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Optimistic Outlook For Malaysia’s Industrial Property Sector

Bar chart showing Malaysia’s property transaction volume in 2017 (in number of units). In 2017, Malaysia property transactions in number of units were as follows: Residential 194,684 units, Commercial 22,162 units, Industrial 5,725 units, Agriculture 70,290 units, and Development Land and Others 18,963 units.

Demand for Malaysian industrial real estate could rise further driven by a resilient manufacturing sector and ASEAN’s growing e-commerce market.

Accounting for just 1.8% of Malaysian property transaction volume and 8.3% of transaction value, industrial properties contribute the least to Malaysia’s property transactions by volume and value according to data from Malaysia’s National Valuation and Property Services Department’s (JPPH) Property Market Report 2017.

Bar chart showing Malaysia’s property transaction volume in 2017 (in number of units). In 2017, Malaysia property transactions in number of units were as follows: Residential 194,684 units, Commercial 22,162 units, Industrial 5,725 units, Agriculture 70,290 units, and Development Land and Others 18,963 units.

Bar chart showing Malaysia’s property transaction value in 2017 (in millions of Malaysian Ringgit). In 2017, Malaysia property transactions by value were as follows: Residential RM 68,467, Commercial RM 25,439, Industrial RM 11,642, Agriculture RM 13,501, and Development Land and Others RM 20,794.

However, with Malaysia’s residential and commercial property sectors facing oversupply issues, the country’s industrial property sector may offer better prospects; Malaysia’s manufacturing sector is resilient (contributing 23% to GDP in 2017 and accounting for 15% of 2017 FDI inflows) which suggests industrial properties for manufacturing and warehousing could offer investment potential, and the country’s ecommerce market is booming which could open opportunities for industrial real estate in areas such as logistics and warehousing. In particular, larger storage space near ports and airports, and smaller warehouses located close to urban areas could see an uptick in demand, as distributors look to establish fulfillment centers close to their customer base in an effort to shorten parcel delivery times to online shoppers.

An example of this is when real estate private equity and advisory firm Area Management Sdn Bhd announced its plan to set up an inner city distribution hub in Kuala Lumpur. The warehouse which will have 1.2 million sq ft of warehouse space will be located in Hulu Kelang, in the town of Ampang, just about 10 minutes away from KLCC.

Such investments in industrial property could be just the beginning. ASEAN’s e-commerce market is booming, yet with e-commerce accounting for just 2% of the region’s total retail sales, (this is lower than the average worldwide which saw 10.2% of total retail sales coming from online sales in 2017 according to eMarketer). Singapore has the highest e-commerce penetration with 5.4% f total retail sales being made online, followed by Malaysia at 2.7% according to a report by Maybank Kim Eng Research suggesting ample room for growth. Research by Google and Temasek forecasts the region’s e-commerce sales to grow at a CAGR of 32% from US$ 5.5 billion in 2015 to reach US$ 88 billion in 2025, when they will make up 6% of total retail sales in the region. Management consulting firm A.T. Kearney expects Malaysia’s e-commerce market to grow 23% annually until 2021 according to a 2017 report.

Furthermore, as intra-ASEAN trade grows and consumption increases stimulated by rising incomes among ASEAN’s 600 million plus population (larger than that of North America and the European Union), logistics demand in the region is poised to grow. Malaysia’s strategic geographical location, and its strong infrastructure network puts it in prime position to emerge as a logistics hub for the ASEAN region. Malaysia’s infrastructure is second only to Singapore among ASEAN countries according to a report by the World Economic Forum.

Bar chart showing the World Economic Forum's Global Competitiveness Index, 2017-2018 Infrastructure score for selected Southeast Asian nations. Singapore ranks highest with a score of 6.5, followed by Malaysia (5.5), Thailand (4.7), Indonesia (4.5), Brunei (4.3), Vietnam (3.9), Philippines (3.4), Laos (3.3) and Cambodia (3.1)

A number of multinationals looking to capitalize on Southeast Asia’s emerging markets have already spotted Malaysia’s logistics potential. Swedish furniture company IKEA has selected Malaysia to be its ASEAN logistics hub and the company will be investing nearly a billion Malaysian ringgit to establish a regional distribution and supply chain in the country in what would be among its 10 biggest regional distribution centers globally. E-retailer Zalora has invested RM 20 million building a regional e-fulfillment hub in Malaysia and Chinese e-commerce giant Alibaba (NYSE:BABA) has selected Malaysia’s commercial capital Kuala Lumpur as one of the company’s five global hubs with the others being Hangzhou, Dubai, Liege and Moscow. French automaker Groupe PSA has selected Malaysia to be its ASEAN hub and Chinese tech giant Tencent (HKG:0700) has selected Malaysia as its ASEAN data center hub.

West Malaysia – Central Region

Selangor, Malaysia’s most prosperous state and the top contributor to Malaysia’s GDP (accounting for 22.7% of Malaysia’s GDP), dominates Malaysia’s industrial property market, boasting about 35% (or 39,139 units) of Malaysia’s industrial properties. Selangor is followed by southern region state Johor (16,117 units) and northern region state Penang (9,057 units).

Boasting logistics hubs such as Port Klang (Malaysia’s busiest container port), Shah Alam, and the upcoming KLIA Aeropolis, the state of Selangor, Malaysia’s richest state, shows potential to be developed into a regional logistics gateway to the ASEAN region thereby supporting ASEAN international trade. For instance, Swedish furniture retailer IKEA set up a new regional distribution and supply chain center in Pulau Indah Industrial Park in Port Klang, which will serve IKEA stores throughout the ASEAN region.

Port Klang is Malaysia’s busiest port and the world’s 11th busiest port according to the World Shipping Council. Although the formation of a new global shipping alliance, the Ocean Alliance, in April 2017 saw a number of carriers shifting from Malaysian ports to Singapore ports, resulting in a 10% drop in Port Klang’s container throughput, and with the rise of competing ports in the region such as Ho Chi Minh City and Jakarta further eating into Port Klang’s share of transshipment volumes (which account for over 60% of Port Klang’s volume according to data from the Port Klang Authority), Port Klang, ASEAN’s second biggest port, is still expected to remain as a secondary transshipment hub, second only to Singapore.

Thus, the current limited supply and higher prices of industrial land in Port Klang townships such as Pulau Indah is likely to persist. Last year, a land transaction in Pulau Indah topped the list of Malaysia’s highest industrial real estate transactions by value when a 274,413 sqm vacant plot in Pulau Indah Industrial Park sold for RM 112 million according to data from the National Property Information Centre (NAPIC).

With Malaysia’s first Digital Free Trade Zone being set up in KLIA Aeropolis, Port Klang has been identified as a potential location for another new Digital Free Trade Zone, industrial real estate demand in Port Klang as well as the surrounding area could see further increases.

Companies moving in to capitalize on the opportunity include Sime Darby (KLSE:SIME) and Japan’s Mitsui (TYO:8031) which have announced a partnership that would see the development of industrial facilities on 39 acres of land at Bandar Bukit Raja in Klang (about 20 kilometers away from Port Klang) with an estimated gross development value of RM 530 million.

Selangor is among the fastest growing states in Malaysia, with much of that growth driven manufacturing, services and agriculture (this compares with Kuala Lumpur where growth is driven by services).

Bar chart Malaysia’s economic growth by state in 2017. Sabah was Malaysia’s fastest growing state with a growth rate of 8.2%. Sabah was followed by Melaka (8.1%), Pahang (7.8%), Federal Territory of Kuala Lumpur (7.4%), Selangor (7.1%), Johor (6.2%), Labuan (6.1%), Terengganu (5.9%), Perak (5.5%), Penang (5.3%), Kelantan (5.0%), Kedah (5.0%), Negeri Sembilan (4.9%), Sarawak (4.7%), and Perlis (2.3%). Malaysia as a whole registered a GDP growth rate of 5.9% in 2017.

Shah Alam, the state capital of Selangor, is a popular manufacturing hub, located about 20 kilometers away from Malaysia’s biggest container port, Port Klang, 50 kilometers away from Kuala Lumpur International Airport and about 30 kilometers away from Malaysia’s vibrant city center Kuala Lumpur. This makes Shah Alam an attractive location for manufacturing, warehousing and distribution activities, and the city already boasts a number of high profile occupants including German logistics company DHL which maintains a supply chain logistics hub in Shah Alam,

Yet, as Malaysia’s burgeoning e-commerce market continues to grow, Shah Alam could see rising industrial real estate demand as its advantage of being strategically located close to Selangor’s key airport (KLIA), sea port (Port Klang) and being located within Malaysia’s Klang Valley (one of Malaysia’s most advanced retail markets) lure multinationals and e-commerce companies looking to establish warehousing, e-fulfillment and distribution facilities to tap into ASEAN’s growing army of online shoppers.

Suggestive of this potential, Singapore-based property developer Aspen (Group) Holdings Limited (SGX:1F3), has diversified into logistics, having acquired a 71 acre industrial land in Shah Alam which will be developed into an integrated logistics, warehousing and e-commerce hub.

FM Global Logistics (M) Sdn Bhd, a subsidiary of Malaysian freight services provider Freight Management Holdings Bhd (KLSE:FREIGHT) is developing an e-commerce fulfillment hub in Shah Alam.

Axis Real Estate Investment Trust (REIT) has acquired two parcels of industrial land in Shah Alam, for RM87 million.

Meanwhile DRB-HICOM (KLSE:DRBHCOM) has disposed of its non-industrial real estate assets in an effort to focus on industrial property development.

Fashion e-retailer Zalora selected Shah Alam to establish its e-fulfillment hub, fancying the industrial city’s merits of being close to the airport, the seaport and close to Kuala Lumpur where it has a large customer base.

Volvo, the Sweden-based subsidiary of China’s emerging automotive giant Geely (HKG:0175) announced that it is looking at making Shah Alam its export hub to serve the ASEAN market.

Malaysia’s KL International Airport is a 45 minute drive away from Malaysia’s leading container port, Port Klang, a 45 minute flight away from Singapore, a one and a half hour flight away from Bankok, Jakarta and Ho Chi Minh City.

Malaysian airport operator Malaysia Airports Holdings Berhad (KLSE:AIRPORT) is developing an air logistics hub, named KLIA Aeropolis, in a 404.7 hectare site surrounding the Kuala Lumpur International Airport. The airport city project is expected to attract RM 7 billion in foreign and domestic investments.

Having selected Kuala Lumpur to be its global hub along with five other cities, namely Hangzhou, Dubai, Liege and Moscow, Cainiao Network, the logistics arm of Chinese ecommerce giant Alibaba, is constructing the company’s first regional e-fulfillment hub outside China – a new distribution center in KLIA Aeropolis near the KL International Airport, as part of a wider agreement to build a Digital Free Trade Zone (DFTZ) which aims to facilitate SMEs to engage in cross-border trade. The DFTZ is scheduled to begin operations in 2020.

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Vietnam’s Industrial Real Estate Sector Holds Potential For Growth

Pie chart showing 2017 Foreign Direct Investment (FDI) into Vietnam by industry (% share). In 2017, 44.2% of FDI into Vietnam went into the Manufacturing and processing Sector, 23.3% into Power production and distribution, 8.5% into Real estate and 24% into other sectors.

With labor costs rising and regulatory requirements increasing in China (the current Factory of the World), Vietnam is rising as a manufacturing hub and is poised to continue doing soas the country’s advantages of being geographically located close to China and relatively lower production costs entice multinationals as well as Chinese manufacturing companies to relocate production facilities to Vietnam enabling them to serve the enormous and lucrative domestic Chinese market while reducing costs. In 2017, Vietnam’s manufacturing output rose 14.4% and 44% of FDI investment into Vietnam were channeled towards the manufacturing and processing sector according to data from the Vietnam Foreign Investment Agency (FIA).

Pie chart showing 2017 Foreign Direct Investment (FDI) into Vietnam by industry (% share). In 2017, 44.2% of FDI into Vietnam went into the Manufacturing and processing Sector, 23.3% into Power production and distribution, 8.5% into Real estate and 24% into other sectors.

The trend is likely to continue. China’s labor force is dwindling, (the country’s working age population, defined as those between 16-59 fell by 5.5 million last year to 901.99 million according to the National Bureau of Statistics), wages are rising (according to a study by Euromonitor, manufacturing wages in China have risen steadily over the past decade and are now on par with high-income economies such as Portugal and Greece), and changing policies (such as the government’s effort to move to high end manufacturing) have made regulations more stringent and subsidy programs reduced.

However, with China boasting top-notch infrastructure, a large talent pool, and extensive sourcing options among other reasons, the Middle Kingdom still retains its appeal as a manufacturing base for multinational and Chinese manufacturing companies; the trend is not of abandoning China altogether but either of moving production towards China’s interior where wages are lower, or of supplementing Chinese production facilities with outsourced facilities (particularly for labor-intensive, low-end manufacturing operations such as product assembly) from lower-cost countries such as Vietnam, a production model known as China+1.

For China, the world’s largest exporter, exports account for about 19% of the country’s economy. The United States is the single largest export destination of Chinese-made products absorbing about 20% of Chinese exports in 2017, and Asian countries such as Hong Kong, South Korea, Japan, Vietnam and India collectively account for about 45% of China’s exports. Unsurprisingly, the vast majority of China’s factories are strategically located in the coast, in areas such as Shanghai, Shenzhen, Ningbo, Qingdao, Guangzhou, and Tianjin where the majority of China’s key ports are located such as the Port of Shanghai, Port of Shenzhen, Port of Ningbo, Port of Qingdao, Port of Guangzhou and Port of Tianjin which are among the world’s busiest and largest ports. Much of China’s export products are transported via sea through these ports which are the origin points of key shipping routes such as the Pacific route, one of the world’s busiest shipping routes, which goes through the Pacific Ocean.

Thus, relocating to inner provinces may make sense for some manufacturers such as those with substantial domestic sales or for those with major exports to countries such as Central Asia or Europe as goods can be transported via a growing rail system which is part of China’s ambitious “Silk Road” logistics network. Chongqing for instance, an inland Chinese province which is gaining prominence as a hub for railroad shipments across Central Asia and Europe, has lured the likes of Hewlett Packard which shifted production to Chongqing as part of China’s Go West initiative and transports products such as motherboards and laptops to Europe via the China-Duisburg rail line which connects China to Germany. The railway line which originates in China, crosses Kazakhstan, Russia, Belarus and Poland before finally entering Germany, a distance of over 10,000 kilometers taking about 16 days to complete, considerably less than the 3 months or so transport time for container ships. Add in the lower transport cost, and the rail option beings to look very favorable for companies such as HP. Duisburg-China traffic has reportedly quadrupled since the service was established in 2011.

For others however, such as Intel, the Chine+1 production model whereby some production facilities are relocated to another country to supplement existing Chinese manufacturing bases may make more sense. Vietnam’s close proximity to China (port city Hai Phong in northern Vietnam is about 865 km away from Shenzhen, considerably closer than Vientiane which is 1,200km away, Bangkok which is 1,700km away, Jakarta which is 3,300km away, and Kuala Lumpur which is 3,025km away) low wages, relatively young population (the median age is 30), and improving infrastructure (including ports enabling access to Vietnam’s East Seam, one of the major shipping routes in the world), make it an attractive option for manufacturers migrating away from China. According to the World Economic Forum’s latest Global Competitiveness Index, Vietnam ranked 79th out of 137 nations in terms of infrastructure, ahead of Southeast Asian peers Philippines, Laos and Cambodia.

Bar chart showing the World Economic Forum's Global Competitiveness Index, 2017-2018 Infrastructure score for selected Southeast Asian nations. Singapore ranks highest with a score of 6.5, followed by Malaysia (5.5), Thailand (4.7), Indonesia (4.5), Brunei (4.3), Vietnam (3.9), Philippines (3.4), Laos (3.3) and Cambodia (3.1)

This opens an opportunity for Vietnamese industrial real estate in the years to come. Vietnam’s industrial real estate market is at a nascent stage of development, and as Vietnam continues to grow its position as a new industrial powerhouse, the market holds considerably potential to expand as well. In 1986, just 335 hectares of land in Vietnam were dedicated to industrial parks. By 2018, this had grown to 80,000 ha a CAGR of over 18%.

Northern Vietnam in prime position to benefit from China+1 production model

Considered to be the ‘Number 1 option’ for manufacturers looking to move away from China, Northern Vietnam is poised to be among the biggest beneficiaries of the China+1 production model, which should drive demand for industrial property in the area. The China+ 1 model has been noted to be a major reason for Vietnam’s growing presence in global electronics supply chains with manufacturers such as LG, Samsung, and Nokia to name a few, maintaining substantial manufacturing operations in northern Vietnamese provinces such as Haiphong. This explains why manufacturers of computers, electronic and optical products account for the largest occupiers of industrial property in northern Vietnam according to JLL.

Pie chart showing Northern Vietnam industrial property, key occupiers by sector (%). By sector, the biggest occupiers of industrial property in Northern Vietnam were Computer, Electronic and Optical Products 25%, Machinery and Equipment 15%, Fabricated Metal Products except Machinery and Equipment 12%, Rubber and Plastic Products 7%, Chemicals and Chemical Products 6%, Other 35%.

According to CBRE Vietnam, rents in the northern region of Vietnam are expected to increase by 2% in 2018 and 1.5% in 2019 and 2020 while the vacancy rate is expected to drop to 19% in 2020 from 22% in 2018.

The North key economic zon (NKEZ) comprises seven cities/provinces; Hanoi, Hai Phong, Bac Ninh, Hai Duong, Hung Yen, Vinh Phuc, Quang Ninh. Of the seven provinces, Hai Phong and Bac Ninh boast the highest number of industrial parks in the country; according to JLL, as of March 2018, these two provinces accounted for 46% of total industrial land in Northern Vietnam and given their geographically advantageous location of being close to Vietnam’s seaports, these two cities are likely to continue seeing greater supply of industrial land.

Vietnamese city Hai Phong (located in northern Vietnam, 865 km away from China’s manufacturing hub of Shenzhen and about 100km away from Vietnam’s capital Hanoi) is increasingly emerging as a manufacturing and logistics hub with its increasing number of industrial zones (such as the VSIP Hai Phong Industrial Zone, the Nomura-Hai Phong Industrial Zone, and the Trang Due Industrial Zone), growing presence in Vietnam’s port system, and its direct rail line, the Kunming-Hai Phong railway, which connects Vietnam with China, with a transport time of about 9 hours.

Such economic merits have helped the city notch a 14.01% GDP growth rate in 2017, the highest since 1994, and twice the national average of 6.81%. During the first six months of 2018, exports turnover reached US$ 9.3 billion, a 25.34% increase compared to the same period in 2017. With numerous infrastructure developments taking place, from highways and bridges to port expansion projects, the city is actively working to increase grows its appeal as an alternative for manufacturers looking to shift production to Southeast Asia, potentially benefiting Hai Phong’s industrial property market.

Haiphong, already known for its existing port (which however is not a deep water port) is set to further strengthen its position as a rising logistics hub with its new Lach Huyen International Gateway Port (also known as the Hai Phong International Gateway Port) which was opened in May 2018; the new deep water port can handle around 300,000 20-foot equivalent units (TEUs) currently, and capacity is expected to expand going forward enabling the port to handle between 2 million TEUs and 3 million TEUs by 2019. Haiphong’s existing port handled 4.10 million TEUs in 2016 according to data from the World Shipping Council. Coupled with the new port’s capacity, Haiphong will be able to handle about 5 million TEUs, placing Haiphong on the same level as Vietnam’s leading port Ho Chi Minh City in south Vietnam which handled 5.99 million TEUs in 2016 according to data from the World Shipping Council.

Southern Vietnam

With its relatively well-developed infrastructure and favorable investment policies such as tax breaks, industrial property in southern Vietnam (the area surrounding Ho Chi Minh City which includes popular investment provinces such as Binh Duong, Long An and Dong Nai) have long been Vietnam’s industrial growth engine and remain as favored destinations for investors in Vietnam. Companies maintaining manufacturing operations in Southern Vietnam include Samsung, and Intel.

Companies adopting a China+1 production model may find southern Vietnam to be less appealing compared to northern Vietnam, particularly for time-sensitive manufacturing operations that require speedy transport of components between Vietnam and China.

Others however find value the area’s merits such as close proximity to Ho Chi Minh City, which boasts Vietnam’s largest commercial port – the port of Ho Chi Minh City, and Vietnam’s highest-earning consumer base (according to a 2017 report by VietnamWorks, employees in HCMC earn the highest average salaries in Vietnam at about 38% higher than the national average). This explains why a fair proportion of industrial occupiers in Southern Vietnam are in consumer-related businesses such as apparel, textiles and food processing.

Pie chart showing Southern Vietnam industrial property, key occupiers by sector (%) as follows: Machinery and Equipment 15%, Textile and Apparel 11%, Fabricated Metal Products (except Machinery and Equipment) 9%, Rubber and Plastic Products 9%, Chemicals and Chemical Products 8%, Food Processing 7% and Other 41%.

Yet, there is still potential for expansion. Southern Vietnam is general the preferred “launch market” for consumer products companies and as the country’s middle class population expands, demand for warehousing, distribution centers and manufacturing facilities should grow thereby driving industrial property demand. Already enjoying strong occupancy rates (occupancy rates in HCMC, Dong Nai and Bunh Duong Binh Phuoc stood at 77%, 85%, 88% and 85% as of June 2018 according to JLL) strong economic growth and continued growth in manufacturing activity is expected to continue driving industrial property demand with JLL forecasting industrial property in southern Vietnam to enjoy higher occupancy and rental growth over the next few years.

This year, US private equity investment firm Warburg Pincus formed a JV with Vietnam’s state-owned Investment & Industrial Development Corp (known as Becamex IDC, one of the largest industrial real estate developers in Vietnam owned by the government of Binh Duong province in Southern Vietnam) to develop industrial properties in Vietnam. The JV, known as BW Industrial Development JSC, was seeded with eight industrial property development projects across five cities in the North and South of Vietnam, including Binh Duong, Dong Nai, Hai Phong, Hai Duong and Bac Ninh. Warburg Pincus owns 70% of the JV.

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India Hotel Market: Long Term Growth And Opportunity

Bar chart showing India hotel transaction volume (in Indian Rupees millions), 2001-2017. In 2017, hotel transaction volume in India reached Indian Rupees 9,709 million, a four year low.

India’s hotel market is a growth market, and the country’s tourism and hospitality industry which contributed about 9.6% to India’s GDP in 2016, has emerged as a key growth driver of India’s service sector and thereby the Indian economy.

India’s hotel industry as a whole has been going through a relatively rough patch over the past few years with distressed loans from the sector jumping 63% over the past three years as a result of overinvestment, cost overruns, and high interest rates among other reasons, which have restricted capital flow into the industry and reduced hotel real estate transactions in the past few years.

 

Bar chart showing India hotel transaction volume (in Indian Rupees millions), 2001-2017. In 2017, hotel transaction volume in India reached Indian Rupees 9,709 million, a four year low.

However, there are numerous fundamental reasons to be optimistic on the industry’s long term prospects, particularly in the mid-scale and budget segment which have not been affected by the financial woes plaguing the luxury and upscale hotel segment. The Development Cost Per Key declines considerably the lower the hotel class, and coupled with robust demand from India’s growing wave of middle class domestic travelers, India’s mid-scale and budget hotel segments have been doing brisk business, a boon to their bottom lines.

Line chart showing the Average Development Cost Per Key in India (in India Rupees millions) by hotel positioning. The Average Development Cost Per Key in India for hotels in the Luxury, Upper Midscale, Upscale, Upper Mid Market, Mid Market, Budget, and Economy categories are INR 22.3 million, INR 14 million, INR 9.8 million, INR 7.2 million, INR 5.6 million, INR 3.5 million, and INR 1.7 million respectively.

India’s expanding population of middle class travelers have also helped boost Indian hotel occupancy rates which have been on an uptrend over the past few years, rising to 66% in 2017, the highest since 2007-2008, according to a report by hospitality consulting firm Horwath HTL.

Bar chart showing all-India hotel occupancy rates, FY 2013 - FY 2017 (E). Occupancy rates have been rising in India; during FY 2013, FY 2014, FY 2015, FY 2016 and FY 2017 (E) hotel occupancy rates were 58%, 59%, 61%, 64% and 66% respectively.

The momentum is expected to continue. However, with hotel demand exceeding supply (according to data from Hotelivate, Indian hotel demand is growing at around 12% while new supply is growing by up to 6% annually) and with hotel rooms per capita in India standing at just 18 per 100,000 people, considerably lower than China where there are 307 hotel rooms per 100,000 people, there is ample potential for expansion in India’s hotel sector driven by a growing middle class, rising disposable incomes, a growing fleet of low cost airlines and government measures to boost the country’s tourism industry such as the UDAN Regional Connectivity Scheme, and incentives such as the five year tax holiday offered for 2, 3 and 4 star category hotels located around UNESCO World Heritage sites (except Delhi and Mumbai) and the establishment of Special Tourism Zones. Further encouraging measures may be expected in the country’s upcoming Tourism Policy as the Indian government works towards its target of attracting 20 million Foreign Tourist Arrivals by 2020 and thereby addressing the country’s imbalance of outbound tourists being four times more than inbound tourists.

India is expected to be one of the fastest growing tourism economies over the next decade and the country is forecast to emerge as the world’s 3rd biggest tourism economy by 2028 according to a 2018 report by the World Travel and Tourism Council. According to forecasts by CARE Ratings, India’s hotel industry is expected to see an increase of 11-13% CAGR in room revenues during FY2017-FY2021. The Indian hotel market is projected to reach US$ 13 billion by 2020 according to a paper by FICCI-Yes Bank titled ‘Tourism Infrastructure Investments: Leveraging Partnerships for Exponential Growth’.

Unsurprisingly, global hotel operators are increasingly keen on expanding into India to grab a slice of the growing pie. International hotel brands already account for about half of India’s 123,000 branded hotel rooms, a dramatic increase in market share since 2002 when international hotel brands accounted for less than 20% of the 25,000 branded hotel rooms in India. By 2020, international hotel brands are expected to account for about 76% of India’s branded hotel room supply according to Patu Keswani, chairman and managing director, Lemon Tree Hotels.

Land scarcity and high development costs in Delhi and Mumbai are likely to encourage upscale hotel developers to focus on Tier II and Tier III markets

For several years after the global financial crisis in 2008, India’s luxury hotel sector struggled with an oversupply of hotel inventory and poor demand leading to lower occupancy and Revenue Per Available Room (RevPAR).

However, the tide may be turning as signs of a demand recovery and a limited supply pipeline push up occupancy levels, particularly in India’s top two hotel markets, Delhi and Mumbai where occupancy rates reached 75% and 70% respectively during 2016-2017, thanks to increasing business and leisure travellers, and a muted hotel room supply.

During the year ended March 2017, new hotel rooms in Delhi increased by just 1.1% compared to a CAGR of 5.3% over the past decade. The situation is the same in Mumbai where new hotel rooms increased 3.4% in 2016-2017, compared to a 5.3% growth over the past decade.

Bar chart showing the number of hotel rooms in Mumbai and Delhi during 2007-2008 and 2016-2017. During the CY 2007-2008, Mumbai and Delhi had 8,454 and 9,019 rooms respectively. By FY 2016-2017, Mumbai and Delhi had 13,494 and 14,296 hotel rooms, reflecting a CAGR of 5.3% in hotel room growth during the decade.

Yet, while rising demand in India’s top cities of Mumbai and Delhi may lure hotel developers, problems such as land scarcity, and zoning laws among other reasons are likely to continue restricting new hotel room supply going forward. While the difficulties may not hinder the expansion plans of some luxury hotel operators such as Jumeirah (which is planning to launch an upscale business hotel in Mumbai), other hotel operators may go down the acquisition route instead, which could drive up acquisition demand for existing hotel assets in these two cities, as high development costs may compel players looking to ride the tourist boom in Delhi and Mumbai to pay a premium for brownfield and existing hotel assets rather than developing new hotels.

With much of India’s luxury hotel room inventory concentrated in NCR, Mumbai and Bengaluru, developers are also likely to explore untapped opportunities in Tier II and Tier III cities such as Jaipur, Goa and Ahmedabad where occupancy rates and RevPAR have shown strong growth. According to JLL India’s 2017 report, Goa remained India’s most expensive hotel market for the second consecutive year, while Ahmedabad enjoyed the strongest RevPAR of 21% followed by Jaipur at 12.2%.

Marriott, currently India’s largest hotel by room inventory, appears to have spotted the potential; the hotel group has plans to expand its current Indian hotel portfolio of around 120 with the addition of 50 new hotels, which will add another 12,000 rooms to its current tally of more than 22,000 rooms in India. In addition to Tier I cities, the company is looking at opportunities in Tier II cities such as Ahmedabad, Jaipur and Kerala.

Ashmi Holdings, which manages the Bristol Hotel, an upscale business hotel in the business city of Gurgaon, (recently renamed Gurugram), has plans to lunch upscale, midmarket and budget hotels in Tier III and Tier IV cities with a target of 1,000 keys by 2020.

Significant upside potential in the midscale and budget hotel segment

India has welcomed rising numbers of foreign tourists, with Foreign Tourist Arrivals exceeding 10 million last year, and the number is expected to grow in the coming years as the government rolls out favorable measures as part of its effort to double Foreign Tourist Arrivals to 20 million by 2020.

However, the country’s tourism and hospitality sector is largely driven by domestic travelers and domestic hotel demand has historically been higher than inbound demand as domestic travelers account for a larger share of India’s travelers.

During the period 1991-2016, domestic visits to all Indian states grew at a CAGR of 13.03%, far outpacing foreign visits which increased at a CAGR of 8.25% during the same period according to data from India’s Ministry of Tourism driven by rising domestic travel among India’s swelling numbers of travel-hungry middle class citizens – a relatively price-sensitive and value conscious demographic who opt for hotels in the mid-scale and budget categories.

This trend is likely to continue as India’s middle class rise grows and their disposable incomes increase, which should increase their propensity to travel as well as their travel spend which currently accounts for about 88% of the tourism sector’s contribution to India’s GDP.

The opportunity in India’s midrange hotel sector has attracted the likes of companies such as Lemon Tree Hotels (NSE:LEMONTREE) and Royal Orchid Hotels (NSE:ROHLTD) which expanded their midscale offerings, thereby driving up the country’s midscale room inventory over the past several years; in 2002, some 6,000 of the 26,000 branded hotel rooms in India – less than 25% percent – were mid-market hotel rooms. By 2017, mid-market hotel rooms jumped nine-fold to 53,200, accounting for 43% of the total branded hotel rooms in the country which increased five-fold to 125,000 according to data from hospitality consulting firm Horwath HTL.

Apeejay Surendra, plans to expand its ‘Zone by the Park’ midscale hotel brand in Tier II and Tier III towns, positioning the hotel as a price and design conscious offering.

Goldman Sachs-backed hotel investment firm SAMHI Hotels Ltd plans has plans to acquire hotel assets around the country, mostly in Tier I and Tier II cities.

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Opportunities In Philippines’s Multi-Billion Dollar Infrastructure Bonanza

Pie chart showing 2017 FDI inflow into the Philippines, share by industry (%). The largest share of FDI inflows to the Philippines went to the electricity, gas, steam and AC industry (42.4%), followed by Manufacturing (35.2%), Real estate activities (7.6%), Construction (4.9%), and Finance and insurance (4.2%) while the balance 5.6% was taken up by other industries.

President Duterte’s ‘Build, Build, Build’ (BBB) project, an ambitious infrastructure program that will see US$ 180 billion being spent over the next decade towards building much needed roads, dams, bridges, airports, seaports and more in the Philippines is expected to push Philippines’s infrastructure spending from 6.3% of GDP this year to 7.3% by 2022 helping close the infrastructure gap between the Philippines and other countries; in the World Economic Forum’s latest Global Competitiveness Index, the Philippines ranks 97th out of 137 nations in terms of infrastructure ranking, lagging behind most of its Southeast Asian neighbors according to the World Economic Forum’s latest Global Competitiveness Report.

Bar chart showing the World Economic Forum's Global Competitiveness Index, 2017-2018 Infrastructure score for selected Southeast Asian nations. Singapore ranks highest with a score of 6.5, followed by Malaysia (5.5), Thailand (4.7), Indonesia (4.5), Brunei (4.3), Vietnam (3.9), Philippines (3.4), Laos (3.3) and Cambodia (3.1)

The latest World Economic Forum’s Executive Opinion Survey also revealed that inadequate supply of infrastructure is considered to be the second most problematic factor for doing business in the Philippines (inefficient government bureaucracy was rated as the number one problematic factor for doing business).

Philippines’s infrastructure challenge and the government’s ‘Build, Build, Build’ initiative which aims to usher in a “golden age of infrastructure” opens numerous avenues for business and investment for locals as well as foreigners. Business and investment opportunities in Philippines’s ‘Build, Build, Build’ program is attracting foreign investor interest, with the country enjoying record high FDI in 2017 which reached US$ 10.05 billion, a 21% YoY increase. Direct equity investment for local companies which made up 32% total FDI inflows, increased 26% YoY, much of which were channeled towards electricity, gas, steam and air-conditioning supply; construction; manufacturing; and real estate activities.

Pie chart showing 2017 FDI inflow into the Philippines, share by industry (%). The largest share of FDI inflows to the Philippines went to the electricity, gas, steam and AC industry (42.4%), followed by Manufacturing (35.2%), Real estate activities (7.6%), Construction (4.9%), and Finance and insurance (4.2%) while the balance 5.6% was taken up by other industries.

Numerous opportunities exist for local and foreign players in areas such as design engineering, cement and construction equipment, noteworthy opportunities are discussed below.

Cement

At about 212 kilograms per person (as of 2014), Philippines has one of the lowest per capita cement consumption compared to its ASEAN counterparts, and is about half the global average per capita cement consumption. However, that figure is set to improve as President Duterte’s Golden Age of Infrastructure which includes building six airports, 32 roads and bridges and a number of other developments such as bus rapid transits, industrial estates, and seaports drives domestic cement demand which is estimated to exceed 40 million metric tons by 2021, according to estimates from the Philippines’s Department of Trade and Industry. This is about double the quantity of Philippines’s current cement consumption which stood at 25.9 million metric tons in 2016.

This is a growth opportunity for cement firms such as LafargeHolcim, Cemex Holdings Philippines, Republic Cement and Eagle Cement Corporation. These four cement industry players account for about 80% and 82% of total clinker and cement domestic production, respectively.

German industrial giant Thyssenkrupp AG (ETR:TKA) expects its Philippines revenues to rise three-fold as a result of the country’s BBB initiative with much of that being driven by cement.

Cement producers are actively building capacity to capture a share of the country’s anticipated increase in cement demand. As of December 2016, the Philippine cement industry has an estimated annual clinker and cement capacity of 20.6 and 28.63 million tons, respectively, according to the 2017 Cement Market Report. The Philippine cement industry is estimated to need over 10 million tons of additional cement capacity to meet domestic cement demand until 2025. Unless local cement manufacturers increase capacity, the Philippines will have to fill the deficit through imports.

Construction equipment

According to BMI Research, Philippines’s construction industry is forecast to expand at an average real rate of 9.8% between 2017 and 2026, and the firm expects Philippines to be one of the fastest growing construction markets in Asia, which is expected to create heavy demand for construction equipment such as cranes, excavators and other heavy machinery, an opportunity companies such as Korean automotive firm Hyundai, Swedish auto firm Volvo, American heavy machinery giant Caterpillar (NYSE:CAT) among others are aiming to capitalize on.

Hyundai Heavy Machineries dominates Philippines’s excavator market and is expanding capacity to participate in the government’s BBB program.

Volvo Construction Equipment, the second largest player in Philippines’s excavators market according to a 2016 report by Ken Research is aiming to supply construction equipment as well as trucks, and buses to help with the program.

American heavy machinery giant Caterpillar is bullish on heavy machinery opportunities from the BBB initiative such as supplying excavators.

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High-Flying Growth Prospects In India’s Domestic Travel Market

Bar chart showing domestic and foreign visits to Indian states, 2006-2016 (in millions of visits). Domestic visits to Indian states grew from 462.4 million in 2006 to 1,613.6 million in 2016 while foreign visits grew from 11.7 million in 2006 to 24.7 million in 2016.

Tourism is booming in India, and the industry is emerging as a key growth driver in India’s service sector. Much of the growth stems from India’s domestic tourism sector which has seen a steady increase in visits from domestic travelers over the past decade; domestic tourist visits (DTVs)  increased 12.7% to 1.613 billion in FY 2016, (the latest year for which data is available) according to statistics from India’s Ministry of Tourism.

Domestic tourist visits have consistently registered positive growth rates over the past decade; during 2006-2016 domestic tourist visits grew at double digit rates every year except in years 2008 and 2013 when growth was at single digits. This compares with foreign tourist visits which mostly saw single-digit growth and sometimes zero or negative growth. In 2012 for instance, foreign tourist visits registered negative 6% growth while domestic tourist visits jumped 20%.

The rise of India’s domestic visitor numbers has been a long term trend; during the period 1991-2016, domestic visits to all Indian states grew at a CAGR of 13.03%, far outpacing foreign visits which grew at a CAGR of 8.25% during the same period according to data from India’s Ministry of Tourism.

Bar chart showing domestic and foreign visits to Indian states, 2006-2016 (in millions of visits). Domestic visits to Indian states grew from 462.4 million in 2006 to 1,613.6 million in 2016 while foreign visits grew from 11.7 million in 2006 to 24.7 million in 2016.

Domestic travelers also account for the lion’s share of tourism earnings; India’s tourism industry contributes about 7% to India’s GDP, and domestic travelers accounted for 88% of the sector’s contribution to GDP in 2016.

India’s rising numbers of domestic tourists have largely been driven by an expanding middle class with rapidly increasing purchasing power (currently estimated at 250 million Indians and counting), infrastructure development, a growing fleet of low cost airlines, and initiatives such as the UDAN Regional Connectivity Scheme.

Yet, there is considerable potential for further growth as a result of demographic, regulatory and economic factors. The number of middle class Indians is small compared to China and their purchasing power is considerably lower than their Chinese counterparts. However, India continues to be the fastest growing major economy in the world and this is likely to remain so in the foreseeable future; the International Monetary Fund (IMF) predicts India’s Gross domestic Product (GDP) will grow at an average of more than 8% every year over the next five years and this should drive income growth. According to Global Insight Inc, some 150 million additional Indian households are due to achieve real PPP incomes of more than US$ 20,000 by 2026, almost triple the amount in 2016 and according to Steelcase Growth Market Research, India’s middle class population is expected to grow to around 475 million people by 2030.

India’s expanding middle class citizens are expected to drive India’s consumption expenditures to reach US$ 4 trillion by 2025, helping India emerge as the world’s third biggest consumer market by 2025 according to consultancy firm Boston Consulting Group.

India’s domestic tourism sector is also benefiting from an encouraging regulatory environment; the Indian government is planning to turbocharge the tourism sector with tax cuts, incentives, infrastructure development and more. The Union Budget 2018 focuses on expansion of airport infrastructure (a key constraint limiting air traffic growth in the country) and there are expectations of a reduction in hotel tariffs and tax exemptions on investments in new hotels.

Thus, with several growth drivers in place from favorable demographics to a supportive policy environment, India’s domestic tourism sector is poised for greater expansion in the future. Domestic tourism is expected to maintain its dominance in India’s tourism industry through 2021. A report by Google India and Boston Consulting Group projects India’s domestic travel market to grow at a five-year CAGR of 11.2% to US$ 48 billion by 2020 from US$ 27 billion in 2015 opening numerous opportunities for businesses and investors.

 

Airlines

India’s domestic air traffic crossed the 100 million mark for the first time with 117 million passengers flying in 2017, up 18% from 99.88 million passengers in 2016 according to data from India’s Directorate General of Civil Aviation (DGCA) making India the world’s fastest growing domestic aviation market for the third consecutive year according to IATA. India was followed by China and Russia where domestic air passenger numbers increased 13.3% and 10.1% respectively in 2017.

Bar chart showing India’s domestic air traffic, 2013-2017 (in millions of passengers). India’s domestic air traffic grew from 61,426 million passengers in 2013 to 117,176 passengers in 2017, representing a CAGR of 17.5% between 2013 and 2017.

The boom in domestic air travel was a boon to local airlines such as Indigo (NSE:INDIGO), Jet Airways (NSE:JETAIRWAYS), Spice Jet (BOM:500285) and Vistara (a joint venture between Tata Group and Singapore Airlines) which enjoyed higher passenger load factors.

In 2017, market leader Indigo commanded a market share of 39.6%, Jet Airways had 17.8%, Air India 13.3%, Spice Jet 13.2%, Go Air 8.5%, Air Asia 3.7%, and Vistara 3.5%.

Yet the growth potential is still enormous; less than 10% of Indians take to flying and at around 0.08 annual domestic seats per capita, India’s penetration rate is relatively low compared to other developing markets such as Brazil (0.6) and China (0.4) according to data from flight information and data company OAG. By comparison, the United States has around 2.8 annual domestic seats per capita.

Rising incomes particularly among India’s tech-savvy millennial generation (those born between 1981 and 1996) which have a greater affinity to travel could propel India’s domestic aviation sector in the years to come. India has about 400 million millenials which account for about a third of the country’s one billion plus population and India is expected to be the youngest nation in the world by 2020 with a median age of 29. A survey by Phocuswright and ixigo revealed that Indian millenials take more trips per year compared to seniors and they also spend more.

The Indian government is also taking encouraging measures to boost efficiency and reduce flying costs. For instance, India is mulling the prospect of breaking the monopoly held by public sector oil companies in the supply of Aviation Turbine Fuel (ATF) at the Mumbai airport by allowing private refiners to enter the market, thereby improving operating costs and increasing efficiency. Mumbai airport, India’s busiest airport, accounts for about 20% of India’s ATF consumption. With ATF costs making up about 40% of the operating costs of airlines, the move could be a boon for India’s aviation industry, benefiting airlines as well as private refiners such as Reliance Industries (NSE:RELIANCE).

The International Air Transport Association expects India to overtake the United Kingdom to emerge as the third largest aviation market by 2025 (China will be the biggest market followed by the United States).

Morgan Stanley forecasts India to witness a CAGR of 13% in domestic air traffic during 2016-2026.

According to a report by Google India and Boston Consulting Group, air travel is expected to be the biggest contributor to the India’s travel market, registering a CAGR of 15% reaching a market value of US$ 30 billion by 2020, making up over 50% of the projected value of India’s domestic travel market which is forecast to reach US$ 48 billion by 2020.

Hotels

Overinvestment, cost overruns and high interest rates have hampered the financial performance of India’s hotel industry with stressed loans jumping 63% over the past three years.

Much of the industry’s woes appear to be concentrated on branded, full-service hotels in the luxury and upscale segment in Tier I and Tier II cities.

On the other hand, India’s mid-market hotel segment (i.e., two, three and four star hotels) is booming, driven by both domestic and overseas tourists, encouraging brands such as Lemon Tree Hotels (NSE:LEMONTREE), and Royal Orchid Hotels (NSE:ROHLTD) to expand into the sector pushing up the supply of mid-market hotel rooms over the past several years; in 2002, some 6,000 of the 26,000 branded hotel rooms in India – less than 25% percent – were mid-market hotel rooms. By 2017, mid-market hotel rooms jumped nine-fold to 53,200, accounting for 43% of the total branded hotel rooms in the country which increased five-fold to 125,000 according to data from hospitality consulting firm Horwath HTL.

However, there are signs of recovery in India’s hotel industry with occupancy rates rising to 66% in 2017 – the highest in nine years according to a report by Horwath HTL – and average room rates growing by 8% since 2008 according to hotel consultant firm Hotelivate.

Bar chart showing all-India hotel occupancy rates, FY 2013 - FY 2017 (E). Occupancy rates have been rising in India; during FY 2013, FY 2014, FY 2015, FY 2016 and FY 2017 (E) hotel occupancy rates were 58%, 59%, 61%, 64% and 66% respectively.

The momentum is expected to continue going forward driven by a muted hotel room supply pipeline, an increasingly travel-hungry Indian middle class population, and favorable policies such as the Indian government’s UDAN scheme Phase-II which is expected to open new opportunities benefiting domestic mid-tier hotels in particular. Horwath HTL anticipates all-India occupancy rates to be more than 70% next year and mid-market segment occupancy rates will hit 82%.

The annual average leisure hotel spend per household is expected to grow 7% to US$ 18 by 2020 compared with US$ 13 in 2015.

A report by Google India and Boston Consulting Group expects hotels to grow at CAGR of 13% to US$ 13 billion by 2020, making up slightly more than a quarter of the overall domestic travel industry which is expected to be valued at US$ 48 billion. Much of the demand will be fueled by domestic travelers who are expected to account for over 60% of hotel spend in India. The mid-scale segment is expected to retain its dominant share, accounting for about 44% of India’s branded hotel rooms in 2020.

Bar chart showing India hotel spend by domestic and foreign tourists in 2010, 2015 and 2020 (forecast) (in US$ billions). India’s hotel market was valued at US$ 4 billion in 2010, US$ 7 billion in 2015 and is expected to grow to US$ 13 billion by 2020. At about US$ 9 billion - US$ 10 billion, domestic travelers will account for more than 60% of hotel spend in India by 2020.

Online travel portals

According to consulting firm Praxis, India’s online travel market was valued at US$ 5.71 billion at the end of 2015, and is expected to more than double to US$ 13.6 billion by 2021, representing a CAGR of over about 16% driven by increasing penetration of international hotel and flight bookings from travel portals such as MakeMyTrip (NASDAQ:MMYT) (India’s largest online travel agency), Yatra (NASDAQ:YTRA), and Cleartrip to name a few.

Increasing internet penetration and rising incomes among India’s tech savvy millenials as they increasingly climb up the income ladder are some of the tailwinds that are expected to drive India’s online hotel market. The country’s internet user base stood at 481 million in December 2017, up 11.34% from a year earlier, representing an internet penetration rate of less than 40% indicating ample potential for growth. Much of India’s offline population resides in rural India. However, even in urban India where incomes are higher and residents generally have a higher propensity to travel, there is potential for higher internet penetration; about 295 million (equal to about 64%) of India’s 455 million urban population are connected to the internet leaving a potential market of about 160 million internet users in urban India alone. This is equal to nearly one half of the entire population of the United States.

Indian millenials are expected to be a key driving force in India’s online travel market going forward. According to booking data from India’s largest online travel company MakeMyTrip which is often touted as India’s answer to Ctrip  (NASDAQ:CTRP) and Expedia (NASDAQ:EXPE), the majority of the platform’s customers were millenials; over half of travelers who made bookings through MakemyTrip were under 35 years of age.

India has the world’s largest millenial population and as their disposable incomes grow, they are likely to travel more and thereby drive the country’s online travel market as they plan their itineraries online, presenting a major growth opportunity for online travel companies.

Online hotel bookings in particular presents a major growth opportunity in India’s online travel market. According to a report by Morgan Stanley, Indian millenials have shifted a large part of their activities online, for instance through the adoption of digital entertainment channels (to the detriment of traditional channels such as radio) and online shopping. However, online travel booking is an exception to the trend with 63% of all hotel bookings being reportedly made by walking into hotels. Less than 20% of hotels were booked online, and only one third of those were booked using travel agencies indicating tremendous potential for growth.

One third of all hotels are expected to be booked online helping the sector grow at a CAGR of 25% to be worth US$ 4 billion by 2020 according to a report by BCG and Google India.

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Healthy Opportunities In China’s Blossoming Healthcare Market

Bar chart showing the top 10 countries by health expenditure per capita and China’s health expenditure per capita (in US dollars), 2000, 2005, 2015 according to data from the World Health Organization. The top countries by per capita health spend as at 2015 are: Switzerland (US$ 9,818), U.S.A. (US$ 9,536), Norway (US$ 7,464), Luxembourg (US$ 6,236), Sweden (US$ 5,600), Denmark (US$ 5,497), Australia (US$ 4,934), Ireland (US$ 4,757), Netherlands (US$ 4,746), and Germany (US$ 4,592). By comparison, China’s per capita health expenditure in 2015 amounted to just US$ 426.

China, the world’s second largest healthcare market in the world after the United States, is growing rapidly driven by an ageing population, government support,  and rising urbanization (which is contributing to an increase in lifestyle diseases such as diabetes and cancer.

China is currently the fastest growing major healthcare market in the world with a five-year compound annual growth rate (CAGR) of 17% compared with just 4% for the United States and -2% in Japan according to 2015 information from the World Bank. Healthcare spending in China has risen four-fold from about CNY 1 trillion (US$ 126 billion) in 2006 to CNY 4.6 trillion in 2016 (US$ 698 billion).

Yet, the Chinese healthcare market is still relatively immature compared to developed economies such as the United States and Germany. China holds nearly 20% of the world’s population but the country accounts for just about 3% of the world’s healthcare spend.

As a percentage of GDP, China’s healthcare expenditure is about 5.6% of the country’s GDP compared with 17.1% for the United States, 11.3% for Germany and 10.3% for Japan according to 2013 data from the World Health Organization.

Furthermore, despite being the world’s second biggest healthcare market, China’s per capita healthcare spending is only a fraction of mature markets such as the United States, Luxembourg and Germany. China does not even make it to the list of the world’s top 10 countries with the highest per capita health expenditure indicating huge potential for spending increases.

Bar chart showing the top 10 countries by health expenditure per capita and China’s health expenditure per capita (in US dollars), 2000, 2005, 2015 according to data from the World Health Organization. The top countries by per capita health spend as at 2015 are: Switzerland (US$ 9,818), U.S.A. (US$ 9,536), Norway (US$ 7,464), Luxembourg (US$ 6,236), Sweden (US$ 5,600), Denmark (US$ 5,497), Australia (US$ 4,934), Ireland (US$ 4,757), Netherlands (US$ 4,746), and Germany (US$ 4,592). By comparison, China’s per capita health expenditure in 2015 amounted to just US$ 426.

China’s healthcare market is expected to continue its rapid growth in the years to come propelled by growth drivers such as an greying population, increasing lifestyle diseases as a result of increasing urbanization and government support.

China’s population is ageing with the country’s over-65 year olds accounting for 11.4% of the total population in 2017, up from 10.8% in 2016 and less than 8% in 2000 according to data from the statistics bureau. That equates to over 150 million Chinese over the age of 65 which is slightly less than half of the entire population of the United States. This number is expected to grow with the State Council expecting 25% of China’s population to be aged 60 and over by 2030, up from 13% in 2010 which is expected to drive healthcare costs going forward.

China’s urbanization rate has been on the rise and it currently stands at 59% according to the National Statistics Bureau. This compares with the United States which is at 82%, the United Kingdom which is at 83% and South Korea which is at 83%. China’s increasing urbanization has contributed to a greater incidence of lifestyle diseases such as diabetes and cancer. China has the most number of obese children in the world and has the world’s second -biggest population of obese adults after the United States according to the Global Burden of Disease report by a team at the University of Washington.

The urbanization process is continuing in China and thus as Chinese get increasingly wealthier and urbanized which leads to unhealthy diets and sedentary lives, the country’s lifestyle disease burden is expected to increase thereby driving China’s healthcare market.

Recognizing the need for a robust healthcare industry to meet the country’s increasing healthcare needs, the Chinese government has undertaken a series of reforms and supportive government policies such as the blueprint “Healthy China 2030” which aims to improve the level of health throughout the country by improving health services, expanding the medical industry and encouraging private investment in the local healthcare sector.

By 2030, the National Health and Family Planning Commission (NHFPC) estimates China’s health-related industries will reach CNY 16 trillion (approximately US$ 2.4 trillion).

These factors are expected to drive China’s healthcare industry going forward. According to a 2017 report by Research ad Markets, China’s healthcare market is poised to expand from around US$ 710 billion in 2016 to over US$ 1.11 trillion in 2020 creating numerous opportunities.

 

Pharmaceuticals

Pharmaceuticals is the largest sector of China’s healthcare market and China’s pharmaceuticals industry has been growing rapidly; the Chinese pharmaceutical market grew at a CAGR of 9.4% from 2013 to 2017 helping China overtake Japan to emerge as the world’s second largest pharmaceutical in the world after the United States.

Bar chart showing the world’s top 10 pharmaceutical markets in 2016 by market value (US$ billion). The top 10 markets are U.S.A. (US$ 461.7 billion), China (US$ 116.7 billion), Japan (US$ 90.1 billion), Germany (US$ 43.1 billion), France (US$32.1 billion), Italy (US$ 28.8 billion), U.K. (US$ 27 billion), Brazil (US$ 26.9 billion), Spain (US$ 20.7 billion), and Canada (US$19.3 billion).

 

Yet, China’s pharmaceutical market lags far behind the United States in sales; despite having a population that is three times the size of the United States, at US$ 122.6 billion in 2017, China’s pharmaceutical market was worth less than a quarter of the United States’ which was valued at US$ 466.6 billion the same year according to data from health information vendor IQVIA. However, with drug demand expected to grow due to factors such as a greater incidence of lifestyle diseases and faster drug approvals, IQVIA forecasts China’s pharmaceutical market to expand from US$ 122.6 billion in 2017 to reach US$ 145 billion to US$ 175 billion by 2022.

In 2017, China announced new rules aimed at speeding up the country’s inefficient drug approval process, which could be a revenue boost for pharmaceutical companies.

Foreign pharmaceutical companies in particular stand to benefit as the new rules allow foreign drug makers to file for drug approval in China using data from international, multinational trials (provided China is included as a study site) which enables them to gain greater inroads into the Chinese market and eliminates the necessity of conducting additional costly and often time-consuming clinical trials in China after receiving approval overseas.

Swiss pharmaceutical giant Novartis AG (VTX: NOVN) aims to double China sales over the next five years.

AstraZeneca (LON:AZN) has deepened its substantial China business with the announcement of a new company Dizal Pharmaceutical, which is a drug development joint venture with the Chinese Future Industry Investment Fund (FIIF).

French pharma giant Sanofi (EPA:SAN), one of the leading insulin providers in the world and in China, expects to maintain double-digit sales growth in China thanks to China’s growing diabetes population. One third of the world’s approximately 420 million diabetic population live in China which amounts to over 100 million diabetic Chinese, accounting for about 11% of Chinese adults as of 2015 up from less than 1% in 1980, a dramatic increase over the past 35 years. China’s growing insulin demand has been a boon to Sanofi’s rival insulin makers as well, Novo Nordisk (CPH:NOVO-B) and Eli Lilly (NYSE:LLY).

Local drug makers also stand to benefit from accelerated drug approvals.

Hutchison MediPharma, a subsidiary of Hutchison Meditech (LON:HCM) is expected to receive approval this year for its fruquintinib capsule for colorectal cancer, the second-most common prevalent cancer in China with about 380,000 new cases annually according to the National Central Cancer Registry of China. The market potential for cancer drugs in China is substantial with cancer rates rising nationwide as a result of aging, and environmental factors among other reasons. With China seeing approximately 700,000 new cancer cases annually, the country has one-third of new cancer patients in the world.

While China is the world’s biggest producer of APIs, the country lags behind the U.S. and other developed markets in drug innovation, and most innovative drugs are produced by foreign pharmaceutical companies. To help its pharmaceutical industry move up the global value chain, the Chinese government has been actively creating a supportive regulatory framework to galvanize homegrown pharmaceutical companies through grants and tax breaks for research, and through initiatives such as the ‘Made in China 2025’ plan which mentions innovation in pharmaceuticals, among 10 other key sectors, a national priority.

With the results of such initiatives likely to bear fruit in the long term, in the shorter term Chinese pharmaceutical companies’ expansion efforts are likely to remain focused on capturing market share in the global generic drugs market. China’s drugs market is dominated by generics, accounting for 85% of total drug sales as of 2016 according to data from Fitch, and over 95% of the 170,000 drug approvals by the China FDA according to data from the National Health Commission. China’s generics market is dominated by a large number of low-cost domestic pharmaceutical companies, and these Chinese pharmaceutical companies are now venturing out to overseas markets. In the United States, the world’s largest generics market, Chinese generic drug manufacturers have reportedly won approval for 38 generic drugs from the U.S. Food & Drug Administration in 2017, up from 22 in 2016. Jiangsu Hengrui (SHA;600276), Zhejiang Huahai Pharmaceutical (SHA:600521), Zhejiang Hisun Pharmaceutical (SHA:600267) are among the Chinese pharmas that received U.S. FDA approval.

Meanwhile the world’s largest exporter of generic drugs, India, (which won U.S. FDA approval for 300 drugs, roughly one third of the 927 generic drugs granted U.S. FDA approval in 2016)  has seen its imports of Chinese generic drugs soar 50% in dollar terms over the past four years (2012/2013 – 2016/2017) according to data from the Pharmaceuticals Export Promotion Council (Pharmexcil).

 

Medical devices

One of China’s fastest growing sectors, the Chinese medical device industry has grown in leaps and bounds, with the industry maintaining double digit growth for over a decade. According to data from China Medical Pharmaceutical Material Association, China’s medical device market expanded from CNY 53.5 billion in 2007 to CNY 370 billion in 2016, representing a CAGR of 23.97%, which is three times faster than the global average growth rate of 8%.

Bar chart showing China’s medical device market size (US$ billions) in 2014, 2015, 2016 and 2017 (estimate). China’s medical device industry has been growing at double digits over the past few years with the market valued at US$ 39.32 billion in 2014, US$ 47.38 billion in 2015, US$ 53.62 billion in 2016 and an estimated US$ 58.63 billion in 2017.

The stellar growth has helped boost sales of multinational medical device manufacturers such as Siemens (ETR:SIE), J&J (NYSE:JNJ), Philips, and General Electric (NYSE:GE).

Yet the Chinese medical device market is still at a relatively immature stage considering the fact that globally, the medical device market is about 42% the size of the pharmaceutical market but in China however, the percentage is considerably lower at about 14%, indicating an attractive growth opportunity for medical device manufacturers.

China is Johnson & Johnson’s second largest market after the United States and the company expects China to remain as a key growth engine in the years to come.

Carlyle Group (NASDAQ:CG) owned American in-vitro diagnostics company, Ortho Clinical Diagnostics plans to build manufacturing facilities in China, as it banks on the mainland to be its “No. 1 growth country”. China’s in-vitro diagnostics (IVD) market is expected to grow at a CAGR of over 14% by 2021 according to research firm Technavio, which could be a boon for Swiss healthcare giant Roche Holdings (VTX:ROG), which is the dominant player in China’s IVD market.

But much like China’s pharmaceutical industry, foreign-made medical device brands are perceived to be of superior quality compared to those produced by domestic manufacturers. Consequently, while Chinese medical device manufacturers dominate the local market in general, the vast majority of them compete in the low to mid-range medical device product categories (according to figures from the International Trade Administration, more than 80% of Chinese medical device manufacturers compete in the low to mid-end medical device categories).

Meanwhile foreign medical device manufacturers such as those from the United States, Germany and Japan tend to dominate the higher-end, high-value medical device product category; medical device brands from the United States, which is the number one foreign supplier of medical devices in China, rake in nearly 75% of their local revenue from China’s top tier i.e., Tier III hospitals with the rest from Tier II hospitals according to figures from the International Trade Administration.

In an effort to help local medical device manufacturers play a greater role in the higher-end medical device segment, the Chinese government unveiled its ‘Made in China 2025’ plan which focuses on domestic high-end medical devices in sectors such as diagnostic imaging, medical robots, wearable devices and telemedicine.

Under the plan, China hopes to increase the use of domestically produced medical devices in hospitals to 50% by 2020 and 75% by 2025. The move could further accelerate the rise of local device manufacturers which have been growing faster than multinationals, (albeit from a smaller revenue base), and as a result of continuous product improvement, they have been increasingly taking market share from foreign rivals in medium-level segments of the country’s medical device sector.

For instance, multinationals’ share of China’s orthopedic implant market has dropped from 80% to less than 50% over the past five years, multinationals’ share of China’s drug-eluting stents market (which stood at about 90% as recently as 2004), has declined considerably with local manufacturers such as Biosensors International, Lepu Medical, and MicroPort selling about 80% of China’s drug-eluting stents and multinationals’ share of China’s direct radiography market has dropped from 100% in 2004 to about 50% currently according to data from Boston Consulting Group.

Buoyed by their growing financial, technological and R&D capabilities and supportive government initiatives, Chinese medical device manufacturers appear poised to take further market share in more of China’s medical device sectors in the long term.

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China’s $150 Billion AI Ambition Opens New Growth Opportunities

Line and bar chart showing facial technology investment value and deal volume (including grants) in China 2013-2017. Disclosed funding in facial recognition in China grew from US$ 2 million in 2013 to US$ 41 million in 2017 while the number of deals increased from 3 in 2013 to 41 in 2017.

China is aiming be the world’s leading player in artificial intelligence (人工智能) by 2030 and by some measures, the country appears to be on track.

According to a report by CB Insights, Chinese companies seem to be overtaking their US counterparts in AI-related patent applications; the number of patents published in China containing the words “artificial intelligence” and “deep learning” have grown rapidly over the past few years, and the middle Kingdom finished 2017 with six times more patent publications containing those words than the United States in 2017.

Line graph showing the number of AI related patent publications published in China and the United States, 2013-2017.

While the United States continues to lead in terms of the number of AI startups and equity deal volume, it has seen its share of global AI equity deal volume shrink from 77% in 2013 to 50% in 2017. By comparison, China accounts for a mere 9% share of the world’s AI equity deal volume.

Bar chart showing global AI equity deal share (US vs Non-US deal share), 2013-2017.

However, in terms of global AI funding value, China is the dominant player accounting for 48% of global equity funding in 2017 representing a major increase from the 10% share China held in 2016 and surpassing the United States for the first time. By comparison, the United States accounted for 38% while the rest of the world accounted for the balance 13% of global AI funding value in 2017.

The numbers are likely to be just the beginning for China’s AI industry expansion which, driven by government funding, an encouraging regulatory environment, and the natural advantage of having the world’s largest population yielding unrivaled quantities of data (AI systems need to be “trained” with real-world data and the more data fed into a system, the more accurate it is) positions China as a hotbed of AI opportunities for investors and entrepreneurs.

The Chinese government has set forth a plan for the Development of a New Generation of Artificial Intelligence Industry, which runs in three stages during which the country’s AI capabilities will be steadily developed through 2020 and 2025 and conclude in 2030 when the government aims China will be the leading player in artificial intelligence.

Towards this end, the Ministry of Industry and Information Technology (MIIT) unveiled the first stage of the plan in December 2017, a detailed Three-Year Action Plan (2018-2020) which supports the local AI sector as a strategic area by developing AI-related technologies, bolstering AI talent and investing in AI research through various initiatives, incentives, grants, and funding commitments. The plan focuses on the development of some key AI areas namely,

  1. Intelligent Networked Vehicles (智能网联汽车)
  2. Intelligent Service Robots (智能服务机器人)
  3. Intelligent Drones (智能无人机)
  4. Medical Imaging Diagnostic Systems (医疗影像辅助诊断系统)
  5. Video Image Recognition (视频图像识别)
  6. Intelligent Voice Systems (智能语音)
  7. Intelligent Translation Systems (智能翻译)

 

This creates tremendous business opportunities. By 2030, the Chinese government expects China’s AI sector to blossom into a CNY 1 trillion (US$ 150 billion) industry which could stimulate as much as CNY 10 trillion in related businesses.

The opportunity has attracted local and foreign tech giants eager to profit from China’s burgeoning AI industry. Google (NASDAQ:GOOGL) for instance has opened an AI research facility, Google AI China Center, in Beijing to hire China’s top talent in artificial intelligence while homegrown tech giants such as Alibaba (NYSE:BABA), Baidu (NASDAQ:BIDU), Tencent (HKG:0700), Xiaomi, Huawei and JD.com (NASDAQ:JD) are making hefty investments in AI technologies.

 

Artificial Intelligence chips

AI systems depend on powerful AI chips to run and while numerous Chinese tech giants such as Alibaba, Baidu and Tencent are actively deploying AI technologies to improve their core offerings, much of the AI chips that power their systems are made by foreign suppliers such as Nvidia (NASDAQ:NVDA) and Intel (NASDAQ:INTC).

Although China is the world’s largest semiconductor market, accounting for about 45% of the world’s demand for chips (also known as integrated circuits), much of the country’s demand for chips is met through imports which account for about 90% of China’s total consumption of integrated circuits.

AI chips make up the basic infrastructure of AI systems and having a greater presence in the supply of such strategic components could potentially facilitate the Chinese government to achieve its goal of becoming an AI powerhouse.

Furthermore, as the global AI industry expands at a rapid clip, the global AI chips market is expected to witness extraordinary growth as well. According to research from ResearchAndMarkets, the AI chipset market is poised to expand from US$ 7.06 billion in 2018 to US$ 59.26 billion by 2025, representing a CAGR of 35.5% during 2018-2025.

Globally, chip startups have raised more than US$ 1.5 billion from in venture capital funding last year, nearly double the amount the year before according to CB Insights.

The Chinese government appears intent on capturing some of that profit potential too; in its Three Year Action Plan (2018-2020), the Chinese government aims to mass-produce neural network processing chips by 2020. China’s previous attempts to build the local semiconductor sector (from as way back as the 1990s) had mixed results partly due to the fact that government incentives and funds were concentrated on research and academia than on business.

This time however, Chinese AI chip businesses seeing greater government support, putting them in good position to participate in the growing global AI chip market.

Within 18 months of its founding by scientists at the Chinese Academy of Sciences (CAS), Chinese AI chip developer Cambricon Technologies raised US$ 100 million in Series A funding making it China’s first AI unicorn. Led by SDIC Chuangye Investment Management which is a subsidiary of China’s State Development and Investment Corporation, the funding round attracted prominent investors including e-commerce giant Alibaba Group, computer manufacturer Lenovo (HKG:0992), robotics company Zhongke Tuling Century Beijing Technology and the investment arm of the Chinese Academy of Sciences (CAS).

Scientists and engineers from Beijing’s Tsinghua University (which is known as China’s ‘MIT’) have developed “Thinker” a multi-purpose AI chip that can support any neural network and is extremely energy efficient. Beijing-based chip manufacturer Tsinghua Unigroup, a subsidiary of Tsinghua Holdings which is owned by Tsinghua University received up to US$ 22 billion in state financing in early 2017.

Chinese e-commerce goliath Alibaba is also reportedly developing its own chips, joining global tech giants such as Google, Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB) which are already working building their own AI chips. Called the Ali-NPU, Alibaba’s AI chips will be made available for anyone to use through its Alibaba Cloud service.

 

Facial recognition

 Over the past few years, China’s facial recognition market has seen a rapid growth in investment in terms of deal value and volume.

Line and bar chart showing facial technology investment value and deal volume (including grants) in China 2013-2017. Disclosed funding in facial recognition in China grew from US$ 2 million in 2013 to US$ 41 million in 2017 while the number of deals increased from 3 in 2013 to 41 in 2017.

According to CB Insights, of all countries in the world, China appears to be making the greatest use of facial recognition software with the technology being widely used throughout the country from supermarkets, airports, streets, office buildings, apartments, hotels, bank counters and ATMs.

The business opportunity has given birth to a number of Chinese facial recognition startups such as Alibaba-backed AI unicorn SenseTime (the most valuable AI startup in the world as if April 2018), Megvii (which develops Face++, one of China’s most common facial recognition platforms used for applications such as to manage entry in places such as Beijing’s train stations and Alibaba’s office building, and to enable Alipay customers to authenticate payment), CloudWalk Technology (a facial recognition software developer whose clients include the Zimbabwean government and Bank of China), DeepGlint, Zoloz and Yitu Technology (which counts the Malaysian Police as a client).

Chinese police are already using facial recognition sunglasses to track its citizens and the Chinese government is reportedly aiming to build a national database that will recognize any of the 1.3 billion citizens in China (the world’s most populous country) in three seconds. Already, more than 4,000 people have been arrested by Chinese authorities, helped by facial recognition technology.

Alipay, China’s most popular mobile payment app owned Alibaba affiliate Ant Financial has rolled out the world’s first payment system that uses facial recognition to enable customers to authenticate payments using just their face and a second authentication using their mobile phones.

In spite of China seeing rapid advancements in facial recognition, there is still considerable potential for the industry to grow driven by the growth of intelligent vehicles in China.

 

Intelligent vehicles

While autonomous cars are gathering momentum worldwide, China, the world’s largest car market is speeding towards intelligent vehicles with the country’s top economic planning agency, the National Development and Reform Commission naming intelligent vehicles as a national priority in a three year action plan unveiled in December 2017.

Autonomous cars refer to vehicles that are equipped with sensors and GPS while intelligent vehicles (the so called “smartphones on wheels”) refer to cars with technologies such as road safety monitoring, interactive entertainment, facial recognition, voice interaction systems and in-vehicle payment systems.

By 2020, the Chinese government expects the market share of smart vehicles to reach 50% of total new vehicles sold in China. Towards that end, the Chinese authorities have taken steps to boost the country’s intelligent and connected vehicle industry such as through talent training and research, encouraging investment, and encouraging cross-border mergers and acquisitions.

Strong regulatory support coupled with Chinese car buyers’ seemingly high enthusiasm for connected vehicles which presents a potentially sizeable market for smart cars suggests the government’s target could be within reach. According to a survey conducted by McKinsey in 2017, 64% of Chinese consumers would switch brands for better in-car connectivity. By comparison, 37% of Americans would switch brands for better in-car connectivity and just 19% of Germans would do the same.

Bar chart showing desire for in-car connectivity from consumers in China, United States and Germany. 64% of Chinese consumers surveyed were willing to switch brands for better in-car connectivity compared with just 37% of American consumers and 19% of German consumers. For 33% of Chinese consumers, having in-car connectivity is critical while 20% of American consumers and 18% of German consumers felt the same. 62% of Chinese consumers were willing to pay a subscription for in-car connectivity while just 29% of American consumers and 13% of German consumers were willing to do the same.

The opportunity has turned China’s intelligent connected vehicle market into a hot sector attracting a raft of companies, from established tech giants to smaller startups, keen to participate.

Alibaba has signed agreements with auto companies such as Ford (NYSE:F), Dongfeng Peugeot Citroen and SAIC Motor (SHA:600104) to develop connected vehicles which use its AliOS automotive operating system which was unveiled in 2016.

Chinese social media behemoth Tencent has teamed up with Changan Automobile, while Chinese internet giant Baidu has partnered with Great Wall Motors towards develop intelligent connected vehicles.

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The Digitization Of Global Agriculture And Agtech Startups Poised To Profit

Bar chart and scatter chart showing livestock products consumption (Kcal/person/day) and beef and mutton consumption (Kcal/person/day) and percentage change in 2016 and 2050 (forecast). From 2006 to 2050, world livestock products consumption (Kcal/person/day) is forecast to increase 23% while world beef and mutton consumption (Kcal/person/day) is forecast to increase 30%.

The agtech startup scene is booming with venture capital funding climbing steadily over the past few years. According to data from PitchBook and US fund Finistere Ventures, the agtech industry raked in US$ 1.5 billion in investments in 2017, most of which were in early stage startups.

The flurry of interest in agtech startups is driven by a number of reasons. From climate change to increasing water scarcity, the global agriculture industry faces numerous long term challenges which, if unaddressed could affect global food availability in the future due food supply growth being far outpaced by food demand growth which is driven by a growing population and rising income levels.

Today’s approximately seven billion population is forecast to grow to 8.5 billion by 2030 and 9.7 billion by 2050, according to data from the United Nations Department of Economic and Social Affairs (UN DESA). Consequently, the demand for food is projected to be 60% greater than it is today.

Global rice consumption is poised to increase by around 1.1% annually from 2016 until 2025 when rice consumption is expected to reach 570 million tons according to market research firm IndexBox.

Per capita meat and dairy consumption is expected to see tremendous growth, particularly in China and India according to information from the World Resources Institute; global per capita, per day livestock products consumption is forecast to grow 23% while global per capita, per day consumption of beef and mutton is projected to grow 30% between 2006 and 2050.

Bar chart and scatter chart showing livestock products consumption (Kcal/person/day) and beef and mutton consumption (Kcal/person/day) and percentage change in 2016 and 2050 (forecast). From 2006 to 2050, world livestock products consumption (Kcal/person/day) is forecast to increase 23% while world beef and mutton consumption (Kcal/person/day) is forecast to increase 30%.

Yet, resource availability is growing increasingly scarce due to pollution and climate change among other reasons. Globally, agriculture uses 70% of freshwater worldwide according to data from the National Groundwater Association, making it the biggest consumer of the world’s freshwater. Water consumption for domestic use is second, accounting for about 10% of global freshwater consumption.

With agriculture having to feed a population of more than 9 billion by 2050, water demand from the agriculture sector is expected to increase substantially in the decades to come; without improved water-use efficiency measures, water consumption by the agriculture sector is expected to increase 20% globally by 2050. However with climate change affecting rainfall patterns, the world’s freshwater resources are being depleted faster than they are being replenished by rainfall.

About 50% of the world’s habitable land is used for agriculture. However, soil erosion and pollution have resulted in the loss of nearly 33% of global arable land in the past 40 years, at a rate faster than the ability for natural processes to replenish diminished soil, according to a study by the University of Sheffield’s Grantham Centre for Sustainable Futures. The study found that soil erosion had been occurring at a rate of up to 100 times faster than the rate of soil formation.

Environmental challenges coupled with rapid population growth and urbanization has resulted in a steady decline in arable land per capita; according to data from the Food and Agriculture Organization (FAO), arable land per capita declined from 0.35 hectares per person in 1965 to about 0.19 hectares per person in 2015, which is about a 40% decline over four decades.

Line graph showing global arable land (hectares per person) from 1961 to 2015. From 1961 until 2015, global arable land per capita has declined by about 40%.

Therefore, in order to feed the world’s population that is growing in number and purchasing power, the agriculture industry is compelled to solve these challenges by achieving greater productivity gains such as by reducing input cost, increasing yield, and increasing environmental sustainability and thereby increase food supply with limited resources.

Technology is emerging as a key solution and this growing digitization of the global agriculture industry is an opportunity numerous agtech startups are working to profit from. According to a report by Accenture, the market for digital agriculture services will expand 12.2% between 2014 and 2020 to reach US$ 4.55 billion.

WeFarmUp – France’s Airbnb of agriculture

Launched in 2015, French startup WeFarmUp could be described as the Airbnb of agriculture. The farm machinery rental platform allows French farmers with underused machinery to rent equipment to other farmers in need of such machinery which ultimately boosts farmer bottom lines since underutilized machinery could be converted into assets generating extra income and farmers can be relieved of the potential debt burden that comes with purchasing costly farm machinery.

Although France is the biggest recipient of EU farm aid under the EU’s Common Agricultural Policy (CAP), French farmers struggle with debt and weak farm incomes which are more volatile than wages and salaries in other sectors according to a report from the European Commission.

With the UK, a net contributor to the EU budget, reportedly not contributing to the CAP after 2020, the subsequent budgetary gap could result in a downward review of the Common Agricultural Policy which represents one of the biggest expenditures under the EU budget.

It has been estimated in 2016 that without the current level of subsidies under the CAP, more than 50% of all French farms would not break even, which suggests that any reduction in subsidies under the CAP could result in bigger losses for France’s farmers. This presents an opportunity for a platform such as  WeFarmUp which indicates bright prospects for the startup. WeFarmUp is currently focused on France but plans to expand to Belgium.

 Gold Farm and EM3 AgriServices – disrupting India’s agri sector with Farming as a Service (FaaS) platforms

Agriculture is one of the most important sectors of India’s economy. The country has the world’s second largest amount of agricultural land after the United States, is the world’s second largest producer of horticultural crops and fruits after China, and is the world’s largest producer and consumer of dairy.

However, the industry is challenged by low productivity and low profitability. While at least 50% of the country’s workforce depends on agriculture, the sector contributes just about 15% of India’s gross domestic product.

India lags behind countries such as China in terms of crop yields. For instance, India produces 2.4 tons per hectare (t/ha) of rice (nearly half of China’s yield of 4.7 t/ha) and 3.15 t/ha of wheat (compared with China’s 4.9 t/ha).

According to data from the World Bank, as of 2016, agricultural value added per worker in India amounted to US$ 1,202, far behind the world average of US$ 16,730, ranking India 119th in terms of agricultural productivity out of 155 countries.

Farm mechanization could help boost crop productivity however, much of India’s farmers have small-scale farming operations and are often heavily in debt, which constrains their ability to invest in expensive farm machinery; almost half of India’s agricultural households are in debt and the average farm land size in India is estimated at 1.15 hectares according to India’s Agriculture Census conducted in 2015. 65% of Indian farmers are marginal farmers holding less than one hectare of land, while less than 1% have large land holdings of 10 hectares or more.

The challenge is an opportunity for Indian agtech startups such as EM3 Agri Services and Gold Farm which manage platforms that aim to improve India’s poor farm mechanization levels by allowing farmers to rent, rather than purchase, expensive but much needed farm machinery. Using their respective mobile apps, farmers choose and book the machinery required and pay based on the amount of time the machines are used (hence the term Farm as a Service) which cost-efficiently boosts farm productivity.

Of India’s approximately 120 million farmers, just about one-quarter or roughly 30 million are equipped with smartphones. However, smartphone and mobile internet penetration are on an uptrend among rural Indians, including rural segments such as farmers, aided by increasing affordability of smartphones and mobile data, as well as government initiatives to help digitize Indian farming as part its Digital India program, such as the Government of India’s AgriMarket app.

This factor coupled with an increasing trend among younger Indians to move away from agriculture, rising input costs and rising labor costs, could result in greater demand for FaaS solutions such as the outsourced farm mechanization services offered by Gold Farm and EM3 Agri Services. According to data from Bain & Company, total investor funding into FaaS startups in India is currently about US$ 105 million to US$ 115 million, and more than 40% of funding rounds are at “series stage”.

Gold Farm partners with local entrepreneurs and farmers who have the financial wherewithal to invest in farm machinery and helps them with demand generation by renting out the machines to India’s rural, small-scale farmers through the Gold Farm platform, creating a win-win situation for all parties. The payback time for the entrepreneur is reportedly around two years.

Stellapps – improving productivity along India’s dairy supply chain through IoT and Big Data

 India is the world’s largest producer and consumer of dairy and the country has been the largest milk producing country in the world since 1997.

However, despite per capita milk consumption in India steadily rising over the past few years, there is still ample potential for growth; Indian per capita milk consumption is just about half that of countries such as the United States, Australia and New Zealand.

Bar chart showing annual per capita milk consumption (kilograms per capita) during 2012 and 2017 in Ukraine, New Zealand, Australia, United States Russia and India.

As India’s middle class expands and incomes grow, protein needs are expected to grow as well which should drive demand for milk and milk products. India’s urban dwellers being wealthier on average tend to consume more milk per person than the average rural Indian.

But with just about 31% of the one billion plus Indian population living in urban areas, there is tremendous potential for growth in per capita milk consumption as India’s remaining half a billion or so population urbanize over the longer term.

While India could meet this additional demand by growing its huge livestock population which is already the largest in the world (58% of buffaloes and 15% of cattle), the country may be better served by increasing efficiency and productivity in its dairy industry; according to India’s Agriculture Ministry, the average milk yield for cross-bred cattle stands at around 7.1 kg per day which is significantly lower than developed countries such as the United Kingdom, the United States and Israel which boast daily milk yields of 25.6, 32.8 and 38.6.

Indian agtech startup Stellapps Technologies, which is backed by the Bill and Melinda Gates Foundation is aiming to address this issue. The company’s solution uses technologies such as IoT, Big Data, Cloud and data analytics to help dairy farmers, cooperatives and private dairies optimize their dairy operations and covers all aspects of the dairy supply chain across milk production, procurement, cold chain, animal insurance and farmer payments. The full dairy technology solution, brand named SmartMoo™ uses different types of sensors which gather data through wearable devices. For instance, on the farm, data on the animal’s health and yield is gathered,  while data on milk quality (such as fat content) is gathered at dairy collection sites which assists with pricing. The data is automatically sent to relevant parties across the supply chain such as the dairy farmer and dairy companies with the ultimate aim of helping participants improve efficiency, quality and productivity by improving milk yields, improving animal health, reducing pilferage, spoilage etc.

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Multi-Billion Dollar Water Sector Offers Business Opportunities

Bar chart showing the top 15 countries with the largest estimated groundwater extractions in 2010, breakdown by sector (%): agriculture, domestic use and industrial use . The top 15 countries are (in order), India, China, United States, Pakistan, Iran, Bangladesh, Mexico, Saudi Arabia, Indonesia, Turkey, Russia, Syria, Japan, Thailand, and Italy. Data from the National Groundwater Association.

The gap between global water demand and global water supply is widening. Already more than half of the people in the MENA region (Middle East and North Africa), live under conditions of “water stress” (i.e., the demand for water exceeds supply) according to the World Bank and a report by the United Nations reveals that the world could face a 40% water shortfall by 2030. Demand for water is expected to grow by nearly one-third by 2050 according to a 2018 World Water Development Report by the United Nations.

Yet while water demand is projected to grow, earth’s water supply is limited. Just 1% of all earth’s water is fit for human use according to the National Groundwater Association, and 99% of this is derived from groundwater, 0.86% from lakes and 0.02% from rivers.

Earth’s total groundwater supply is estimated at 5.5 million cubic miles (equal to about 23 million cubic kilometers). However, groundwater is being depleted faster than it is being replenished due to a rapidly increasing population and increasing urbanization. Data from NASA’s Gravity Recovery and Climate Experiment (GRACE) satellites indicate that 13 of the world’s 37 biggest aquifers are being depleted due to irrigation, industrial usage and human consumption (groundwater supplies about 50% of all drinking water worldwide) faster than they are being replenished by rainfall. Climate change has affected rainfall patterns and as a consequence, the availability of groundwater resources will be impacted in the decades to come.

Of the 13 aquifers, eight aquifer systems are “overstressed” which means water is being withdrawn faster than it is being naturally recharged. The most overstressed aquifer is the Arabian aquifer system which lies underneath Saudi Arabia and Yemen. Other overstressed aquifers are the Indus Basin in Pakistan and India, and the Murzu-Djado Basin in Africa. The other five aquifer systems are “extremely” or “highly” stressed, which means they are being recharged by some rainfall but not enough to enough to offset withdrawals. California’s Central Valley is one of the five aquifer systems under this category.

The result has been a steady decline in the volume of renewable water resources per capita from 28,377 m3 per person per year in 1992 to 19,804 m3 per person per year in 2014, which corresponds to a roughly 30% decline over the last 22 years according to data from Aquastat.

Addressing the world’s impending water crisis demands better water management practices such as through the adoption of water recycling as is done in Singapore and Israel and to make water intensive sectors more efficient. This opens considerable opportunities for entrepreneurs and investors in the global water sector. A report by investment firm RobecoSAM expects market opportunities related to the water sector to reach US$ 1 trillion by 2025.

Smart irrigation

Global annual ground water withdrawals are estimated at 982 cubic kilometers a year according to estimates by the National Groundwater Association. By sector, agriculture is the largest user of groundwater, accounting for about 70% of groundwater withdrawals. Household use accounts for about 10% of groundwater withdrawals.

By country, India is the largest user of groundwater in the world, China is the second largest and the United States is third.

Bar chart showing the top 15 countries with the largest estimated groundwater extractions in 2010, breakdown by sector (%): agriculture, domestic use and industrial use . The top 15 countries are (in order), India, China, United States, Pakistan, Iran, Bangladesh, Mexico, Saudi Arabia, Indonesia, Turkey, Russia, Syria, Japan, Thailand, and Italy. Data from the National Groundwater Association.

The world’s growing population will lead to growing water usage while rising urbanization will increase per capita water and food consumption, particularly meat consumption. Food production is water intensive and meat-based products are among the most water-intensive sectors in the food industry. About 15,400 liters of water is required to produce one kilogram of beef and 5,988 liters to produce one kilogram of pork. By comparison just about 2,500 liters of water is required to produce one kilogram of rice.

As incomes rise and meat consumption sees a corresponding increase for the one billion plus population in India and China, which are already the world’s largest groundwater using nations, the water demand-supply mismatch will widen. This suggests the global demand for water will increase exponentially in the decades to come. Without improved water-use efficiency measures, agricultural water consumption is expected to grow by about 20% globally by 2050.

Smart irrigation solutions for agriculture are expected to help increase efficiency in water intensive sectors such as agriculture. Driven by expanding farming operations, an increasing need to increase farm profit, and government initiatives to promote water conservation, smart irrigation, which is a branch of the broader agtech sector, holds considerable growth potential particularly in India, China and the United States where over 50% of extracted groundwater is used by the agriculture sector.

92% of groundwater extraction from India’s overstressed Indus Basin is from the agriculture sector according to analysis by Earth Security Group.

Israeli agtech startup CropX offers a cloud-based smart irrigation solution for agriculture. The integrated software and hardware platform helps farmers increase yields by saving water and energy. On-field purpose-made sensors monitor soil moisture and gather data which is sent to CropX’s cloud platform where it is analyzed by CropX software which then updates the farmer through a mobile app on the farmer’s smartphone.  The farmer is then able to control the amount of water to each plant eliminating the need to water the whole field at one time thereby preventing water wastage through over watering and improving crop yields by maintaining optimal soil moisture levels.

Smart water solutions

Household consumption accounts for 10% of global groundwater withdrawals, the volume of which is likely to increase in the years ahead drive by population growth and urbanization. Smart water solutions for domestic use are expected to help optimize household water consumption such as by reducing wastage of water.

About 30% of global water supply is lost through leakage costing water utilities US$ 14 billion annually according to the World Bank. Wasted water, which is called non-revenue water (NRW), is a problem not just in developing countries but in developed ones too. London loses 25% of water through leakage, Hong Kong wastes 32.5%, Norway loses 32%, and the United States loses 14%-18%.

Such losses are avoidable. Countries that have comparatively better rates of water loss include Tokyo which loses about 2%, and Singapore which loses about 5%.

Consequently, the market for smart water solutions which monitor, detect and reduce leakage is a potential growth opportunity.

Research firm MarketsandMarkets projects the global smart water management market will grow from US$ 8.46 billion in 2016 to US$ 20.10 billion in 2021, representing a CAGR of 18.9% driven by a growing need to reduce NRW losses, sustainable use of energy, regulatory compliance and smart city projects.

Boston-based Inkwood Research projects the global smart water management market will expand at a CGAR of approximately 20.6% during the period 2017 – 2026 driven by smart city projects, aging water infrastructure and increasing need to reduce water loss. North America is expected to be the largest market. However Asia Pacific is expected to be the fastest growing market driven by countries such as China, India and Japan.

China and India, already the top two groundwater extracting nations in the world as illustrated in the chart above are likely to see greater water demand and water stress in the years ahead due to rising per capita income, increasing urbanization and industrialization. This is particularly true in China where water demand has been rapidly increasing and water supply has been rapidly dwindling, a situation that has been getting worse over the years; about one-fifth of China’s groundwater extraction is used for domestic purposes and according to research from the World Resources Institute, the percentage of land area in China facing high and extremely high water stress increased from 28% in 2001 to 20% in 2010.

The over-extraction of groundwater is impacting China not just through growing water scarcity risk but also increasing ground subsidence, i.e., sinking of land caused by the excessive removal of oil, natural gas or in China’s case, groundwater. According to a report released in 2012, more than 50 Chinese cities suffer ground subsidence issues.

Israeli startup TakaDu offers a cloud-based water management software-as-a-service (SaaS) solution that uses IoT, big data analytics and algorithms to help utility companies cut NRW losses by reducing leakage and supply interruptions, and anomaly detection  and automatic early warning anomalies.

TakaDu has deployed Water Network Monitoring solutions for a number of water utility companies including Portuguese water utility Águas de Cascais (AdC), Australian water company Hunter Water Corporation, and Chilean to water supplier Aguas de Antofagasta.

Industrial water treatment and recycling

About 20% of global water consumption is for industrial use and roughly 75% of industrial water withdrawals are used for energy production according to the United Nations World Water Development Report 2014.

Certain types of fuels require more water to produce than others. For instance, coal is among the most water-intensive fuels while natural gas is among the least water intensive. Coal production requires 10 times more water per ton of oil equivalent than natural gas production. Shale gas production requires 10 times more water per ton of oil equivalent than conventional natural gas production.

Coal extraction and refining is a very water intensive process and in China the world’s largest coal producer, the impact of coal production on the country’s water resources is already evident. China’s overstressed North China Aquifer serves 11% of the country’s population, 13% of the country’s agricultural production and a whopping 70% of the country’s coal production.

Yet, with coal accounting for about 40% of the world’s generated energy, it is likely to continue playing a role in the world’s energy mix going forward, particularly in China, India, the United States and Australia which are the world’s largest, second-largest, third-largest and fourth-largest coal producing nations respectively, and all four of which face water shortage issues; the Indus Basin in northwestern India and Pakistan is the second-most overstressed in the world while California’s Central Valley aquifer has been labeled as “highly stressed” according to studies led by the University of California using data from NASA’s GRACE satellites.

According to the U.S. Government Accountability Office, water managers in 40 out of 50 U.S. states expect water shortages in some portions of their states in the next decade.

This opens opportunities for industrial water treatment solutions. The industrial water treatment and recycling market is projected to grow by over 50% from around US$ 7billion in 2015 to US$ 11 billion in 2020 according to a report by Global Water Intelligence.

Much of today’s wastewater treatment involves treating wastewater, or effluent, and returning the treated effluent to groundwater or aquifers. Water reuse or water recycling however, sees the treated water being reused rather than being returned to the environment. Water reuse tends to be practiced in water-stressed countries such as Israel and Australia. Israel, the world’s leader in water recycling, over 70% of treated wastewater is reused.

Bar chart showing the percentage of treated wastewater reused, in 2015. Israel reuses 70% of all its treated wastewater. Australia reuses 19%, North America 4% and Brazil 1%.

It is likely that as water shortage issues grow, the market increasingly moves from water treatment to water reuse.

Much of reused water is currently used for agricultural purposes according to data from Global Water Intelligence and with agriculture accounting for 70% of global water withdrawals, the opportunity for water reuse technologies is evident particularly in countries such as India, China and the United States which are the world’s top three largest groundwater extracting nations and agriculture accounts for over half of water withdrawals in all three countries.

Pie chart showing global treated wastewater reuse, market share by application. 32% of the world's treated wastewater was reused for agricultural irrigation, 20% for landscape irrigation, 19.3% for industrial use, 8.3% for non-potable urban uses, 8% for environmental enhancements, 6.4% for recreational purposes, 2.3% for indirect potable reuse, 2.1% for groundwater recharge and 1.5% for other purposes.

Water desalination

Historically, desalination plants were concentrated in Gulf regions which have little alternatives for water supply. However, depleting water supplies and increasing water demand has forced countries outside the Gulf such as Australia, China, Japan, and the United States to build desalination plants to address impending water shortages. Desalination is in practice in more than 150 countries.

Yet, with increasing pollution, climate change, population growth and rising urbanization expected to drive water demand amid stagnant or falling water supplies, the demand for desalination technologies are expected to increase in the coming years. According to Hexa Research, the water desalination market is expected to grow to US$ 26.81 billion by 2025 driven by reverse osmosis.

There are two primary water desalination technologies; multi-stage flash distillation and reverse osmosis.  Flash distillation involves boiling seawater at low pressures (which requires less heat) and then condensing the resulting steam into salt-free water. This technology has been the most commonly used method for desalination over the past few decades and still remains so. According to Hexa Research, the market for multi-stage flash distillation is expected to grow at an 8,4% CAGR between 2014-2025.

Reverse osmosis, on the other hand, uses a membrane to filter salts from seawater to produce salt-free water. The technology was commercialized in the 1970s but was considerably costlier compared to multi-stage flash distillation; the membranes were not as effective in filtering salts and the membranes tended to wear out quickly.

However, over the past few years, there have been significant improvements that have helped increase its competitiveness and the fact that reverse osmosis consumes less energy than flash distillation (which has helped drive down desalination costs over the past few years) makes the technology more attractive. Consequently, new desalination plants are increasingly being built with membrane technology; according to the International Desalination Association (IDA), as much as 90% of new desalination capacity worldwide uses RO as opposed to distillation technologies. For instance in 2017, membrane technology accounted for 2.2 million m3/d of annual contracted desalination capacity while distillation technologies accounted for just 0.1 million m3/d.

The momentum is expected to continue; reverse osmosis is expected to be the fastest growing desalination technology going forward with Hexa Research predicting the market will be valued at US$ 15.43 billion in 2025. This could be a growth opportunity for companies such as Tetra Tech (NASDAQ:TTEK) and Veolia Environnement (EPA:VIE). Tetra Tech provides consulting, engineering, and technical services for the water sector while Paris-based Veolia Environment has been in the water business for over a century, designing and operating desalination plants for municipalities and industry around the world.

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These Are The Companies Profiting From China’s Belt And Road Initiative

"One Belt, One Road" map showing the Silk Road Economic Belt and the Maritime Silk Road under China's One Belt, One Road (aka Belt and Road) Initiative.

China’s Belt and Road Initiative (BRI) also known as the One Belt and One Road Initiative (OBOR), is an ambitious, trillion-dollar infrastructure project that aims to connect countries along two primary trade routes known as the “Silk Road Economic Belt” and the “Maritime Silk Road” in an effort to enhance connectivity, investment, international trade, and economic development.

The “Silk Road Economic Belt” represents the land-based route, and is named after the ancient trading route known as “Silk Road” which went through China, Central Asia, West Asia, the Middle East and Europe. The “Maritime Silk Road” represents the sea route which, like the original maritime trade route, linked Chinese ports with ports located in Southeast Asia, the Indian subcontinent, the Mediterranean, Europe and Africa.

"One Belt, One Road" map showing the Silk Road Economic Belt and the Maritime Silk Road under China's One Belt, One Road (aka Belt and Road) Initiative.

By various measures, BRI is one of the largest infrastructure and investment projects in history. About 70 countries representing about two-thirds of the world’s population and accounting for about one-third of the global economy are participating in Belt and Road projects. Under the initiative, some US$ 900 billion worth of projects are currently either under way or in detailed planning stages according to data from China Development Bank.

While some projects have encountered roadblocks and delays, numerous others are ongoing. Ongoing projects under the initiative include the Eurasian Railway Program (an 81,000 km railway linking China with Europe), the Colombo Port City (CPC) development project in Sri Lanka, the Khorgos Gateway project in Kazakhstan (a railway linking China with Kazakhstan), the Hungary-Serbia high speed railway (a 350km railway line from Budapest to Belgrade), the Gwadar deep sea port project in Pakistan, the China-Laos Railway (a 414km railway linking Laos with China), the Karot Hydropwer project in Pakistan, the Sino-Oman Industrial City in Oman’s port of Duqm, the Malaysia-China Kuantan Industrial Park in Malaysia, the Kohala hydropower project in Pakistan, the Melaka Gateway in Malaysia, the Yanbu Refinery in Saudi Arabia, and the Kunming-Singapore High Speed Railway (a 3,000 km railway line connecting China to Southeast Asia) to name a few.

Projects under the BRI initiative fall into one of six economic corridors, namely:

  1. The China-Indochina Peninsula Economic Corridor (CICPEC)
  2. The China-Mongolia-Russia Economic Corridor (CMREC)
  3. The New Eurasian Land Bridge (NELB)
  4. The China-Central Asia-West Asia Economic Corridor (CCWAEC)
  5. The China-Pakistan Economic Corridor (CPEC)
  6. The Bangladesh-China-India-Myanmar Economic Corridor (BCIM)

BRI projects that have been successfully completed include the Ethiopia-Djibouti High Speed Rail Link (a 752km railway linking Ethiopia’s capital to the Port of Djibouti), the Amsterdam-Yiwu railway (an 11,000km railway linking  Amsterdam in Netherlands with  Yiwu in China’s Zhejiang province), the Baku-Tbilisi-Kars Railway (an 846km railway linking Baku in Azerbaijan, Tbilisi in Georgia and Kars in Turkey), the Nairobi-Mombasa railway (a US$ 3 billion railway project linking Kenya’s capital Nairobi,  with Kenya’s port city of Mombasa), and the Rudbar Lorestan hydropower station in Iran to name a few.

The initiative is expected to unlock substantial commercial opportunities in the decades to come. With the initiative already having a positive impact on the bottom lines of some companies, many other companies around the world are keen to participate and are positioning themselves for a share of the pie.

Caterpillar (NYSE:CAT)

American heavy-machinery manufacturer Caterpillar which has been investing heavily in China the world’s largest construction and mining equipment market in the world, expects strong sales growth in 2018 boosted by robust business from China’s Belt and Road Initiative. The company said Asia-Pacific sales grew 22% in the fourth quarter of 2017, with half of the increase coming from China alone where contractors buy much of the machinery for BRI projects to take advantage of the initiative’s tax rebates and export them to the relevant countries where the BRI project is being carried out.

The company has also been flexing its finance arm to boost sales, lending to Chinese companies including state-owned enterprises.

Caterpillar is involved in BRI projects in 20 countries such as Kazakhstan, Sri Lanka, and Pakistan supplying heavy machinery such as drills, excavators, and hydraulic mining shovels for BRI projects such as roads, ports, mines, and oil fields.

Although Chinese rivals such as Sany Heavy Industries (SHA:600031) and Zoomlion Heavy Industry Sci & Tch Co Ltd (SHE:000157) dominate the local market and are expanding their international presence, Caterpillar’s advanced technology, superior reputation for quality and reliability, and extensive global dealer network in over 180 countries, (compared with Caterpillar’s key rival Sany Heavy Industries which has dealers in 100 countries) are solid competitive advantages that have put the company in a better position to capture orders for BRI-related projects. Caterpillar’s wider international dealership network is particularly advantageous considering the fact that while both companies maintain active dealerships in developed markets such as the United States and Europe, Caterpillar has a relatively wider footprint in developing markets where much of the Belt and Road projects are being carried out.

For instance, thanks to Caterpillar’s strong brand name and its active, experienced dealer network in Sri Lanka (unlike Sany Heavy Industries which is relatively unknown and has a relatively limited presence in the country), Caterpillar captured a number of equipment orders for the Colombo Port development project in Sri Lanka which required machinery such as hydraulic excavators.

COSCO Group (SHA:601919) (HKG:1919)

 Chinese shipping giant COSCO has been riding on China’s Belt and Road Initiative to aggressively expand and strengthen its global presence helped by a supportive government and access to low-interest loans which enable the company to make more aggressive bids for port assets compared to competitors; loans from Chinese state banks to fund BRI-related initiatives are as low as 2.5%.

In 2017, COSCO acquired APM Terminals Zeebrugge in Belgium, and acquired a 51% equity interest in Spanish port company Noatum Port Holdings which operates terminals at ports such as the Valencia port and railroad terminals in Madrid.

In 2016, the company acquired a 51% stake in Piraeus Port, which is the largest port in Greece, and has launched of a number of projects to upgrade the port to help make it a transshipment hub for expanding trade between Asia and Eastern Europe.

COSCO has signed a 35-year concession agreement with Abu Dhabi Ports (which operates Khalifa Port) that sees COSCO building and operating a new container terminal at Khalifa Port in Abu Dhabi, in an ambitious plan that aims to almost double the container handling capacity at Khalifa Port over the next several years by adding 2.4 million TEUs to  the existing 2.5 million TEUs.

COSCO acquired a stake in the Khorgos Gateway in Kazakhstan, an ambitious BRI project that aims to develop the biggest dry port in the world. The project, which Chinese president Xi Jinping called “the project of the century” connects Kazakhstan to China by rail.

Kazakhstan, the world’s largest landlocked country, sits right in the middle of China’s Silk Road Economic Belt. The country’s strategic location makes it a key link in transport routes between markets in Asia and Europe. Overland freight routes pass through Kazakhstan from all directions and with trade expected to grow along the Belt and Road, freight volumes are expected to accelerate in the decades to come making the China-led transportation projects significantly important to landlocked Kazakhstan and other countries in Central Asia such as Azerbaijan.

Volumes of rail freight moving between China and Europe are on the rise; during 2013 and 2016, rail freight volumes grew more than three-fold in just two years to over 300,000 tons in 2016 according to data from aviation consulting firm Seabury Consulting (owned by Accenture).

Bar chart showing China-Europe rail freight volumes ('000 tons) in 2013 and 2016. - LD Investments

China-Europe rail freight volumes registered a CAGR of 65% between 2013 and 2016, far surpassing growth rates in other trade types.

Bar chart showing CAGR of ocean trade, air trade, international express, parcels by mail and the China-Europe rail pre financial crisis and post crisis - LD Investments

Yet, much of China-Europe cargo is still carried by sea and to a lesser extent by air; more than 90% of trade between China and Europe occurs via ocean, while rail accounts for less than 5% of goods moved between China and Europe (most of which is carried through the Trans-Siberian railway).  However, rail is considerably cheaper than air and faster than sea and rail is particularly competitive to transport goods between points located deep inland.

Thus, there is a case for rail freight transport as Chinese manufacturing bases relocate from coastal areas where wages and realty prices are rising, to areas further inland where wages and property prices are more competitive.

China-EU transit volumes transported via Kazakhstan amounted to just about 32,000 TEU in 2015, which is just about 1% of total China-EU container traffic according to data from The Brookings Institution. However, driven by the relocation of manufacturing bases in Western China, and greater trade among Belt and Road countries, there is potential for Kazakhstan to increase the volume of transit container traffic to 240,000 TEU by 2030.

Thus, COSCO is well positioned to profit from expanding trade among Belt and Road countries. According to its 2017 annual results, 62% of the company’s total container shipping capacity was deployed along Belt and Road routes, comprising 180 container vessels with a total capacity of 1.15 million TEU.

China Merchants Port Holdings (HKG:0144)

China’s leading port operator China Merchants Port Holdings (CMPort) is actively involved in China’s Belt and Road initiative which has helped the state-owned conglomerate expand its international presence.

At the end of 2017, the company owns 31 ports in across 16 countries and five continents and the number is likely to grow in the coming years as the company aggressively snaps up terminals worldwide, helped by an encouraging regulatory environment for BRI-related projects and easy access to cheap BRI-financing from state banks (typically funding comes as a loan from the state-owned Export Import Bank of China, which usually have long maturity periods of about 20 years, and low interest rates of about 2%).

The company built and owns a stake in the new Doraleh Multipurpose Port, a US$ 600 million “flagship” project in Djibouti which recently began operations.

The company participated in upgrading the port facilities and the planning and construction of the Djibouti Free Trade Zone.

CMPort owns and operates the Colombo International Container Terminal (CICT) which saw an 18.5% YoY increase in container throughput to 2.39 million TEUs last year, making it one of CMPort’s top performing overseas port facilities in terms of volume growth last year. The boost helped CMPort handle a total container throughput of 102.9 million TEU in 2017 surpassing the 100 million TEU container throughput milestone for the first time.

As of 2017, Colombo was ranked among the top 30 busiest ports in the world in terms of container traffic. Colombo sits at the heart of China’s 21st Century Maritime Silk Road making it a strategically important location on the East-West shipping route.  As trade grows between China and other BRI countries, Colombo is poised to capture some of the increase in container traffic.

CMPort has also acquired an 85% stake in Sri Lanka’s Hambantota International Port Group Ltd which is involved in the Hambantota port development project in Sri Lanka.

Hambantota, located about 200km south of Colombo, holds immense potential to develop into a top container port in its own right. Hambantota’s strategic location coupled with its owner China Merchants Port Holdings’ global clout and commercial relationships with its network of Chinese shippers could help Hambantota emerge as a major port.

In the longer term, CMPort is poised to profit as container throughput grows along with growing trade among Belt and Road countries. The total value of China’s imports and exports to Belt and Road countries reached 7.37 trillion yuan (about US$ 1.14 trillion), a 17.8% increase YoY in 2017 according to Huang Songping, spokesperson for the General Administration of Customs. The value of imports and exports to Belt and Road countries accounted for 26.5% of China’s total imports and exports in 2017.

Alibaba (NYSE:BABA)

China’s new Silk Road is going digital and China’s largest e-commerce platform, Alibaba, is positioning itself to profit from the anticipated increase in trade among Belt and Road countries in the decades to come.

Alibaba’s finance affiliate Ant Financial which owns China’s most popular mobile payment app, Alipay, has been expanding its global reach by rolling out the payment app in countries along the Belt and Road such as Malaysia, Indonesia, Pakistan, Cambodia, Laos, Myanmar, and Vietnam. Ant Financial has also signed a partnership with London-based Standard Chartered Bank to collaborate on enhancing financial inclusion in Belt and Road countries.

Alibaba is also positioning itself as the platform of choice for SMEs in Belt and Road countries looking to capitalize on cross-border trade opportunities as a result of greater trade connectivity the BRI initiative is expected to bring.

Alibaba is leading the charge, together with the Malaysia Digital Economy Cooperation (MDEC) to develop a ‘Digital Free Trade Zone’ in Malaysia, a BRI-project expected to facilitate trade between Chinese and Southeast Asian SMEs. The effort includes a regional e-commerce and logistics “hub” near the Kuala Lumpur International Airport and an electronic World Trade Platform (eWTP) which offers Malaysian SMEs the necessary infrastructure for cross border ecommerce such as order fulfillment, logistics, and centralized customs clearance services. Already more than 1,900 Malaysian businesses have signed up to use the eWTP hub. The e-commerce and logistics “hub”, which is expected to be developed by the end of 2019, will be jointly developed by Malaysia Airports Holdings Berhad (KLSE:AIRPORT) and Cainiao Network (Alibaba’s logistics arm).

Siemens (ETR:SIE)

German industrial giant Siemens has been actively positioning itself to capitalize on business opportunities in China’s Belt and Road projects. The company has set up a Belt and Road office in Beijing and has signed ten cooperation agreements with Chinese companies such as China National Chemical Engineering Group Corp, China Railway Construction Corp (International) Ltd and China Civil Engineering Construction Corp. The agreement covers a wide range of business sectors such as power generation, energy management, building technology and intelligent manufacturing among others for BRI projects in countries such as Indonesia, the Philippines, Nigeria, Mozambique and South America.