Macro Pressure, Market Future

Market sentiment in the domestic capital market was subdued in May, reflected in three aspects: first, a contraction in trading volume; second, a high retreat in the Hang Seng Index, which is a measure of market optimism; and third, a continued group rally in dividend-heavy sectors at relatively high levels.

The downward pressure on China's economy remains significant.

Data from April to May shows weak credit demand in financial figures, PPI is still in a deflationary range, PMI data has fallen again, and the growth of key consumer goods is generally poor.

Since the end of 2023, monetary easing in 2024 has been implemented, with the central social interest rate (such as government bonds, mortgage rates, etc.)

continuously declining, but credit easing has not yet been realized.

The confidence of residents and enterprises to leverage investment is weak, and government fiscal expenditure is insufficient.

Under such a background, the mentality of the whole society's funds pursuing low-volatility fixed returns is still expanding, driving the leading position of dividend and value stocks in the capital market.

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The comprehensive shift in real estate policy has brought a good start to the bottoming out of the domestic economy, but for a "big car" with a large downward sliding quantity, it takes some time to see results.

An optimistic estimate suggests that the second half of 2024 may see a gradual improvement in domestic demand.

However, considering that the inventory replenishment cycle in Europe and America is more than half over, and the probability of trade frictions intensifying is high, the economy will face greater pressure in the second half of the year.

In summary, this is an urgent moment that requires more powerful and effective domestic economic stimulus policies.

We believe that the "turning point" of policy thinking has been initiated, and we are optimistic about the intensification of economic policies in the second half of the year.

Back to the capital market, the market is short-term defensive, with dividend-heavy "bond-like" stocks performing well.

Both A-shares and Hong Kong stocks have experienced more than three years of decline, and the overall valuation is very attractive.

In fact, compared with domestic and foreign markets, a strong stock market does not require rapid GDP growth (i.e., the growth of the entire market).

A good competitive pattern, moving towards globalization, and valuing shareholder returns are more important.

In the past 2-3 years, despite market adjustments, some industry-leading companies have still provided outstanding positive examples.

Looking to the future, although the macroeconomy still has pressure, as long as the market is stable, there will still be many high-quality investment opportunities.

On one hand, state-owned and central enterprises continue to promote reforms, improve dividends, and make high-quality development more common.

On the other hand, we see leading private enterprises in fields such as the internet, new energy, and chemical machinery also adjusting towards improving shareholder returns.

Our stock selection framework, in addition to looking at industry prosperity, will put competitive patterns and shareholder returns in a more important position for comprehensive evaluation.

The discussion this issue focuses on the lithium battery industry.

The lithium battery industry has experienced ups and downs in the past few years.

Due to the rapid growth in downstream demand (electric vehicles, energy storage, etc.

), the valuation level once reached more than 50 times the price-to-earnings ratio.

After 2022, due to excessive industry capacity, it fell into a situation of extreme oversupply, with a significant decline in product prices and profit margins, and the lithium battery sector fell sharply again.

The valuation of leading companies generally contracted to less than 20 times the price-to-earnings ratio, and the valuation level returned to the level of 2018-19.

The essence of the lithium battery industry is still manufacturing.

The upstream raw materials are the cathode, anode, separator, electrolyte of lithium batteries, as well as a series of additives, and the downstream demand is various electric vehicle manufacturers and energy storage integrators.

Most of the production and manufacturing processes are standardized, and the production and manufacturing equipment are also standardized, with no significant differences among companies.

The product technology of lithium batteries has some differences between manufacturers, but there is no essential difference.

The product technical indicators and consistency of leading companies are slightly better.

So the question arises, if product technology, manufacturing processes, raw materials, and downstream customers are all highly standardized - if downstream demand is explosively high-speed growth, and a stage of supply shortage brings excess profits, then the lithium battery industry must be everyone's crazy expansion to meet demand.

However, the explosive growth of demand is destined to be short-lived.

Once demand enters a stable stage, the problem of homogenization and oversupply on the supply side will emerge, and the industry will fall into a price war.

In the past few years, this process has actually occurred.

The period of excess profits in the industry is short, and the period of price war is long.

Most companies in the industry are negative in terms of shareholder cash returns - the destruction of shareholder value in the lithium battery industry, accompanied by overcapacity, price decline, and the improvement of the economic nature of electric vehicles and energy storage, is beneficial to promoting the development of the industry of electric vehicles and energy storage, but it is extremely unfavorable to shareholders investing in the lithium battery industry.

Where is the differentiation of enterprises in the lithium battery industry reflected?

First, scale, under the premise of consistent technology and processes, doing a large scale is an important aspect of enterprises pursuing strong competitiveness.

Leading companies, after reaching 500GWh and 1TWh, have increased the scale effect of production and the bargaining power of upstream materials, which increases the competitive advantage of enterprises.

Second, supply chain management capabilities, the raw materials of lithium batteries are diverse and the price fluctuates greatly.

How enterprises manage and inventory raw materials, the requirements for refined management are very high - in the same industry, some companies have a net operating cycle of less than 30 days, and some companies have up to 300 days, some companies have a fixed asset turnover rate of 4 times, and some companies only have 1-2 times.

Third, small technological progress, in a 2-3 year cycle, lithium batteries will still have technological iteration and progress.

If it is a technology-leading company, it can continue to obtain excess profits in stages (new products can be sold more expensively) through a 0.5-1 year technological advantage.

But if it is a technology follower, it may face the embarrassment of continuous scrapping and impairment of old capacity, and continuous investment in new technology.

Is there still investment value in the lithium battery industry in the future?

The investment opportunity of the last demand explosion era has ended, and it is currently at the end of fierce price war - the future investment opportunity lies in the first place, the price war is stable, a large amount of capacity on the supply side exits the industry, and the technical and scale thresholds are raised, and the difficulty for new entrants is greatly increased.

The second is the existing global players, the scale of the company is also very large, whether the competition between giants enters a stable stage is quite important, especially considering the trade barriers of the Chinese, American, and European markets.

When the competition pattern on the supply side is greatly eased in the future, due to the demand still has a relatively sustained growth, the leading companies that win the share will have a period of good shareholder returns.

Lithium batteries are still a relatively complex industrial product, and the technology continues to iterate and progress, and the requirements for the industry players are very high, even giants need to keep running.

Overall, it is a very poor business model for shareholder returns, but among them, the leaders with strong differentiation capabilities may have a certain investment value in the mature period of the industry.