What China’s transformation means for European companies

• European companies need to adapt to China’s transformation.
• High-end manufacturing, luxury, pharma and finance set to benefit.
• EV, batteries and renewable energy sectors could face challenges from Chinese competition.

The list of companies which have exposure to the Chinese market is long and covers a broad range of sectors such as technology, raw materials, capital goods and consumer goods.

Prominent examples are ASML (semi-conductor equipment maker), BMW (premium carmaker), Rio Tinto (resources company) and Richemont (luxury goods company).

China is not only an important sales destination for European companies. According to some statistics, China’s share of global manufacturing rose from less than 10% in 2003 to 31% in 2021. As China has developed a dominant position in global manufacturing (c.f. US 16%, EU 16%), many European companies have direct or indirect value chain exposure to China.

In many cases, it is hard to imagine a “pure” European product without the involvement of Chinese manufacturing.

For example, Europe relies heavily on China for the production of some important pharmaceutical products, especially with regards to crucial ingredients (i.e. active pharmaceutical ingredients - APIs), and China is almost Europe’s sole provider of photovoltaic panels. Even for industries such as robotics, where European companies dominate in final assembly, China is involved in the manufacturing of many components and the provision of raw materials.

After decades of rapid growth, China cannot continue to rely on the old model of heavily debtfunded property and infrastructure to generate growth. Besides, structural bottlenecks such as its ageing population are becoming increasingly apparent. Upgrading the Chinese economy, often referred to as “high-quality development” in policy documents, is the key focus of the Chinese government. Meanwhile, China has been trying to generate more growth from domestic consumption and reduce reliance on international trade through the “dual circulation” strategy.

When China was discovered as an investment theme 20 years ago, a popular phrase among investors was seeking companies which could “feed the Dragon”. During that time, investment favourites were raw materials producers and energy companies which supported China’s seemingly unsatiable demand for property and infrastructure. This analogy is still relevant, but the difference is that the Dragon has a different appetite. European companies specialising in high-end manufacturing, automation, and digitalisation will continue to benefit from China’s industrial upgrade. As the role of consumption becomes more prominent, companies which offer luxury or unique consumer products will remain beneficiaries. Pharmaceuticals and wealth management are also interesting areas as Chinese society is ageing quickly.

Over the past years, AllianzGI’s dividend-focused strategies have been positioned to capture the above-mentioned structural themes. One interesting name is a German logistics and courier company which derives a large part of the operating income from express business. It has particularly benefited from the strong growth of some Chinese e-commerce companies in Europe.

Investors used to seek companies which could “feed the Dragon”. But nowadays the Dragon has a different appetite. European companies specialising in highend manufacturing, automation, and digitalisation will continue to benefit from China’s industrial upgrade.

Nevertheless, for European companies, China’s industrial upgrade may be a double-edged sword. For instance, China is forging ahead with the strategy of developing the “three new growth drivers” of electrical vehicles, EV batteries, and renewable energy. On the one hand, those industries offer potential solutions for Europe’s renewable efforts. On the other, Chinese companies have become serious competitors for their European counterparts, especially considering that these industries in China are already facing huge overcapacity. Fierce pricing wars look inevitable.

The EV industry is a good case in point. The first cargo ship carrying 3,000 electrics cars “Made in China” docking at the port of Bremen made a lot of headlines in Europe.

It is widely believed that Chinese EV makers have about a 30% cost advantage versus their European peers. Their entry into the European market will exert huge competitive pressure on mass producers in Europe. These are really testing times for European car manufacturers, as well as their traditional supply chains.

Global capital markets face a very different geopolitical backdrop compared to the last three decades. European companies, which on average have wider global exposure, now need to consider various new geopolitical factors in their decisionmaking processes. A major Dutch semiconductor supplier, for example, will need to re-calibrate their growth opportunities in the future as the company faces rising export restrictions to China. Major companies in the automobile or the chemicals sector will need to adopt a “local production for local market” approach. In these cases, European companies will have to weigh more carefully between efficiency and security, which may lead to less attractive capital returns over time. In the stock selection process for the European portfolios, investors will need to give appropriate weight to these factors.

In the eyes of global investors, current uncertainty about China focuses on the following issues: 1) China seems to have hit a growth bottleneck, with its ageing population adding further pressure; 2) the property market, which used to a key growth engine, is facing huge structural problems; 3) heavy-handed regulation in the e-commerce and education sectors has stifled entrepreneurship; 4) rising geopolitical tension requires investors to assume a higher equity risk premium.

As bottom-up investors, it is observable that these unfavourable factors have led to an aggregate decline in the profitability of listed companies. Global investors will therefore need to closely consider how the roadmap to resolve the above issues develops before they re-engage in the Chinese equity story.

So far, the measures by the Government and the Central Bank to support the property market and reduce reserve rates are steps in the right direction. However, they are not considered sufficient as positive triggers for the market. It remains to be seen whether the government will introduce further fiscal measures to encourage consumption and resolve the local government debt issues and stabilise the property sector. The Government’s 5% growth target laid out in the recent NPC, with a focus on highquality development, means that the country may put more focus more on stimulating domestic consumption as well as continuous up-grades of industry, a challenging task which will also provide investment opportunities for European consumer goods and industrials companies.

The Chinese economy is in a transition. This provides both opportunities and risks for European companies, which investors need to carefully assess.

While most global investors are taking a “wait-andsee” attitude, we would like to strike a more optimistic note and quote the famous Song dynasty poet Lu You: “ After endless mountains and rivers that leave doubt about a way out, coming through shades of willow trees, one encounters once again bright flowers and a lovely village - 山重水复疑无路，柳暗 花明又一村”.

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