We set out to cover three major topics with this report. First, we are turning even more bullish on China’s automation sector. Second, the idea that robots are taking over factory floors is a fairly well-known theme so we throw the debate forward by looking at whether China’s automation leaders can dominate at home, as well as compete on the global stage? Third, given many of these stocks have had a great run and are well owned, we look closely at how to play this theme.

1. Doubling our forecasts: We now see China’s automation sector growing 20% in 2021e from 10% previously, and a further 10% in 2022e from 5% before. The pandemic and China’s push for smart manufacturing has been a tailwind for some time, but what’s changed has been robust order momentum. We see two sectors outperforming the market: industrial robot sales and customised automation solutions.

2. Can China’s leaders dominate at home and then go global? We see a strong case for China’s domestic robot makers to increase their market share at home from c30% in 2020 to c50% in 2025e, and even start to challenge overseas players abroad too. The advantages of China’s automation leaders are that they have lower costs, are faster to react to changing market conditions locally, and can produce customised offerings. As a case study, we look to the domestic excavator market where the share of local leaders rose from c30% to c70% over the past decade on similar drivers.

3. How to invest? We have a differentiated view. The automation market trades at a discount as it is widely seen as a cyclical industry. However, we believe it is becoming more secular given labour shortages are leading to rising demand from an increasing number of industries while manufacturing facilities are being upgraded. That drives our forecast for higher valuation multiples. In an accompanying report we initiate on Estun, China’s largest domestic industrial robot maker, at Buy for its strong growth potential. We also continue to like Inovance – China’s leading industrial automation company by revenue – for its high ROE, strong balance sheet, and high R&D. And we maintain our Buy on relay-focussed Hongfa Technology.

With this report Corey Chan assumes primary coverage of Hongfa Technology.