By Dominic Jacobson Analyst, Emerging Markets Equity and Oksana Miller Senior Product Manager

We believe that China is at the beginning of a structural shift thanks to the country’s policy support, demographic trends and technological progress. Furthermore, the ongoing trend of domestic substitution will likely provide a fertile breeding ground for local champions to be born and thrive – and our portfolio companies Shenzhen Inovance Technology Co., Ltd Class A (“Inovance”) (0.64% of Strategy assets)1 and Shanghai Baosight Software Co., Ltd. Class A (“Baosight”) (2.06% of Strategy assets)2 are a great example of that. These tailwinds make it an exciting time to invest in the thematic,3 and a deep understanding of the policy and technological landscape will be crucial for stock picking.

The largest existential threat facing China is its declining population – the impact of an aging population on the country’s economy has the potential to be highly unsavory and should not be ignored by global investors. Industrial automation and robotics are the solutions to China’s aging population.

Problem – China’s population growth rate has decelerated to its lowest point in six decades. A higher cost of living, delayed marriages and a lack of social mobility are often cited as contributing factors.

Solution – Welcome to the world of China’s industrial automation! The country views industrial automation as a key component in its aging population playbook. It is no surprise that China now represents a staggering 30% of global automation, and continues to expand its role from a “final assembler” to one with a comprehensive end-to-end supply chain. Therefore, we believe that China is at the beginning of a structural shift thanks to its policy support, demographic trends and technology progress.

If the last two years have taught us anything, it’s that it is critical for portfolio companies to be aligned with the goals of the Chinese government when investing in China.

So when China’s 14th FYP (2021-25) and 2035 Long-Range Objectives unequivocally raised the strategic importance of the manufacturing sector (see Exhibit 18), the Investment Team knew it was time to roll up their sleeves and perform the rigorous due diligence. Our view is that China’s intention of sustaining manufacturing’s current share in GDP will meaningfully reaccelerate investment growth in the sector (see Exhibit 19) and that China has a more than adequate set of tools at its disposal to achieve their goal (see Exhibit 22).

Exhibit 18: China’s latest FYP marks an inflection: it aims to reverse a decade-long trend of the declining importance of the manufacturing sector

Source: World Bank, Haver, Chinese government, China NBS, and Bernstein analysis.

Exhibit 19: In the last decade, as manufacturing sector’s share in GDP declined, investment in the sector decelerated; the trend is now reversing with the 14th FYP directive

Source: China NBS, China Ministry of Industry and Information Technology, and Bernstein analysis.

Exhibit 22: List of related policies explained

Source: China National Development and Reform Commission, Ministry of Finance, State Tax Administration, Ministry of Industry and Information Technology, multiple company reports, and Bernstein Analysis. Bernstein, The Robot Renaissance – China Investment Global Implications.

Targeted technology upgrades are another key policy objective, targeting three main areas:

Although many policy tools have been in place for years, recently China’s support for upgrade has become far more sophisticated and targeted. Rather than distributing broad-based subsidies to anyone whose company name happens to contain certain key words in their policy documents, more resources are being allocated to companies that are making real Research & Development (“R&D”) efforts, have met certain technology bars and show high potential to succeed.

There are two main trends that are exacerbating the already tight labor supply dynamics:

For factory owners, automation is no longer a consideration based solely on cost parity — the intensifying labor shortage gives first-movers the additional advantage of stable production to win market share. Since the shift in China’s demographics is a decade-long trend and its impact on automation has just become material for the first time, we think the strong automation demand in China will be enduring.

Exhibit 62: Migrant worker population in manufacturing sector peaked in 2012 and the decline is accelerating

Source: China NBS and Bernstein analysis.

Exhibit 65: “New economy” creating better options than working in factories

Note: Meituan rider monthly income is based on estimates by the Bernstein Asia Internet team; the Didi driver monthly income is based on estimates and analysis by the Bernstein Asia Logistics & Transport team. For more information on these stocks see Bernsteinresearch.com.

Data Source: Bernstein, The Robot Renaissance – China Investment Global Implications.

China is making considerable progress toward internalizing its supply chains and import substitution will be another key growth driver for Chinese automation companies in the coming years. To date, local Chinese companies have experienced success in key components such as Variable Frequency Device (VFD)/Inverter and Distributed Control System (DCS), while the localization ratio of other products, such as Programmable Logic Controllers (PLC), sensor and industrial robots remain low.

Technology will be a key barrier to entry for most domestic automation players. Local companies that command minimal market share typically operate within verticals where products require complicated algorithms, advance chips and components. However, there are some companies, such as Inovance and Baosight, that are breaking through and emerging as local champions.

Western industrial tech companies will inevitably encounter stiffer competition, but it’s not all doom and gloom. “Decoupling” is not part of China’s primary objectives – to move to high-value-add segments (i.e., shifting from making shoes and cement to making electric vehicles, high-speed trains, large aircrafts, smartphones, fuel cells, and innovative drugs, advanced industrial technologies, etc.) are in demand. These technologies span across domestic and foreign regions, and range from laser technology and industrial software, to robotics and CNC machinery. With this in mind, China knows better than to close the market to “protect” local players. Quite the contrary, the country has been encouraging the import of advanced technologies with its tariff scheme. Upgrade is the dominant goal, while local substitution is a by-product.

Established in 2003 as a high- and new- technology company, Inovance focuses on the R&D, production and sale of industrial automation control products that are used in the equipment manufacturing, energy saving, environmental protection and new energy sectors.

Baosight is a software company listed in China’s A-Share market, its main business is digitizing the steel sector and making it more efficient through software and software enabled processes, such as combustion control systems for tempering furnaces and hot blast furnaces.

For over twenty years, the VanEck’s Emerging Markets Equity Investment Team has worked hard to identify and invest in forward-looking, sustainable and structural growth companies centered on the demographic and technological growth trends shaping the transformation of emerging markets economies. In this blog, we wanted to showcase our investment philosophy and process through actual portfolio stock examples. In this case, we have identified China’s aging population as a problem and industrial automation and robotics as the viable solution to address it. As a result, we have expressed our views and conviction by doing heavy due diligence and investing in China’s leaders in the automation and robotics space – Inovance and Baosight.

Originally published by VanEck on June 30, 2022. 

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3 Defined as industrial automation and robotics thematic in this instance.

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