In our last article, we discussed about how consumption is increasingly digitalised in China and how the Internet is progressively interwoven into the fabric of everyday life. In this, we take a deeper look into two key demographic shifts in China responsible for the rising usage of Internet services, as well as the paradigm shifts in consumption that are ultimately driving the secular tailwinds for the country’s Internet sector
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Chinese millennials at the heart of paradigm shifts in consumption and Internet usage patterns
The technology sector in China has been expanding rapidly in the past five years, thanks in part to the Chinese millennials (born between 1981 and 1996). At more than 350 million strong, this particular group of young adults now accounts for a quarter of China's population and is bigger than the entire population of the US.
As the first generation to be brought up in the age of digital technology, Chinese millennials are avid Internet users. These digital natives were responsible for more than half of the total Internet usage in China last year (Chart 1). As a result, their online footprint and consumption habits are set to bring forth a profound impact on the future development of China’s Internet sector.
Chart 1: Millennials account for more than half of total Internet usage in China
The beneficiaries of the yesteryears’ producer-led economic reforms, these young adults grew up knowing little about the hardships of older generations. Raised as the only child in their families during a period of rapid economic growth, their parents spared no effort in providing them with the best education and pandered to their every whim. Unburdened by student loans and mortgages, Chinese millennials enjoy greater financial freedom and have a higher propensity to spend than preceding generations.
The primary force behind the country's surge in consumption, spending by Chinese millennials contributed to two-thirds of total consumption growth last year. In the next decade, these young adults will form the bulk of the country’s core workforce population and will be starting their own families. With greater earnings power, their spending is projected to increase by over 10% annually for the next three years.
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Online services thrive on millennials’ demand for fast, simple and convenient options
The unique consumption patterns of the highly-connected Chinese millennials are increasingly evident in China’s digital space. Harnessing technological capabilities, they are transforming various sectors of the economy, from travel, education to entertainment. These young adults are the main driving force fuelling the rapid growth in Internet sub-sectors, such as food delivery, grocery shopping, online gaming and travel booking.
The explosive emergence of the online food delivery service is one such example of the millennials’ influence in the Internet sector. The group accounts for more than 90% of regular users of online food delivery services like Alibaba’s Ele.me 饿了吗 (NYSE: BABA) and Meituan Dianping's 美团外卖 (HKEX: 3690) (Chart 2). Virtually non-existent five years ago, food delivery in China hit RMB 500 billion yuan in transactions last year, with the figure widely expected to triple by 2023.
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Chart 2: Millennials and Gen-Z form the bulk of regular users of food delivery services
Their constant pursuit for fast, simple and convenient methods of shopping has also extended to include fresh groceries. With a few taps on their smartphones, these consumers can place orders for fresh groceries, like seafood and fruits, and have them delivered straight to their doorstep within one to two hours. Forecasted to expand at double the rate of the country’s total grocery retail market, China’s online grocery space is dominated by the likes of Alibaba’s Freshippo 盒马 (NYSE: BABA), Tencent’s Super Species 超级物种 (HKEX: 700) and JD’s 7Fresh 七鲜 (NASDAQ: JD).
Besides seeking convenience, Chinese millennials also enjoy travelling. With two-thirds of all Chinese passport holders being millennials, they contributed to the bulk of the USD 115 billion spent by Chinese visitors on global travel in 2017. Last year, their total spending on international travel surged by 80 percent year-on-year.
Better educated and more exposed to worldly affairs, millennials’ ‘free and easy’ travelling style gave rise to the booming online travel aggregator (OTA) industry in China. Over 70% of all millennials now travel independently, booking their flight tickets and accommodation through OTAs like Ctrip.com (NASDAQ:CTRP) and Meituan Dianping (HKEX: 3690), instead of structured group tours preferred by older Chinese travellers. To these young travellers, online booking makes researching for travel options and planning for trips convenient and efficient.
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Rural China presents an emerging supply of Internet users
While Millennials are unquestionably the main users of the Internet, there is another demographic group that is fast emerging as a major part of the Internet population – rural China. More than one-third of the eight million people from rural China are now regular Internet users, a vast improvement from the 12% a decade ago (Chart 3).
Chart 3: Surge in number of Internet users in rural China
Not only are rural Internet users growing more numerous, these initiates of the Internet are increasingly reliant on technology and Internet services in wider areas of their daily lives, such as mobile payments, e-commerce, online education and e-healthcare. For example, close to half of China’s rural internet users have already adopted mobile payments last year, up from 31.7% in 2017. As a result, Internet usage duration per user grew rapidly in the lower-tier cities, at a pace faster than their urban peers (Chart 4).
Chart 4: Average Internet usage duration growing at faster pace in rural China than urban China
The acceleration in Internet usage did not occur by chance, it was strongly supported by the China government. Unlike their city-dwelling peers, who have integrated the Internet into their daily lives, the rural populace have largely been left behind by the Internet revolution. Flagged as a worrying concern, the digital divide was actively addressed in recent years by the Chinese government, which has been pushing big telco players to progressively install broadband infrastructure in the remote regions.
Yet, the Internet penetration rate of 36% in rural China is still drastically lower than the 70% in urban cities. As urbanisation gets underway in rural China, we can expect to see a steady growth in both Internet users and usage duration per user, especially as the penetration rate of rural Internet users converges towards the urban levels.
China’s lower-tier cities represent huge untapped opportunities for Internet companies like Tencent and Alibaba. While rural consumers may not be as wealthy as those in urban areas, their disposable income has been rising steadily over the last ten years and will soon develop needs and wants similar to their urban counterparts. Moreover, the sheer size of the rural population easily offsets their lower spending power.
eCommerce, eEducation and eHealthcare to thrive as rural China goes digital
The surge in rural Internet usage also partially stemmed from the fact that technology and Internet are effective tools in addressing some of the pain points faced in rural China. For example, Internet services for education, healthcare, and shopping can fill the gaps caused by insufficient resources and structural inefficiencies of these essential services in the more remote parts of China.
One of the biggest barriers to educating China’s rural poor is finding enough teachers willing to take up jobs in remote and impoverished areas. Rural schools typically suffer from a lack of qualified teachers and teaching materials, which inadvertently result in poorer standards of education received by schoolchildren. Online education services like Tencent’s online tutoring platform Fudao QQ (HKEX: 700) can address the issue by providing quality curriculums to these rural kids, enabling them to keep up with their urban peers.
As China advances into a relatively fast-ageing society, the growth of the elderly population is creating greater demand for healthcare. With most of China’s elderly residing in lower-tier cities where healthcare resources are fairly limited, online healthcare services like Tencent’s WeDoctor (HKEX: 700) and Ping An Good Doctor (HKEX: 1833) are stepping up to bridge the gaps in supply-demand mismatch. These elderly can seek professional opinions on their health conditions through online consultations in those apps, but without the need to travel to further cities, a process that can be time-consuming and a big hassle.
E-commerce has also been an instant hit with the rural populace, giving them access to brands and products that were previously unavailable, especially with fairly limited shopping options in rural areas. Unlike urban cities where there are plenty of shopping malls within striking distance, malls in the remote regions of China are small and few in numbers. As a result, increasingly more rural consumers are relying on online shopping for their daily necessities, clothing and home appliances.
Online shopping is not only a boon to rural China, it is also paving a profitable route for e-commerce giants like Alibaba (NYSE: BABA) and JD.com (NASDAQ: JD). They have been ramping up their efforts to reach China’s rural customers via service centres that act like distribution hubs in rural areas. Last year, six in ten new online shoppers in China come from lower-tier cities (Chart 5).
Chart 5: Increasing more online shoppers are consumers from rural China
CQQQ – A Simple Way to Invest in China Technology Sector!
The Invesco China Technology ETF (NYSE: CQQQ) is a US-listed ETF that tracks the AlphaShares China Technology Index, which measures the performance of Chinese companies operating in the technology sector.
Instead of having to pick out and track the stocks of numerous individual technology companies in China, CQQQ presents a simple and straightforward way to gain exposure to the strong growth trend of China’s Internet sector. The nature of ETFs as a basket of stocks also provides diversification away from firm-specific risks that may arise in individual companies.
CQQQ provides exposure to various high-quality Chinese Internet companies, including prominent Chinese tech giants like the BATJ – Alibaba (NYSE: BABA), Tencent (HKEX: 700), Baidu (NASDAQ: BIDU) and JD.com (NASDAQ: JD). We believe that these tech companies are primed to be the main beneficiaries of an increasing domestic consumption by China’s burgeoning middle class (Chart 6).
Chart 6: Breakdown of CQQQ’s shareholdings
Invest in this fast-growing sector before it’s too late
We value Invesco China Technology ETF (NYSE: CQQQ) at a fair valuation of USD 64 calculated using a weighted average of its underlying stockholdings, based on a price-earnings (P/E) ratio of 20.0X on its FY20E weighted earnings-per-share (EPS) of USD 3.20.
This represents an upside potential of 34%, based on closing price of USD 47.63 on 15 May 2019 (Table 1).
While renewed trade tensions has taken a toll on CQQQ, which dipped -8% since President Trump’s latest tariff tweet, we see the recent pullback as an opportunity for investors to accumulate more of the ETF.
Even if the current negative sentiment may weigh on consumer confidence and possibly stifle spending in the near-term, our sights are set firmly on a future in which the Internet is integrated into every aspect of daily living in China. As China continues to spend more online, it certainly bodes well for Chinese Internet companies, the earnings of which are projected to grow at a CAGR of 21% over the next two years
Given its massive growth potential, we believe China’s Internet sector is an attractive investment opportunity for those who are able to withstand the occasional volatility that characterises this sector.
Table 1: CQQQ offers an upside potential of more than 30% by end-2020
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