Mark Draper (GEM Capital) recently spoke with Joe Lai who is the portfolio manager of Platinum Asia fund.
We are pleased to bring you the podcast from this discussion and for those who prefer it, here is a transcript of the interview.
Joe specifically talks about why he believes China is unlikely to experience a debt crisis despite the constant media attention it receives and he outlines the magnitude of the investment opportunity in China.
Speakers: Joe Lai (Platinum Asset Management) and Mark Draper (GEM Capital)
Mark: Joining us here is Joe Lai from Platinum Asset Management and in particular, Platinum Asia, who Joe runs the listed investment company, Platinum Asia, as well as the unlisted version of Platinum Asia that you find across the spectrum. Thanks for joining us, Joe.
Joe: Hi, Mark, thanks.
Mark: We’ll start with the Asian markets because they’ve had a big run, albeit from the low base.
Mark: 18 months ago, 2 years ago. So, is this run—sustainable is not the right word, but is this as good as it gets or can investors expect decent returns from the Asian sector going into the future?
Joe: Yeah, look, I mean, what we believe the opportunity in Asia is one of a long-term opportunity because the growth rate in Asia is going to be, you know, robust, and going forward for quite a long time. And also, the scale of opportunity is just unparallel compared to anything else we’ve seen for a very, very long time.
Growth rate on China, even we’re saying that China is growing at—slowing a bit from the heady days of 8 or 9% growth, to about 6 to 6-1/2% growth, that would be still one of the fastest growing regions of the world.
And outside of China, we’ve got countries like India and also the ASEAN countries. I mean, these are countries with, you know, collectively, more than a billion people and for the region itself, it’s close to three billion people. They are going to grow in a way—in excess of 3-4% on average. Again, the scale is huge.
Mark: And compare that to the American market, the American population I think is somewhere between 3-400.
Joe: Yes, about 300 million people and it’s growing much slower.
We look at that long-term trajectory, I think, is very, very good. And then we look at the markets. I mean, there’s a lot of concern about valuations and whether we’ve peaked. I mean, the U.S. market is definitively expensive if we look at price to earnings multiple or price to book multiple. In fact, if we look at a lot of EPS growth that the American market has been able to generate, a lot of it has been through financial engineering.
What I’m talking about is borrowing money, companies borrowing money, and do share buy-backs, to reduce the number of shares outstanding to—
Mark: Which then increases earnings per share.
Joe: Yeah, absolutely. But in the case of Asia, that has not been the case. Perhaps the Asian corporates or CFOs are a little bit behind in terms of doing engineering, engineering the balance sheets. But certainly a lot of the upside in Asia has been a result of actual earnings growth in the last few years as opposed to EPS growth or a great deal of market re-rating or the PE ratio going up.
Mark: You talk about 6-1/2% growth, but I think—and which is less than 9% growth—but the reality is that China’s been growing at a big rate for a long period of time. Is it possible to put some perspective on the size of the economy? Say compared to where it was historically? Because 6-1/2 might not sound great, but 6-1/2 on a big number is a big number.
Joe: Yeah. I mean, the size of the Chinese economy is by no means small. At the moment, it’s probably slightly more than 10 trillion U.S. dollars and U.S. is probably 16, 17. On an aggregate basis, it is still smaller, but however, when we look at many of the industries in China, they’re already bigger than that of the U.S. I mean, these may be an interesting fact which a lot of people may not realize, if we look at the passenger car market in China, they’re running at about—selling about 28 million passenger cars a year. U.S. is about 20 million.
That market alone, which is a big part of the economy really, it’s already about 40% bigger than that of the U.S. or Europe.
The other part of it is this: That market is still growing. I mean, still growing at about 5% to 10% a year and most people buying cars in China are not reliant on car financing. That’s very different to, I guess, the more developed markets. Eventually, how big this market will grow into, it’s hard to estimate. That’s one.
But when we look at the property market clearly, the Chinese market is a lot bigger than anything else in any other parts of the world, literally, two, three, four times the size of Europe or U.S. If we look at the smart phone markets—I mean, I’m talking the smart phone here which is, I’m sure are made in Taiwan or Mainland China. China domestic smart phone market is about half a billion.
Mark: It’s about 500 million.
Joe: It’s 500 million.
Mark: New handsets every year.
Joe: New handsets a year. U.S. is about a 150 million, so even that market, which is—you wouldn’t say is a back water, sort of like—we’re not talking about sports shoes or T-shirts, we’re talking about a smart phone. Sure, some parts are coming from Japan or Taiwan or U.S. to make the smart phone, but they’re producing a lot of these parts domestically in China as well, as they climb the technological ladder.
The smart phone market it literally two, three times the size of U.S. or Europe and the car market is 50% bigger than U.S. or Europe. That is the scale already. We’re talking about when the economy is about, probably two-thirds the size of the U.S., officially. So, I guess, that’s how far they’ve come and they’re going to—the aim for them is to climb the technological ladder and to clean up the environments going forward.
Undoubtedly, I mean, they will continue to progress further. Compared to where they started, I guess, since liberalization, the GDP per capita of China, if we look back 35 years ago, it would be very close to that of North Korea. I mean, it’s amazing. This country has taken off where some of the countries haven’t moved on at all. That’s, I guess, the scale and opportunities there.
Mark: And part of that is driven by population growth, but it’s more than population growth. It’s the rising wealth in middle class here, so you’ve spoken about car ownership, you’ve spoken about mobile phone and internet access.
Mark: What are some of the other things that you’re seeing in China that as middle class develops, they’re spending money on, that by extension creates investment opportunity, clearly.
Joe: Okay. I mean, that’s a lot of stuff—which a lot of things which are changing for the better. I guess if we sort of go back one step. I mean, what is underpinning sort of this growth in income and all productivity is because they’ve done the appropriate amount of investment in various things. If you travel to China these days, you’ll see that they’ll have first class infrastructure in roads, telecommunication, a 4G network. The high-speed rail, which just completely opened up the country. Even the smaller cities offer a few million people.
So, you mentioned you’re doing business that you can actually ship things around and things just work.
Joe: And also, the investment in education is actually quite interesting. Each year there’s about 8 million university graduates that China produces.
Mark: 8 million is a third of the population of Australia every year as your graduates. [Laughs]
Joe: Yeah. And this number actually has ramped up in the last five or six years, so there has been some effort to increase the supply of skilled labor into the economy where because there has been a desire for the economy to lift productivity, to climb the technology ladder, they knew that they needed people. And of the 8 million, half of which are actually engineers and scientists. I mean, it’s actually what they need. That’s very different, I guess, to other countries which actually haven’t grown their university graduates or the focus on engineering and science may have actually gone backwards in the last 5 or 10 years.
Investment in infrastructure and education are key for—to sort of the strong underpinnings for economic development for the country.
So, looking forward, we mentioned about cars and we mentioned about smart phones. These are markets which are already bigger than in the U.S. compared to—sorry, bigger in China, compared to I guess developed countries in those market size.
There are some areas which China is still smaller in aggregate than Western countries. And we sort of have experienced some of it in this country, like things relating to consumption of insurance, healthcare, some of the luxury goods, some of the—I guess things which are more, I guess, differentiated or tastes which they’ve yet to acquire.
I guess in this country we’ve seen the vitamins doing well. Perhaps some of the milk stuff from New Zealand and also wines going well. These are some of the stuff, I mean, we’re not directly involved in those because these are sort of, I guess, local companies. But the markets which I mentioned, insurance and healthcare, and some of the technology companies, I mean, the insurance market in China is small compared to that of Western countries on a per-capita basis.
Even if you go to places like Shanghai, the insurance penetration is literally a fraction of that of Hong Kong or Taiwan, but you know that it is an essential product that people would want, once they have money and they want to protect their wealth, they want to protect their family’s livelihood.
Mark: You’re talking life insurance or you’re talking car insurance, house insurance, etc.?
Joe: Yeah, yeah. So that’s interesting. And we’re seeing private companies in China doing very interesting things. Some of these industry leaders are doing things which are leading, I think, most of the world. For example, we own one of our biggest, or bigger, positions is a company called Ping An Insurance. I mean, they’ve actually applied artificial intelligence in a big way. I mean, literally spending literally billions of dollars over the last, about three or four years, on improving their ability to serve the customers by using AI. They’ve got a voice recognition product that when you call up, they can, I guess verify your identity without you telling them anything. I mean, you know, when we call up Telstra and ask you for date of birth or address to certify that’s who you are, but here they’ve got technology to go to Mr. A and then we know this voice and then if this voice matches, that’s him.
So, that’s something like that. And also, when the people have car accidents, they’ve got this thing on the smart phone, this app on the smart phone where they can launch their claim. I mean, they can photo of the car, where the damage is, and actually utilizing artificial intelligence to work out what is the damage and also the cost of repair. Then this is, I guess, good for controlling fraud. It’s good also for customer experience.
I mean, these are just some of the things which are happening very rapidly in China because it’s the investment cycle in China of experimentation, try something out. If it works, use it. If it doesn’t, let’s move on. It’s much faster than most other countries.
And then of course healthcare. The next area is healthcare. So the market in China is more and in fact, we’re seeing this to be growing rather quickly because—
Mark: Have they got a national healthcare scheme at the moment?
Joe: Absolutely, Mark. I mean, that’s been ramping up. The desire from the government is to improve the livelihood of those people who sort of didn’t share as much in the fruits or dividends on economic growth in the last 20 years. Over the last few years there’s been progressive rollout of coverage in terms of health insurance. I mean, it’s not perfect. But nowadays, most people in China are covered by one kind of insurance or another, mostly public based and then some are local government based. But what it means is that going forward, we think that the consumption of healthcare will continue to grow, almost irrespective of the growth or GDP growth of the country.
And as the people get more discerning in terms of their healthcare, they will start to use some of the drugs which Western countries are used to. Like if you actually look at the top 10 selling drugs in most Western countries, including Australia, these days, most of those drugs are what are called biologics and they’re actually quite expensive. Expensive drugs which can target specific diseases very accurately. Gone are the days of using one drug to treat everything. It’s almost very titled medicine.
I mean, I was a medical doctor before I did this, working in this industry and the type of drugs I’m seeing today is truly amazing and China is starting to adopt these drugs as well. We own some companies which are producing some of these biologics in China. They’re not the easiest to produce and these drug are not even in the top hundred in the Chinese league of drug sales, whereas some of these drugs are already top 10, including these countries.
That to us is very interesting and it’s going to grow multiples the pace of the economy.
Mark: Are you seeing homegrown healthcare companies compete with the West?
Mark: Or are you seeing Western healthcare going to Asia?
Joe: Yeah, I mean, that’s an interesting question, Mark. I mean, it has certainly been a mix of the two. And the fact is, I mean, it would go to the issue of scale and accountability. I mean, China is almost unparalleled compared to most other countries. But bottom up work suggests that in early days, foreign companies would go into China and sell their drugs or medical devices and actually at a quite high price, because it’s seen as like a luxury good. You know, they can charge—the prices we pay in Australia would be literally a fraction of how much these local Chinese people paid previously.
As you can see, the dynamic, together with sufficient capability, but domestic eyes and capital to invest in R&D, what have you, creates this dynamic where the pressure for the locals to actually substitute for the imports is very high because they can see that if they do well, first of all, they’ll make a lot of money. Second of all, there is some government support for the locals. Thirdly, it is—they also, I think, recognize that they’re doing a benefit for the local people who may not be able to afford imported drugs.
In the case, just some examples, in the case of insurance, I mean, I think some listeners may know insulin, basically it’s used to treat diabetes. There’s different types of insulin and in most parts of the world, this market isn’t only. It’s dominated by four or five, probably four companies. Sales are different, the same kind of insulin, but at a very high price.
In China, there’s already drug companies making insulin, which is actually very uncommon. I mean, it’s almost happening nowhere in the world, so we’re sort of investing in one of them to provide, I guess, cheaper version of high-quality insulin in the country.
The other element, the other example I can cite, is cardiac stents. These are things which are used to treat blockage of the arteries, in the heart. Again, this is, in the rest of the world, is an oligopoly, controlled by a few big U.S. and European companies. In China, more than half, in fact, maybe 60% or 70% of the cardiac stents are made domestically, by domestic companies.
Joe: And some of them are trying to sell it overseas. They’re very successful. We are sort of invested in one of the companies there as well which makes cardiac stent for the locals. They’ve actually gone around the world in acquiring the second player globally, or third player globally, of pacemakers…what else? Orthopedic prosthesis, to bring it back to the country. To maybe make it at a lower price, but huge market. But the product itself is—the products themselves are superior to what the locals have been making previously.
So, I mean, we find that to be rather a prospective area to have some money.
Mark: One of the perineal things that seems to be around the Australian media is the expectation of a Chinese credit crises or a banking collapse over there. Can you give us a feel for whether that’s reality or misguided?
Joe: Yeah, look. I mean, okay, I think it’s misguided. It is understandable why there has been a concern because China has ramped up as a country, rammed up its debt load since the global financial crises. And a lot of it is the stimulus which they implemented. But the good news is this is something that everyone knows about. I mean, if there’s anything that we can trust the local Chinese authorities to do, is to count. They can actually calculate and count where the problems are. I mean, it’s been like literally six, seven years since even Western countries or people outside the country started to talk about geez, there’s debt. You can imagine and I think you can believe that the local authorities who are interested in a 30, 50-year future for the country or more, to want to diffuse any problem that may have arisen as a result of the stimulus.
What are we looking at today? China’s debt to GDP is actually about 250%. And okay, to put it into context, that is actually similar to most developed countries. I mean, USA is about 250, 260. European area is about 250. Japan is about 400% to GDP, so it’s a lot higher and it shows that a country with a trade surplus actually can sustain very high level of debt, because it means that they’re not relying on foreign capital to fund their debt when they run the trade surplus. And Japan is the case, is a good example.
If the absolute accurate good level is high and it’s ramped up quickly, but it’s not disastrous and in fact, it’s manageable. And the second thing is, almost all the debt in China is domestic. In other words, they’re not reliant on foreign countries or people or corporations to keep buying their bonds. They can actually buy their bonds themselves with the savings.
Mark: Like its self-funded.
Joe: And the other benefit of having all the debt in domestic currency is that if really push comes to shove, they can print money, which I guess most countries have done in the last five—or since the GFC. There’s all these levers they can pull.
The next thing is, as we mentioned before, this problem is not unrecognized and if you Googled—I mean, there has been some—basically its getting managed and that’s been, I think, increasingly recognized by people. The Bridgewater guy, Ray Dalio, I think he recently did an interview, mentioned about that. It’s interesting, he said, well, you know, in the GFC, we have I guess developed countries, central banks reacting to the problem. But here we actually have a forthright regulator trying to deal with the problem and in fact, he thinks they’re doing a good job. But anyhow, that’s just an aside.
But what I believe is that China is already trying to reduce the growth of the loan and they call this process deleveraging, which means slow down the growth of loan and then look where the problems are. They’re probably more than halfway through this process and I think at the end of it, the banking system will actually look rather nice. And then after that, even now, you ask the question: What else can we say that’s wrong with the country? I mean, it’s actually a difficult thing to come up with. [Laughs]
Mark: Donald Trump has helped in that respect because he’s, through his Twitter account, talked about potential trade wars. Is that something that is concerning you guys?
Joe: Look, I mean, the fact is, I mean, I find it so hard to predict what Trump—what Mr. Trump is going to say or do. But if we—I guess put it this way, if we go down the path of an all-out trade war, it’s clearly not good for markets, and particularly, I think, it may change the way how people assess the U.S. market, especially given the valuation of that market because put up tariffs and whatever, it is going to harm them just as much as harm everyone else. Just increasing inflation, reduce the ability of people’s real—or reduce real income for the people.
But I think if one, I guess, try to rationalize it, everyone knows that it’s a bad outcome for all and so it makes—it actually makes no sense for anyone to want to go down this path in a big way. There may be skirmishes and there may be some people making statements to actually have across the board withdrawal basically of globalization. I just don’t see how anyone can effectively support that.
The reaction from, I guess, the key countries, interesting. We see these aluminum steel tariffs, which, Trump talked about. China actually didn’t say much about it. They actually said, it’s not good.
Mark: Canada was vocal.
Joe: Yeah, and the reason is, as you know, Mark, that the percentage of Chinese imports into U.S. in these two products is literally less than 5%. I think the percentage of Chinese imports or steel imports in the U.S., China constitutes maybe 2% or something like that. It’s very low percentage. Certainly, it’s a very, like less than 1% output of Chinese steel industry. So, they go, okay.
But whereas Canada is a much bigger part and Mexico and also Brazil and maybe even Korea or Japan.
They’re not too worried but I guess if we go down this path, then it would be something. But also last week, I mean, China sent one of the leaders—this is a guy below the presidency—over to the States to talk to the people in the White House about this issue. It is something that, in a way, they don’t want to—
Mark: It’s not the steel and aluminum and such, it’s the bigger issue of whether it’s more widespread.
Joe: Yeah. It becomes more widespread and because everyone—and so they do want to stave off this—Mr. Trump going down this path by, I think they will announce some things to try to appease him. Whether it’s enough or not, I think it will, I guess, calm down the situation somewhat. But of course, if there is real impact made to the various economies, particularly in China, they would retaliate in the form of maybe tariffs on some of the agricultural imports from the States and maybe cars. I mean, the truth is, most car companies—a lot of foreign car companies, from China’s perspective, are reliant on the Chinese market for profits.
Mark: GM, Ford. They’re all there.
Joe: GM, Ford, yeah. And it is the biggest car market in the world. It makes no sense to go down this path, but I can’t really predict one way or another.
Mark: It’s a good answer. And sorry to drag down the tone actually of this conversation about Asia with Donald Trump.
Joe: That’s all right.
Mark: But that’s just something to cover off.
Mark: It is a generational opportunity to invest in the Asian region and thanks very much for your time to explain some of how you guys are going about harnessing this opportunity for investors. Thanks, Joe.
Joe: Thanks, Mark.
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