
    Head of Research China

Speed read

  • Is Chinese property in bubble territory?
  • The Chinese internet industry is growing explosively
  • Especially e-commerce offers opportunities for investors

Concern: property in China

Headlines about elevated house prices in the largest (tier 1 and 2) cities and oversupply in smaller (tier 3 and 4) cities are worrying some investors. The property sector is inherently diverse, though, and, in our view, not on aggregate in a bubble state.

The nationwide price-to-income ratio has declined from 10x in 2001 to 7.4x in 2016. Although this is a significant improvement, 30% of the country’s market (particularly tier 1 and 2 cities), with price-to-income ratios of more than 10x, is in a bubbly state. The remainder scores healthy on this metric. In the market as a whole, leverage has increased since 2011 and needs close monitoring, as it is still rising. For example, the Chinese are allowed to leverage the amount saved in provident funds (government-managed retirement savings schemes) as collateral, to increase their loans. When we add this leverage to the loans included in the loan to value ratio, the latter amounts to 45%, which we do not consider dangerous.

Inventories have declined since 2015. For tier 1 and 2 cities this is not good news per se, as prices have increased so much. As it is difficult to increase supply there, the primary measure for controlling house prices is to restrict home purchases. For tier 3 and 4 cities further destocking is needed to balance the market and improve profitability of developers. We believe the current trend is positive for the sector.
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Demand remains strong, driven by urbanization and an important but often underrated phenomenon: the shrinking average household size. Late marriages, increased divorce rates and aging have pushed down household sizes. Together with replacement demand, this is sustaining the level of new home sales. Our analysis shows that at around 1 billion m2 per annum, floor demand will stabilize over the coming decade.

Opportunity: phenomenal growth in China’s internet industry

The Chinese internet industry is growing explosively. Internet activities account for 6.9% of China’s Gross Domestic Product (GDP), the second-largest percentage in the world after South Korea. Nascent segments such as AI, social advertising, and internet finance have been growing at 50%-100%+ over the past three years. We expect them to become mainstream and act as long-term drivers of the internet industry over the next decade.

Currently, around 52% of the Chinese population uses the internet, a percentage that may well near 100% by 2025. Growth will mainly come from rural China, where internet use is still low. This does mean that future internet use will be of lower monetary value, as rural disposable income per person is just one third of urban income. But still: the Chinese internet industry is worth RMB 390 billion, or 60 billion in US dollars, and is growing at a compounded annual growth rate (CAGR) of a whopping 30%.

A strong structural tailwind is the transition of China’s economy towards a more consumption- and service-led growth model, with consumers shifting from offline to online consumption and disposable income rising across the country. As China is still not making by far as much money as the US from the internet, a huge potential remains.

An attractive segment is e-commerce. Online shoppers are only 32% of the population and online retail is some 12% of the retail industry. Online retail sales amount to RMB 4 trillion and are growing at a CAGR of circa 22%. This is driven by robust consumption growth, which significantly outpaces overall economic growth, and an expanding user base. Opportunities are found in home appliances and food & beverage, as not many people are buying these online yet.

Online advertising has tremendous room for growth. Advertisement spending is only circa 0.4% of GDP, against 0.7%-0.9% in developed countries. As the economy is becoming more market-oriented, this is expected to grow by a CAGR of 25%.

Many Chinese internet sectors are dominated by industry leaders such as Baidu, Alibaba, and Tencent. They are expanding quickly by building whole networks of related services that make them almost indispensable in daily life. An example is Tencent’s WeChat app, which allows users to book doctor’s appointments, order groceries, pay bills and much more.

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