How does Alpha of Chuhai Chain search for opportunities

Key Points:

Understanding the Difference in Logic Behind Going Global and Dividend

Due to the inherent volatility in the global expansion sector, its fundamental logic may differ from that of the dividend sector: Investors investing in the global expansion chain are buying into the long-term trend of capacity going global; investors investing in the dividend sector are buying into the certainty premium under converging volatility. Long-term and certainty are often hard to achieve simultaneously, and if present, they are often considered "expensive," leading to higher valuations. This is also an important reason why the home appliance industry (which has both a high dividend yield and early global expansion layout) has shown strong performance so far this year.

Global Expansion Behavior: Some resources and retail industries have early layouts, while emerging midstream manufacturing industries have intensified global expansion in recent years

Comprehensive Perspective on Global Expansion Behavior: A-share companies' global expansion is generally concentrated in the United States, Southeast Asia, East Asia, with some involvement in Europe but with dispersed countries. The United States ranks first as the destination for A-share stock global expansion with 439 historical global expansion activities, while Vietnam, although receiving more attention in recent years, has a lower base with a total of 159 global expansion activities. From an industry perspective, some resources and retail industries have early layouts, while emerging midstream manufacturing industries have intensified global expansion in recent years.

In addition to the distribution of the number of global expansion activities in various industries/countries, we also focus on the time distribution of global expansion activities: 1) Global expansion is fundamentally different from exports and requires time to eliminate uncertainty. 2) For a company that has just implemented a global expansion strategy, global expansion is both an opportunity and a risk. 3) Leading industries that have early global layouts and high levels of globalization can effectively hedge against potential domestic demand shortages and are the true beneficiaries of the global expansion chain market.

Difference in Domestic/Global Gross Profit Margin: Emerging manufacturing, mechanical manufacturing, and some traditional industries have stronger global expansion momentum

The difference in gross profit margin between domestic and overseas operations is another analytical perspective we emphasize in the global expansion chain, reflecting how much drive a company has to go global in the future.

1. We found that except for light manufacturing, the gross profit margin of each primary industry weighted by industry market value is higher for global operations than for domestic operations. However, this phenomenon differs when calculating the average weighted domestic/global gross profit margin, with 7 industries having an average global gross profit margin lower than domestic. This phenomenon indicates that the logic of leading companies going global is more advantageous.

2. Emerging manufacturing (power equipment, electronics), mechanical manufacturing (engineering machinery, auto parts), and some traditional industries (textiles, clothing, etc.) all have strong global expansion capabilities. We categorize companies in each industry into two groups based on whether their domestic or global gross profit margin is higher, and then calculate the market value of companies falling into these two groups in each industry. Industries such as power equipment, automobiles, food and beverages, transportation, steel, agriculture, forestry, animal husbandry, fisheries, and building materials have more companies with a higher global gross profit margin than domestic.

Risk Preference Disturbance: Focus on the Ratio of US Revenue to Overseas Revenue

Policy risks in global expansion (such as US Federal Reserve monetary policy, tariff policies, industrial sanctions, and local business rules) are one of the sources of uncertainty in the global expansion chain, which may reduce the risk appetite for global expansion investments. Sectors such as components, semiconductors, textile manufacturing, oil and gas extraction, auto parts, and communication equipment have relatively high absolute amounts of US revenue and a high proportion of US revenue to overseas revenue ** The long-term trend of population and China's entry into a new stage of development determine that going global is a long-term trend. With the development of China's economy and the increase in people's income levels, and the decline in population growth rate, in many traditional industries and low-end sectors, China's cost advantage in terms of labor as the "world's factory" has weakened compared to other developing countries.

1. From the perspective of labor supply, the United Nations "World Population Prospects 2022" expects China's population to decrease to about 1.3 billion by 2050 and about 800 million by 2100. With the decline in the labor force, wage costs rise. Companies going abroad to invest in countries with lower wages can reduce costs and avoid tariffs imposed by Europe and the United States on goods originating from China.

2. From the perspective of demand and consumption, as the aging rate rises and the population decreases, the growth rate of domestic total demand decreases, and the domestic market size may have difficulty digesting more production capacity.

The current soft demand is a problem faced by most industries, and the gradual shift of manufacturing capacity overseas is a necessary demand from the supply side. In addition to the past labor cost advantage, China's advantages in the manufacturing sector also include relatively complete infrastructure, a relatively large domestic market, etc. Therefore, in the early stage of industrial trends, companies often increase capital expenditure, rapidly expand production capacity to occupy the market, hoping to become a surviving leader when the industry clears. The capacity utilization rates of various upstream, midstream, and downstream industries in Q1 2023 and 2024 have mostly declined compared to 2021 and 2017-2019. Capacity absorption is one of the main contradictions in various industries, and the current supply-demand situation needs to be resolved by capacity going overseas.

1.3. Going global is a long-term trend, but the global chain is not a highly defensive sector with strong certainty.

The inherent attributes of the global chain being influenced by overseas economic cycles and policies (overseas tariffs, industrial sanctions, etc.) make it subject to fluctuations and uncertainties, and going global is not a "defensive" sector similar to dividends. Reviewing the market performance of the global chain in 2023, we found that the excess returns of the global chain sector often have a positive correlation with the performance of the Wind A Index itself, and often amplify the fluctuations of the Wind A Index in a positive direction, not a "safe haven" sector. We believe that the main logic behind this is:

1. When the main theme of the Wind A adjustment is poor domestic demand, at this time, going global is relatively advantageous, so the global chain may become a temporary direction for funds when the market falls, running an excess market;

2. When the main theme of the Wind A adjustment itself comes from factors that are more sensitive to the global chain, such as weakening external demand, international geopolitical fluctuations, or tariff policies, the global chain will instead amplify the fluctuations of the Wind A Index in a positive direction, with a greater decline during the Wind A adjustment 1.4. Thoughts on the current main market trends: How to understand the difference in logic behind going global and dividends

Due to the inherent volatility of the overseas market sector, its fundamental logic may differ from that of the dividend sector: investors investing in the overseas chain are buying into the long-term trend of capacity going global; investors investing in the dividend sector are buying into the certainty premium under the convergence of volatility. The long-term and stable nature of investment themes are often difficult to achieve simultaneously. If achieved, they are often considered "expensive" and can obtain higher valuations. This is also an important reason why the home appliance industry (which has both a high dividend yield and early overseas layout) has shown strong performance so far this year.

Furthermore, in the following figure (Figure 7), we also provide insights into the logic of technology and industry reversal, systematically summarizing the four main market trends.

2. Incremental data research on the overseas chain: Overseas behavior, differences in gross profit margin, and US income

2.1. Which countries are A-share companies going to for overseas expansion?

Regarding the overseas behavior of listed companies, we have compiled a panoramic view of overseas behavior - time of going global - destination countries (regions) based on historical company announcements using the following methods.

1. Firstly, based on the attributes of company announcements, we conducted an initial screening, selecting announcements related to capital investment, with a time range from 2008 to the present (May 31, 2024);

2. We define overseas behavior as including establishing factories overseas, setting up subsidiaries or affiliates, establishing project departments, capital increases, etc., and we use keyword processing to search for corresponding content in the announcements;

3. We conduct semantic analysis on the selected announcements to extract the countries or regions involved in the overseas destinations;

4. Manual verification and confirmation are then carried out.

The distribution of A-share companies going global is mainly concentrated in the United States, Southeast Asia, and East Asia, with some involvement in Europe but with more dispersed destinations. The results show that the United States ranks first as the destination for A-share stock overseas activities, with 439 historical instances of going global, while Vietnam, although receiving more attention in recent years, has a lower base with 159 instances of going global 2.2. Some resources and retail industry layouts are early, and emerging midstream manufacturing industries have intensified their overseas expansion in recent years

From the industry perspective, in the primary industries, machinery equipment, power equipment, electronics, and automobiles are the industries with more overseas activities; looking at the secondary industries, the midstream manufacturing industries such as auto parts in the automobile sector and general equipment in the machinery equipment sector are the main industries where overseas activities have occurred in recent years. In addition to the distribution of overseas activities in various industries/countries, we also pay attention to the timing distribution of overseas activities:

1) Going overseas is fundamentally different from exporting and requires time to eliminate uncertainties. Going overseas requires capacity, channels, and operational activities abroad, and it is necessary to establish a complete sales channel, brand recognition, and government relations overseas. Whether these factors can be established and sustained stably requires a long time for confirmation.

2) For a company that has just implemented an overseas strategy, overseas activities are both opportunities and risks. Overseas activities are essentially a type of investment expansion, and failed investment activities will affect the company's ROE. Therefore, for overseas activities with a short duration, we tend to believe that their impact on the company is relatively neutral.

3) Industry leaders who have early overseas layouts and a high degree of globalization can effectively hedge against possible domestic demand shortages and are the real beneficiaries of the overseas chain market. Companies that went overseas earlier, cultivated locally for more than a decade, gained high visibility locally, and even acquired a large number of local brands can be considered truly successful in going overseas and becoming multinational operators. In the current environment where China's economic cycle is asynchronous with overseas markets, these companies can smooth out cycles and benefit from the overseas chain market

3. Analysis of Domestic/Overseas Gross Margin: An Alternative Perspective on the Endogenous Driving Force of Enterprise Internationalization

The difference in gross margin between domestic and overseas operations is another key perspective we emphasize in the analysis of internationalization chains, reflecting how much drive a company has to expand internationally. Unlike commonly used financial indicators that focus on historical data such as the proportion of overseas revenue to total revenue, the difference between overseas gross margin and domestic gross margin reflects whether a company is "profitable" in its internationalization efforts, determining the future internationalization drive of the company. In the current context where demand in various industries is relatively weak, and the capacity utilization rates in various sub-industries have mostly declined since 2023 compared to 2021 and 2017-2019, internationalizing capacity is necessary. The difference in gross margin from a medium and micro perspective is like the "drop" in a river, determining the internal drive and sustainability of a company's internationalization.

3.1. Method: Text Extraction and Summarized Analysis

Companies may selectively disclose domestic/overseas gross margins in their financial reports, but such disclosure is not mandatory and the disclosure criteria may vary. The regional fields may be displayed as "domestic/overseas", "China/overseas", "China/Japan/USA", etc., with a certain degree of randomness. We conducted a comprehensive analysis of all A-share listed companies and ultimately identified 2234 companies that simultaneously disclosed domestic/overseas gross margins in their financial reports.

3.2. Conclusion 1: Leading Companies Have Stronger Profitability in Internationalization, Leading Logic Prevails

Leading companies have a competitive advantage in internationalization gross margin. Through analysis and comparison of the above samples, we found that except for light manufacturing, the internationalization gross margin of each industry at the first level of the Shenwan industry classification weighted by industry market value is higher than the domestic gross margin. However, this phenomenon differs when calculating the average domestic/overseas gross margin by simple average weighting, with 7 industries having an average internationalization gross margin lower than the domestic gross margin, indicating that the logic of leading companies in internationalization may be more dominant.

3.3. Conclusion 2: Emerging Manufacturing, Mechanical Manufacturing, and Some Traditional Sectors Have Stronger Internationalization Drive

Emerging manufacturing (power equipment, electronics), mechanical manufacturing (construction machinery, automotive parts), and some traditional sectors (textiles and clothing, etc.) may have stronger internationalization drive. We divided companies in each industry into two groups based on whether their domestic gross margin or international gross margin is higher, and then calculated the market value of companies falling into these two groups in each industry In the primary industries such as power equipment, automobiles, food and beverages, transportation, steel, agriculture, forestry, animal husbandry, and fisheries, companies with higher market values have higher overseas gross profit margins than domestic ones; while in the secondary industries such as batteries, automotive parts, optoelectronics, automation equipment, plastic and textile manufacturing, companies with higher market values have higher overseas gross profit margins than domestic ones. A higher proportion of samples with higher overseas gross profit margins than domestic ones in the industry may indicate that the industry is more "profitable" for overseas expansion, with stronger momentum for international expansion in the future.

4. Risk Preference Perspective: Which Industries Have a Higher Proportion of US Revenue?

Policy risks in overseas markets (such as tariff policies, industrial sanctions, and local business rules) are one of the sources of uncertainty in the overseas expansion chain, which may reduce the risk preference for investments in the overseas expansion chain. We try to identify industries with a high exposure to US revenue based on the overseas revenue data and US revenue data disclosed in the financial notes of listed companies. Sectors such as components, semiconductors, textile manufacturing, oil and gas extraction, automotive parts, and communication equipment have relatively high absolute values of US revenue and a high proportion of US revenue to overseas revenue.

5. Seeking Excess Returns in the Overseas Expansion Chain

Overseas expansion is a long-term trend, but the inherent attributes of targets in the overseas expansion chain being influenced by overseas economic cycles (including US Federal Reserve monetary policies) and policies (such as overseas tariffs, industrial sanctions, etc.) make it subject to fluctuations and uncertainties. It is necessary to find incremental indicators in the overseas expansion chain and explore new alpha.

Based on the framework and data mentioned earlier, we have identified four incremental indicators for overseas expansion: the need for overseas expansion (revenue not only from exports but also with public announcements of overseas expansion activities), effective overseas expansion (accompanied by an increase in ROE), profitability in overseas markets (higher gross profit margin in overseas business than domestic), and risk prevention against sanctions (focus on the proportion of US revenue). Starting from these indicators, we have selected corresponding stock combinations.

The selected stock combinations are mainly distributed in the midstream manufacturing sector, with many industries possessing characteristics of new quality productivity. Backtesting shows significant and stable excess returns compared to the Wind Overseas Index. Since the condition "ROE accompanied by an increase" appeared in our selection, which is not directly related to the overseas expansion chain indicator system, to exclude the possibility of alpha from ROE improvement itself, we conducted another backtest after removing ROE-related conditions and found that the excess returns of this overseas expansion combination have remained significant since February 2024.

Author: Wu Kaida (Practitioner Number: S1110524030001), Source: Kaida Strategy & Execution, Original Title: "How does the Alpha of the Outbound Chain Find | TF Securities Policy Wu Kaida Team"