Culture as a driver of sustainable alpha
Using insight into workplace practices to identify investments with long-term potential.
Having been away from my hometown Beijing for almost two years, I finally managed to return to China in August this year. Restrictions on even Chinese citizens traveling into China have been extremely tight, and I had already postponed my trip multiple times as planes kept getting cancelled.
My relatives have been able to enjoy life more or less as normal since April last year. But contrary to my expectations, China hasn’t fully moved on from COVID-19, with sporadic outbreaks still weighing heavily on domestic travel and consumption. Recently, there have been two mini outbreaks: one originally centred in Nanjing (1551 cases by day 7), and the other in Putian, Fujian province (2722 cases by day 7).
Travellers in China are required to show the screen from an app (see Figure 1), whose name roughly translates as ‘telecom data-based travel itinerary card’, which lists the cities and provinces visited in the past 14 days. The app flags if any of the cities have active COVID cases, and if it does you may be turned away from hotels, trains and aeroplanes, depending on the rules of the local authority. This disrupts the plans of many business and leisure travellers, including me, and conversations with hotel staff and taxi drivers suggest that activity is still quite a long way from pre-COVID levels.
Most companies and factories I visited required either a clean itinerary card or a negative COVID test within 48 hours before granting access. COVID tests are quite affordable in general, ranging from 15 RMB (under £2 or US$3) in some parts of Shenzhen to 80 RMB (under £10 or US$15) in most other cities. Tight controls have generally enabled manufacturing-related companies to keep their staff healthy and their factories running.
Figure 1: COVID app — a must-have for travellers
Source: Ninety One.
I visited a number of solar-sector companies during my trip. The Chinese solar industry is evolving very rapidly, and one gets the feeling that information gleaned from field research may have a shelf-life of only a week (which is a useful insight in itself). Nevertheless, module suppliers’ improving capacity utilisation rates suggest that the industry is expecting a very robust H2, in both Chinese and international markets. Despite 251% inflation in the price of polysilicon in the year through the start of September, the prices of mainstream PERC modules – a highly efficient type of cell that has 86% market share – only increased 12% (see figure 3) for the mainstream 400W product. Even after the price rises and notwithstanding the presence of some price-sensitive customers, there is still room for suppliers to generate good returns, depending on where in the value chain they sit.
Ancillary materials companies in the solar sector – like Xinyi Solar*, Flat Glass and First Applied Materials – all expected price increases, mostly driven by improving demand, but also by inflation of their own costs. The supply-chain disruptions this year have worked in favour of the more established and vertically integrated players, like Longi Solar, Jinko Solar, JA Solar and Trina Solar, which have more control over upstream products. Perhaps unsurprisingly, they are also the ones that tended to talk down the potential disruptive impact of technology innovations (such as a solar cell technology called heterojunction, which essentially combines two technologies to increase the energy generated by one cell, and even larger wafer form factors).
Figure 2 and Figure 3
Source: Haitong Securities. Data as at end-September 2021.
On the demand side, many companies were optimistic about distributed solar photovoltaic demand (residential, industrial and commercial), encouraged by a number of policies supporting such projects. I even saw some interesting use cases, such as solar ‘carports’ (see Figure 4).
Figure 4: Solar ‘carports’
Source: Ninety One.
The EV industry in China has shifted focus from demand to supply. Whereas in previous years discussions tended to centre on short-term regional demand forecasts and uncertainties over government subsidies, the industry now has much higher conviction in global EV demand in the long run. Consequently, it is paying a lot of attention to the sub-industries that are more likely to experience sustained levels of under-supply. That said, from a demand perspective, most Chinese EV companies believe that 1) China’s target of 20% EV penetration by 2025 is too conservative; 2) EU demand will be very strong, driven by emissions-reduction regulations; and 3) US demand is still uncertain. (1) and (2) are already factored into Chinese EV companies’ capacity expansion plans. However, (3) is an upside risk for the whole supply chain, given the uncertainty of US demand.
Supply-chain cost inflation this year has tilted the balance in favour of lithium iron phosphate batteries (LFP), rather than nickel-based ternary batteries. The latest Chinese value-chain data shows that, on a per KWh basis, LFP cathodes are less than 50% of the cost of ternary cathodes (RMB 130 vs. more than RMB 300), and technologies such as cell-to-pack have helped LFP overcome drawbacks such as lower energy density. LFP batteries’ market share overtook that of the high-energy density alternatives in May 2021, as shown in Figure 5. Most industry players expect LFP to continue to be the mainstream product in the Chinese EV battery market, supported by new models adopting LFP batteries, such as the Tesla Model Y made in Shanghai.
Figure 5: Chinese EV battery shipment market share by chemistry
Note: Ternary batteries refer to nickel-based battery chemistries, mainly NMC (nickel manganese cobalt) and NCA (nickel cobalt aluminium).
Source: Haitong Securities.
Recent car-sales data shows that hybrid EVs (extended-range EVs or plug-in hybrids) are the best-selling models in the mid-end market, rather than pure battery EVs. Companies such as BYD and Li Auto are betting on the electrification potential of this segment with their hybrid models. So far, the fastest-growing EV markets have been the premium segment (led by Tesla and NIO) and the low-end segment (led by Wuling Hongguang’s mini EV). Mid-range customers are mostly first time or family buyers in tier 2, 3 and 4 cities, where ‘range anxiety’ is more prevalent and charging infrastructure patchier than in Shanghai and Beijing.
I noted that the Wuling Hongguang mini EV is everywhere (and it is surely a blessing for people like me who struggle to park).
Figure 6: Wuling Hongguang mini EV
Source: Ninety One.
*This stock is held in the Global Environment portfolio.
1 Source: http://www.xinhuanet.com/politics/2021-07/28/c_1127705466.htm
2 Source: https://news.sina.com.cn/c/2021-09-18/doc-iktzscyx5016906.shtml
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