The One ETF to capture the unstoppable growth of China Tech sector

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Internet has become closely integrated with the everyday life of Chinese people, and some companies are positioned to profit greatly from it. Find out more about one ETF with such high-quality companies!

China’s Internet usage has skyrocketed in recent years, thanks to the growing number of Internet users and rising usage by existing Internet users.
As China shift towards a consumption-driven economic model, the steady growth in consumption is increasingly captured in the online retail and services segments.
With online services becoming increasingly integral to the Chinese lifestyle, permeating many aspects of daily life, consumers in China are likely to continue spending more online, across broader categories.
Invesco China Technology ETF (NYSE: CQQQ) provides exposure to various high-quality Chinese Internet companies, many of which are primed to benefit greatly from the rising domestic consumption by China’s burgeoning middle class.
We value CQQQ at fair price of USD 56.30 with an upside potential of 17.5%.

Supercharged growth in China’s Internet usage

China’s Internet usage has been ballooning at an exponential pace in recent years. Not only are there increasingly more Internet users in China, existing Internet users are also spending increasingly more time online. Expanding at a steady 10% year-on-year since 2008, China is now home to more than 800 million active users – the highest in the world (Chart 1). In comparison, it easily overshadows US’s 300 million Internet users.

Chart 1: China’s Internet users base expanded at double-digit growth rate for the last ten years

With the emergence of inexpensive smartphones from Chinese handset makers like Xiaomi (HKEX: 1810), ththe barriers of entry to the Internet has greatly declined for the general Chinese populace (Chart 2). According to the China Internet Network Information Centre (CNNIC), 98% of all Chinese users now access the Internet through their mobile devices. One in four China Internet users are “mobile native”, meaning they access the Internet by their smartphone exclusively.

Chart 2: China has experienced an explosive growth in mobile Internet usage

As most online retail and services sites become progressively optimised for mobile usage, user experience has become as seamless as that of a desktop computer. With Internet services quickly permeating many aspects of everyday life, mobile apps like social messaging service Tencent’s WeChat (HKEX: 700) have quintessentially evolved into an integral part of the Chinese lifestyle.

(Related Article – Tencent: Oversold Tech Giant With 50% Upside Potential)

Looking ahead, we have reasons to believe that such tremendous growth will persist into the next decade. Despite the remarkable progress China has made in the last ten years, its current Internet penetration rate of 56.7% still trails far behind that of other developed economies (Chart 3). This provides ample room for growth in the Internet sector as China continues to integrate its non-Internet users into the expanding digital landscape.

Chart 3: China’s Internet penetration still lags other developed markets

Domestic consumption increasingly digitalised in China

Domestic consumption sits at the heart of China’s massive economic growth engine. As China’s middle class expands and household income continues to grow steadily, domestic consumption has emerged to become the primary driver of GDP growth in China. It has dwarfed both investments and net exports over the last two decades and now singlehandedly contributes to more than 80% of GDP growth (Chart 4).

Chart 4: Domestic consumption is key driver to China’s economic growth

Yet, the world’s largest middle class, transformed by demographic shifts, has started to reshape consumption. Millennials, digital natives who grew up using the Internet, now accounts for one quarter of Chinese population. In the next decade, some 200 million of them will be starting families and will constitute the bulk of the country’s core workforce. Owing to better education and standards of living, the consumption patterns of the millennials differ significantly from preceding generations.

As China advances into a relatively fast-ageing society, the growth of the elderly population is creating new demands. With most of China’s elderly residing in lower-tier cities where healthcare resources are fairly limited, online healthcare services like Tencent’s WeDoctor (HKEX: 700) and Ping An Good Doctor (HKEX: 1833) are stepping up to bridge the gaps in supply-demand mismatch.

Consequently, as China shifts towards a consumer-driven economy, the growth in consumption is actually increasingly captured in the digital space. Today, Chinese consumers shop using their mobile devices, discover new products through social networks and purchase items via massive e-commerce web portals like Alibaba’s Taobao and Tmall (NYSE: BABA) and JD.com (NASDAQ: JD). Online retail sales now account for more than one-fifth of all retail sales in China, a stark contrast to the meagre 5% at the start of this decade (Chart 5).

Chart 5: Online Shopping Increasingly Becomes the Mainstream Way Consumers Shop for Goods

(Related Article – Alibaba Group: China’s E-Commerce Giant Is Now On Sale)

Not just online shopping, the paradigm shift in consumer behaviour in China has also led to the explosive emergence of on-demand online local services industry. Online services grew from a mere 4% to account for a fifth of total services consumption in China within a short span of five years (Chart 6). With just a few taps on their smartphones, Chinese consumers can now book offline services ranging from restaurants, movie tickets to overseas travel plans.

Chart 6: Not just e-commerce, the Chinese are spending significantly more on on-demand services online

Popular on-demand services like food delivery and ride-hailing have quickly woven themselves into the norms of modern Chinese lifestyle. Food delivery services, such as Alibaba’s Ele.me (NYSE: BABA) and Meituan Dianping (HKEX: 3690), wthe latter of which is backed by both Alibaba and Tencent, are starting to change how restaurants run their businesses in China. Even giant international coffee chains like Starbucks (NASDAQ: SBUX) have to collaborate with Ele.me for its delivery services in China, so as to retain the loyalty of its customer base.

(Related Article – Starbucks Corporation: The Coffee Empire Remains A Great Long-Term Investment)

Internet companies form the backbone of China’s New Economy

As Chinese consumers readily embed Internet services into daily lives, China has leapfrogged developed nations in certain technological innovations. After spending the last four decades catching up with other developed economies, China is now leading the world in emerging technological trends like financial technology (FinTech) and artificial intelligence (AI).

Moving forward, China looks set to dominate the global FinTech industry. More than one-third of China’s population now transact via mobile payment services like Alibaba’s Alipay and Tencent’s Wechat Pay on a daily basis – eclipsing US’s 15%. With financial services like wealth management and personal insurance increasingly accessible online, even traditional industries like banking are forced to keep pace and adapt with China’s fast-emerging digital trends.

The wind of change in China’s consumption habits is also deeply influencing the way retailers attract customers. Mobile online ads have now superseded both TV ads and print ads to become the medium of choice for advertisers globally (Chart 7). As the Chinese people spend progressively more time glued to their smartphone screens, businesses are aggressively vying for a slice of consumers’ screen time, enabling online marketing platforms like Baidu (NASDAQ: BIDU) and Weibo (NASDAQ: WB) free to continuously price their limited ad inventory upwards.

Chart 7: Digital advertising is now the preferred marketing medium for businesses globally

CQQQ – A Simple Way to Invest in China Technology Sector!

Invesco China Technology ETF (NYSE: CQQQ) is a US-listed ETF that tracks the AlphaShares China Technology Index, which measures the performance of Chinese companies operating in the technology sector.

CQQQ provides exposure to various high-quality Chinese Internet companies, including the prominent Chinese tech giants the BATJ – Alibaba (NYSE: BABA), Tencent (HKEX: 700), Baidu (NASDAQ: BIDU) and JD.com (NASDAQ: JD) (Chart 8). We believe that these tech companies are primed to be the main beneficiary of an ever-increasing domestic consumption by China’s burgeoning middle class.

We also like that CQQQ provide a straightforward way to gain exposure to the strong growth trend of China’s Internet and Technology sector, as well as a simple diversification away from specific firm risks that may arise in individual companies.

Chart 8: Alibaba, Tencent, Baidu and JD.com (BATJ) are the dominant players of China Internet sector

We value CQQQ at a fair valuation of USD 56.30, calculated using a weighted average of its underlying stockholdings on 12-months forward basis. This represents an upside potential of 17.5%, based on CQQQ’s closing price of USD 47.93 on 14 Mar 2019 (Table 1).

Table 1: CQQQ offers an upside potential of 17.5% on a 12-month forward basis

Owning to the massive secular growth trend of the Internet sector, earnings-per-share (EPS) of the China Internet industry is expected to grow at a CAGR of 10-15% for the next three years. However, the uncertainties surrounding China’s economic growth, amid trade frictions with the US and its domestic deleveraging drive, has drag on investors’ sentiment of the sector.

Chart 9: EPS of China Internet sector is expected to grow at CAGR of 10-15% for next 3 years

Stay tuned for our next article for an in-depth look into the demographic shifts in China and how it has influenced consumption patterns, both online and offline. We will share why we think these trends contribute to the secular growth of China Internet sector and how you can profit from it.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

The Research Team is part of iFAST Financial Pte Ltd.

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