China’s property crisis (and why there’s still opportunities in the region)

From really 2015 to 2021, you saw a gigantic boom in the property sector. We saw very strong property prices and a lot of speculation and investment that was driving demand because there was effectively an implicit guarantee from the government. They said, "We have to save the economy. We want the household sector to buy property. That's how we're going to save the economy." And then we hit 2021, and over the previous years, what you'd seen is the buildup in household debt in China between 2015 and 2021 was the same as America going into the GFC, but the Chinese economy's a smaller economy and there was just too much credit going in and it was becoming a systemic problem. So the government said, "Enough's enough, we have to address this problem." And they put in very restrictive policies to stop the asset bubble. 

It took a while to work, but eventually, domestic investors heard it loud and clear. And over the last two years, we've seen housing sales fall 60%, and that has put enormous pressure on the developers.

Developers which had benefited massively from the credit creation that was going into the sector, suddenly, no one's buying their properties, and so they're now running into financial problems. What we are seeing today in China is the government is starting to try and stabilise the situation. And I would argue that after a 60% fall in housing sales, you're at a level of demand closer to a natural level, where there's no speculation, there's no investment, it's just people who need homes on a regular basis and like to upgrade. And so we're at this very critical junction now where most likely you get to see some stability, but that doesn't mean these property developers which have over-invested and over-expanded with high leverage are necessarily going to survive this.

This is not specific to two companies. There are a lot of companies that were doing the same thing and even companies with state bank backing in this downturn looked like they would be beneficiaries of this process, particularly private sector companies, which have also faced challenges. So this is a fairly universal problem. 

We see the headlines of the newspapers here around the problems of the two biggest companies, but there's been a much more widespread problem than just those two companies.

LW: Could this flow through to Australia? 

Andrew Swan: It's really interesting because around about a third of the economy was housing two years ago - a gigantic part of the Chinese economy - and that housing market has now more than halved. So you've taken away a very big tailwind from China and turned it into a headwind. 

In theory, countries, companies or sectors that were supplying that housing sector, that investment boom, would also be suffering. Now, iron ore is an interesting one because it obviously goes into steel, and steel goes into residential and other types of property investment, but what we're seeing this year is actually iron ore prices have held up. 

Steel prices have held up in China, and the weakness in property is actually being offset by investment in other areas in China. Under the current five-year plan, there is a desire to boost investment and exposure to things like renewables and electric vehicle supply chains. And what we're seeing is steel demand is actually holding up pretty well even though the housing demand has collapsed because people are building more plants within solar or electric vehicles or other forms of renewable energy. 

So, Australia has been fairly fortunate. I think going back two years ago, if you'd said the housing market was going to more than halve, I think you'd be worried about our iron ore exports. But those exports have been replaced by other new sources of demand in the economy.

LW: Are you seeing any opportunities in China? 

Andrew Swan: The reality is the macro's dominating things at the moment, but below the surface, inside the market at the company level, there's still opportunity within that. We would say the healthcare sector is one. China needs more healthcare and we're seeing some opportunities in that space. 

On top of that, there are certainly niche areas of consumption, which are actually still doing very well. Only about 15% of Chinese people have passports, and we're seeing, post-COVID, a very strong recovery in international travel, as an example. So we also see opportunities in companies related to travel and entertainment. 

LW: Can you take us through an example in the portfolio? 

Andrew Swan: One of our bigger positions over the last couple of years has been a leading travel provider in China. It's expanded its market share during COVID because the smaller players have tended to fold when travel was restricted. And so they've come through the downturn in a very strong position, and margins now are actually higher than what they were before COVID. 

Domestic travel has been very strong, but now that the borders are opening. What we are starting to see is a shift away from domestic travel to international travel. And for this travel-related company, the dollar margin on a person going overseas is actually higher than for a traveller staying domestically. So over the next couple of years, as demand comes back for international travel, we do see a lot of growth lift.

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