China’s 12th Five-Year Plan: Investable shift from growth quantity to growth quality

- More evolutionary than revolutionary "With the aftershocks of the Global Financial Crisis and “global imbalances” still reverberating through international markets, and with China having recently attained the status of the world’s second-largest economy, investors are looking toward October’s release of China’s 12th Five-Year Plan for key guideposts. Yet investors may need to temper expectations. With China well along in its market development, the days are gone when Beijing could exactly determine China’s economic path; and much of the new plan’s thrust should be a continuation of the economic rebalancing initiatives laid out in the 11th Five-Year Plan (2006–10) – a policy bias already well known to markets, and thus in many cases largely priced into listed equities."
- Investable themes – from growth quantity to growth quality "Still, we believe China is marking a path where the quality of growth – in terms of composition, efficiency, and environmental impact – now commands more attention at the margin than sheer quantity. This includes efforts to rebalance aggregate demand toward domestic consumption and service-sector activity from export manufacturing and investment. This implies reduced material- and energy-intensivity, to be effected in large part through higher factor costs – such as wages, energy/utility tariffs, land, and (potentially) capital costs. While these initiatives will generate relative winners, they may also imply downward pressure on margins generally, and a decline in China’s overall profits-to-GDP (which rose precipitously over the past decade). As in recent years, we expect to see continued emphasis on rural reform and Western-regional development – a policy bias that will continue affecting patterns of consumption, credit growth, and construction / investment activity, among others."
- The search for net-yet-fully priced plays "We distil these themes into a select list of ‘Top 25’ Five-Year Plan stocks (Figure 3, page 4). Key among these are names involved in 1) new energy vehicles, 2) clean power (including gas, wind, coal-to-liquid), 3) western-regional development and/or urbanization into lower-tier cities, 4) urban rail build-out, 5) medical system expansion, 6) private consumption and retail mall development, and 7) financial innovation. Yet, as noted, many of these themes are already well known to the market. In the effort to identify outstanding value, we filter our ‘Top 25’ for 1) historical PER discounts larger than the current MSCI China discount of 8%; 2) historical P/BV discounts of 30% or more; and/or 3) a PEG ratio (based on three-year 2010–12E CAGR) below MSCI China’s 0.6x PEG. By these standards, relative value among Five-Year Plan beneficiaries is found in Dongfeng Motor, ABC, Minsheng Bank, Sinoma, Guangshen Railway, Mindray, PetroChina, Longyuan Power, Dongfang Electric, Shenhua Energy, and China Coal Energy."

Macquarie Asia Specialist 20100924

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