China ADRs and New Economy Sectors – Stay the course

We continue to be Overweight such sectors on the growth end of our Barbell Portfolio
Chief Investment Office08 Jul 2021
Photo credit: AFP Photo

China new economy, media, and education sectors have recently faced selling pressure. This was the result of regulatory tightening focusing on antitrust and data protection practices as well as government reviews and actions taken on Didi (DIDI US), Full Truck Alliance (YMM US), and Boss Zhipin.

The Cyberspace Administration of China’s (CAC) action is indeed laying a concrete regulatory foundation as the world’s second largest economy continues with its digital transformation and technology reforms.

From the peak in mid-February, China American Depository Receipts (ADRs) and the new economy sectors have corrected some 30% and 40%, respectively (Figure 1). We have observed that the broader China Technology sector has performed relatively better during this period with a smaller decline of 17% as component and semiconductor stocks outperformed (Figure 2). The divergence in performance among the technology manufacturing segments was due to the mainland government’s decision to support the semiconductor, component, and IC design firms as part of the bigger picture to move up the value chain.

Figure 1: China ADRs under pressure recently

Source: Bloomberg, DBS

Figure 2: The broader China Technology sector has done relatively better

Source: Bloomberg, DBS

In an effort to develop a homegrown technology ecosystem and to be more self-sufficient, a robust policy and governance framework is of utmost importance to ensure enduring success. The recent policy implementation indicated policymakers’ commitment to set a comprehensive supervision foundation.

China ADRs is a large sector – The market capitalisation of the 20 largest ADRs have grown to nearly USD1.8t (Figure 3) and presently, there are more than 150 China ADRs with a combined market value in excess of USD2t.

The 20 most-highly traded ADRs collectively recorded daily liquidity of USD13b, allowing investors (Figure 4) a high level of market access.

The silver lining from the policy stance in tightening the rules on China companies seeking listing in the ADR platform is that local firms are now encouraged to list closer to home, broadening the investment offerings in the onshore capital markets of Shanghai and Hong Kong.

At present, the 12 HK-listed ADRs have a combined market capitalisation of USD1t and the value is expected to rise (Figure 5). This essentially offers investors an avenue to invest in similar stocks without having to worry that these securities might be affected by policy changes in other overseas exchanges.

China’s economic growth clearly has a long runway ahead, particularly in sectors of strategic importance, such as upstream technology, green energy, e-Commerce, and leading health care and software applications.

Figure 3: China ADRs, an important asset class

Source: Bloomberg, DBS

Figure 4: Top-20 most traded ADRs

Source: Bloomberg, DBS

Figure 5: ADRs having parallel listing in Hong Kong Stock Exchange (388 HK)

Source: Bloomberg, DBS


Outlook – China’s economic structure has evolved and expanded over past decades, driven by the emergence of tertiary (services) industries and domestic consumption. In the past decade, the blossoming of ‘new economy’ sectors has further elevated the growth trajectory and placed China among the leaders in digital transformations. Mainland firms have a competitive edge in high growth sectors such as mobile applications, online commerce, and social media, and is making progress in semiconductor developments. Over time, recent regulatory moves would strengthen the robustness of this vital industry.

Recommendation – We stay constructive on China’s technology and new economy sectors. as their long-term fundamentals are truly compelling.

On valuation, given the rather sharp correction, valuations of these sectors are attractive (Figure 6). The price-to-book (P/B) ratio has entered trough territory of below -1 standard deviation to historical mean. Stocks rallied the last time the P/B fell to such levels.

Likewise, the forward price-earnings ratio has retreated to the long-term historical mean of 32x on projected EPS growth of 23%, for an appealing PE/G of 1.4x, by no means excessive in the face of solid earnings growth (Figure 7).

Figure 6: China ADRs at trough price-to-book

Source: Bloomberg, DBS

Figure 7: Forward PER is not demanding

Source: Bloomberg, DBS


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