China Macro Outlook – A New China is Emerging

Victoria Mio, CFA CPA FRM

CIO China, co-Head Asia Pacific Equities, Fund Manager Robeco Chinese Equities

22 February 2016

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For professional investors only

China’s Five Mega Trends in the Next Five Year

Source: CEIC, Morgan Stanley, Robeco

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> A new consumption driven economy is emerging

> The old economy is adjusting to the new normal

> CNY will gradually become an international hard currency

> The Chinese capital market will be more integrated into the global markets

> China will play an increasing important role in international cooperation

Nominal GDP growth by sector

Nominal GDP growth decelerated but expected to stabilize

Source: CEIC, Morgan Stanley, Robeco

3

10.6 10.5 9.7

12.9

17.7

15.7

17.1

23.1

18.2

9.1

18.3 18.4

10.3 10.1

8.1

6.4

0

5

10

15

20

25

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

ppts Nominal GDP growth, ppt contribution

Tertiary Industry

Secondary Industry

Primary Industry

Nominal GDP

Falling old economy vs. rising new economy

Source: Bloomberg, PBOC, Gartner, Haver, Company filings, Boxofficemojo.com, Capital IQ and Bernstein analysis, Robeco

China’s old indicators: YoY growth China’s new indicators: YoY growth

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Power Production

Railway Freight

Export Trade USD

Import Trade USD

New Housing

Floor Space

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

1Q

14

2Q

14

3Q

14

4Q

14

1Q

15

2Q

15

3Q

15

4Q

15

Airline Passen-

gers

Car Sales

Alibaba's GMV

Travel Tours

Movie Box Office

-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

1Q

14

2Q

14

3Q

14

4Q

14

1Q

15

2Q

15

3Q

15

4Q

15

1) China’s emerging middle class leads to emerging consumption

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Chinese household annual disposable income distribution in %

29 16

54

22

14

54

3 9

0

20

40

60

80

100

120

2012 2022

Poor (<US$9,000) Mass middle class (US$9,000-16,000)

Upper middle class (US$16,000-34,000) Affluent (US$>34,000)

Projected growth of consumption

2012-2022 CAGR%

19.6

22.4

-3.3

-1.5

Source: McKinsey

1) China’s internet development catches up with the world

Source: CNNIC, iResearch, Analysis, MIIT

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1) China is at the forefront of mobile ecommerce, cloud computing, and mobile payment

> These emerging sectors still have huge growth potential

> Aug 2015: 276mn mobile payment user (20% penetration), 168mn mobile travel booking user (12% penetration)

Data source: ITThink, Context China, Xinhuanet, Robeco

Mobile e-commerce Mobile payment

China

51.71%

Emerging

Markets

China

40.43%

Emerging

Markets

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Cloud computing

1) Will China Have The World’s Largest Box Office In 2016?

Source: Morgan Stanley, IBTimes, Robeco

China Box Office registered explosive growth Chinese movie-goers wear 3-D glasses watch movie

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> China movie box office growth trend - Quickly catching up with the US, growing from 15% of the US market size to over 60% in less than 5 years.

1) China domestic tourist #s - continues to grow at 10% CAGR for the next 5 years

Source: Morgan Stanley, Disney, Robeco

> As of 2014, China’s per capital GDP, based on purchasing power parity, reached USD11,907. When US per capita GDP reached USD10,000, travel expenditure accelerated.

> China’s first Disney theme park will be unveiled soon, including its six themed lands filled with world-class attractions and live entertainment spectaculars.

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Total Domestic Tourists Growth Accelerated Shanghai Disney Resort opening 16 June 2016

1) Chinese travelers demonstrate an incredible purchasing power (US$229 bn in 2015E)

Source: Luxury Society, WSJ China Real Time Report

> Total outbound passenger journeys will double between 2014 and 2020, to approximately 234 million.

> Overseas spending by Chinese tourists set to jump 23% to US$229 billion in 2015.

> By 2020, FBIC Global Retail & Technology projects this figure to rise to US$422 billion.

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Total Outbound Chinese Journey Numbers, 2005-2020F Chinese tourists pose for a photo in St Petersburg, Russia

1) All signs are pointing to explosive growth of sport in China

Source: www.wantchinatimes.com, Morgan Stanley, en.olympic.cn

> The massive broadcasting deals are an indicator of the growing value of sport in China.

> High-profile overseas soccer player transfers to Chinese soccer teams: Jackson Martinez (EUR42mn); Geuvanio Santos Silva (EUR3mn); Ramires Santos do Nascimento (EUR28mn); Elkeson de Oliveira Cardoso (EUR18.5mn).

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China’s President Xi Jinping is an avid soccer fan 30,000 runners joined in the Beijing Marathon

0

0.2

0.4

0.6

0.8

1

1.2

1.4

0

50

100

150

200

250

300

350

2010 2011 2012 2013 2014 2015

Mill

ion

s

No. of marathon and fun races (left)No. of participants (right)

n/a

1) Uber sees explosive growth in China

Source: Uber, CLSA, Robeco

Number of trips monthly versus months since launch Integrated map + payment app

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China Rest of the World

1) Aging of the population drives demand for healthcare

Source: UN, Deutsche Bank Strategy Research

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Dropping working age population vs rising senior citizens

Now at historical peak

1) While manufacturing sector are firing, services sector are hiring

Source: CEIC and Citi Research, as of Sep 2015

Total No. of Employees and Growth by Sectors

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10%

-7%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

Cult

ural

etc

.

Petr

ole

um, c

oki

ng

Leat

her

etc.

Wo

od

etc.

Elec

tro

nic

Equ

ipm

ent

Oil/

Gas

min

ing

Uti

litie

s

Ferr

ou

s m

etal

Coal

Min

ing

Min

ing

auxi

liary

Total No of Employees 2015 YTD change %(rhs)

(thousand)

Consolidation Expansion

2) Supply side reform is a structural reform, with first step of capacity reduction

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Loss-Making Companies % among Overcapacity Sectors

Source: CEIC and Citi Research, as of Feb 2016

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Oil & Gas

Coal Mining

Steel Mining

Steel pressing

Non ferrous Metal

Textile

2) The impact on banks NPL will be significant, but will not cause systemic risk

Source, NPS, Goldman Sachs Research

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Impact from eliminating zombie companies by 2017

> Employment: Upstream is 3% of total employment, zombie companies employ ~5.6mn people

> Tax: 8.4Bn RMB impact, 1.1% of local fiscal income

> Debt: 480Bn RMB NPL increase a year. Banks NPL balance is 1.2Trn RMB at 3Q2015, annual increase of 420Bn RMB. ~2Trn Profit in 2014 for banks.

23mn employment in commodity related sectors, 3% of total working population

Coal, 4.5mn

Oil and gas, 0.8mn

Ferrous, 4.2mn

Nonferrous, 2.4mn

Other mining, 0.3mn

Non-metal products (cement, glass etc),

6.2mn

Metal products,

3.5mn

Paper, 1.3mn

Urban-others, 370mn

Rural, 380mn

Urban-commodity

related, 23mn

2) China has the ambition and need to catch the automation wave

Source: Bernstein Research, www.alienelement.com

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Market share of Chinese players in robotics in China Industry breakdown between domestic and foreign

> Automation and robotic penetration in China is still very low. Robust government support policies are a key driver

> Customized automation equipment suppliers that are gaining share high end supply chain of international consumer electronics makers

> Able to expand into new addressable markets in 3C and Auto segments

25%

27%

30%

32% 33% 33%

20%

22%

24%

26%

28%

30%

32%

34%

2009 2010 2011 2012 2013 2014

Market share of domestic players in China industrialrobotics

3) CNY depreciated against USD, but appreciated against others

> Despite the depreciation, CNY nominal effective exchange rate has appreciated by over 9%.

> SDR inclusion will create natural demand for CNY by global central banks.

> Stock connect will create natural demand for CNY by global investors.

Source: Bloomberg, Morgan Stanley, Robeco, as of 18February, 2016

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CNY / USD exchange rate CNY nominal effective exchange rate

-7% China CNY vs USD

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

Jan-14 Jun-14 Nov-14 Apr-15 Sep-15 Feb-16

%

-3%

91

93

95

97

99

101

103

105

Jun-1

4

Jul-1

4

Aug-1

4

Sep-1

4

Oct-

14

No

v-1

4

De

c-1

4

Jan-1

5

Feb

-15

Ma

r-1

5

Apr-

15

Ma

y-1

5

Jun-1

5

Jul-1

5

Aug-1

5

Sep-1

5

Oct-

15

No

v-1

5

De

c-1

5

Jan-1

6

Feb

-16

China NEER, Dec 2014=100 Aug 10,

2015

3) USD strengthens due to end of QE and rate hike potential

Source: Bloomberg, Robeco, as of 18 February, 2016

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USD strengthened against other currencies

-41% Brazil BRL vs USD

-56% Russia RUB vs USD

-7% China CNY vs USD

-19% EUR vs USD

-7% JPY vs USD

+21% USD vs a multicurrency global index

-70

-60

-50

-40

-30

-20

-10

0

10

20

30

Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15

%

3) China is far from currency crisis

Source: World Bank, IMF, Haver, Bloomberg, Bernstein analysis, Robeco

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Current Account as % of GDP prior to Currency Crises Benchmark Interest Rate Spread vs US

> Significant currency depreciations happened under the conditions:

– The economy in question has operated a current account deficit

– Interest rates have been high and rising

3) The China Foreign Exchange Trade System (CFETS) RMB index as the new anchor

Source: PBOC, CEFTS, Mizuho, Robeco, as of 18 February, 2016

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Weighting of the CFETS RMB exchange rate composite index

26.4%

21.4%

14.7%

6.6%

3.9%

6.3%

0.7% 3.8%

1.5% 2.5%

4.7% 4.4% 3.3%

USD EUR JPY HKD GBP AUD NZD

SGD CHF CAD MYR RUB THB

Trade weighted index

4) MSCI inclusion of China A shares – likely to announced in June 2016

> Increase China’s weight in MSCI EM to 45% with 100% China A share inclusion.

> When Korea and Taiwan are excluded, China will represent over 56%. Separate asset class.

Data source: Bloomberg, MSCI, Deutsche Bank, Robeco, as of Jan 2016

MSCI EM (100% China A share inclusion) MSCI EM (excl Korea & Taiwan)

China

51.71%

Emerging

Markets

China

40.43%

Emerging

Markets

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A-share, 21.3%

ADR, 4.6%

H+B+P+Red, 18.5%

KR, 11.8%

TW, 9.2%

IN, 6.6%

SA, 5.1%

BR, 4.1%

MX, 3.4%

RU, 2.6%

MY, 2.5% ID, 1.9%

TH, 1.5%

Others, 6.9%

China, 44.5%

Emerging Markets

China, 44.5%

Emerging Markets

China (A), 27.0%

ADR, 5.9%

H+B+P+Red, 23.4%

IN, 8.3%

SA, 6.5%

BR, 5.2%

MX, 4.3%

RU, 3.3%

MY, 3.1%

ID, 2.5%

TH, 1.9%

Others, 8.7%

Emerging Markets

China, 56.2%

Emerging Markets

4) A share stocks’ valuation are high, although we need to take growth into consideration

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Valuation vs. growth (size of the bubble represents the dividend yield, red color are the sectors we like)

Source: Wind, CITICS research

Petrochemical

Coal

Electricity&Utilities

Power Generation&Grid

Environmental&Public Utilities

Basic Chemicals

Construction

Building Materials

Light Industry

Machinery

Power Equipment

Auto

Retail Trade

Catering&Travel

Home Appliances

Textiles&Garments

Pharmaceuticals

F&B

Agriculture

Securities Insurance

Real Estates

Transportation

Elect. Components

Communications

Computers

Media

Comprehensive

0

20

40

60

80

100

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

TTM

P/E

EPS Growth（2016-17）

5) New Silk Road Initiative – improves regional connectivity through infrastructure

Source: Reuters

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> China expects that the annual trade volume between China and the OBOR countries to surpass USD 2.5 tn by 2025.

> Asia will need annual infrastructure spending of approximately USD 730 bn up to 2020

Conclusion: structural opportunities based on the mega trends

New economy will continue to outperform the old economy

> Driven by consumption and innovation, the new economy will have strong organic growth

> But be selective in new economy as valuation is very high in some sectors

Old economy will face more pressure as supply-side reforms intensify

> Government has strong commitment to revive the growth engine but they also need to solve the old problems by capacity reduction, inventory clearance and deleveraging

Key risks to add to uncertainty

> CNY exchange rate fluctuation risks

> Credit default risks

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Investment themes: Aligned with structural reforms

Source: NDRC, State Council announcement, Robeco

Key Themes Rationales Overweight Sectors

1) Consumption Raising minimum wages, transfer payment for healthcare, education, pension

Consumer Discretionary

2) Technology and Innovation Government to support and stimulate consumption in: cultural, entertainment, internet, gaming, travel, IT services

Internet and Hardware

3) Healthcare Reforms Expand access to health services to rural China Improve quality of care and deliver cost-effective care

Healthcare & Services

4) New Silk Road Initiatives Build cross border infrastructure network on road & sea Export infrastructure construction capability

Construction , Railway Equip & Machinery

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