Despite more Chinese able to afford cars, a few dealerships called it a day recently. More may follow. Manufacturing output far outstrips the economy's output of buyers. Expensive materials, new regulations and falling tariffs promise only more woe for carmakers in China.
Few see the market gearing up to cruising speed before 2007. The gloomy outlook might seem odd with sales picking up in December. Rushing to meet year-end targets, dealers cut prices, around 10% for cars built in China, and double that for imported models. Prices recovered around half their December cuts in January ahead of the New Year 7-day break, which fell in early February, and buyers kept coming – but bonuses and shopping sprees do not last forever.
"We see the above recovery in the China auto market as rather deceptive, and not sustainable, and continue to forecast a serious oversupply problem for China's sedan market in the coming 2 years," writes Frank Li, an auto-industry analyst with JP Morgan in Hong Kong, in a February report.
Sales for 2004 hit 2.3m, on par with the UK, up 18% on 2003, reports the China Automotive Manufacturers Association. In 2003 sales leaped 74.3%. But last year sales growth plunged, leaving a record 500,000 cars on dealer lots. "China's auto industry is saying goodbye to high growth, high profitability and entering a multi-year cycle of profit margin normalization, balance sheet destruction and capacity consolidation," says Jerry Lou, China team leader at Morgan Stanley Hong Kong, in a recent report.
General Motors' third-quarter 2004 China earnings fell to US$80m from US$142m. China now accounts for a fifth of GM's overall profit. Shanghai Automotive Industry Corporation, GM's and Volkswagen's principal China partner, is feeling glum too, expecting flat earnings, or worse, for 2004. Supply nationwide is projected to top 2. 83m this year, and 3.33m next, but Li reckons buyers' appetites may only run around 2.37m this year, and 2.42m in 2006. He estimates the total capacity utilization rate at around 65%, compounding global overcapacity.
Lou agrees, reckoning redundant capacity at 35% this year. He estimates production capacity, around 3.5m by end-2004, will grow 37% this year, followed by another 49% in 2006.
Investors shun shares of Chinese carmakers, which cut, weld and paint metal according to designs drawn up by their foreign partners. Li is advising clients to sell what they have if they spy a rally. Lou is counseling caution, after being neutral.
Jeannie Cheung, a CSFB economist in Hong Kong, reckons the sector could be a nice trading play, as prices are well below par, drawing bottom-feeding institutions. Hardly a ringing endorsement though.
Only a few years ago sales were soaring after the gates opened to the latest foreign models. Tired of clunky, ugly, but fairly reliable VW Santanas and Jettas, everyone, public and private sector buyers alike, went shopping.
Foreign manufacturers plunged in, battling with VW, which had had its way for a decade. "In the 1990s VW had more than 50% of the market," says Gary Liu, an analyst with research house Auto Resources Asia in Beijing. "There were not many competitors. Now most global manufacturers are in China, so it is much more competitive, so VW's market share will naturally fall."
Demand for top-line models, like Toyota Camrys, VW Passats or GM Buick Regals, was sated by early 2004. Worried the economy was running out of control, Beijing squeezed credit and reined in discretionary spending by departments, provinces and state-owned firms last year, cutting many buyers out of the market.
That hits the mid-top end harder, where the state-sector or corporations are the biggest buyers. But the credit clampdown also spread into car financing, which accounted for around 30% of private sales in 2003, but fell to 10% or less by the end of 2004. A high default-rate helped turn lenders off.
Top-sellers these days are cheaper, medium-sized autos like Honda's Accord and VW's venerable Santana. Value is now the key to sales in China, as in many developing countries.
A fuel tax is in the pipeline – bets are on the 50-70% mark – which may make more private buyers pause, especially if road fees and annual car taxes do not fall or disappear as expected. "After the introduction of fuel tax, quite a lot of other fees will come down. So for some users, the cost of ownership will come down," says Liu.
Cars rolling off local production lines are also facing more competition from imports, with the WTO scraping quotas and pushing tariffs down to 30% this year, 25% in 2006.
Costs of raw materials, especially steel which rose 25% during 2004, are also squeezing manufacturers. Meanwhile, the government is on manufacturers' backs, pushing them to use more locally-forged complex parts in place of imports, or face higher taxes. "Even the most efficient OEMs in China have net profit margins in the low and mid teens. A 5% margin decline would therefore be significant," writes JP Morgan's Lou.
Cars vs. public transport
Though China is not discouraging car ownership, it is not encouraging their use in big cities, where public transport gets top priority in the medium-to-long term. Gas-guzzlers are also in line for heavier taxes.
Tough as it looks, it is still a profitable market, with top-end models selling 40-50% higher than they do in the US. Among the foreign manufacturers, three stand out. "Beijing Hyundai, a new joint-venture, grew quickly," says Liu. Sales topped 100,000 units, earning it fifth place among sedan makers. "Guangzhou Honda sales were around 200,000 – they have been doing quite well in the past few years [and] considering the whole market is down, GM is doing quite well."
Demand looks unlikely to firm until later this year, at the earliest. Interest rates are rising, insurance and other bills are rising, and oil prices remain high. With the economy growing about 9% last year, it is unlikely the government will let credit flow freely or unclamp spending quickly.
Exports are no savior either. It costs about 20% more to make a car in China than in Germany, though the gap is shrinking. "The cost of manufacturing in China is still quite high, even compared to other developing countries," says Liu.
With carmakers' finance units now free to offer car-loans, financing could return – though buyers must come up with a 20% down payment. Another hitch is China's credit bureau system will not be fully up and running for years, which will leave lenders wary.
So why the glimmer of optimism around 2007? Replacement buyers are, apparently, less sensitive to price – people generally earning more as they grow older. "In 2002 and 2003 there was a boom," Liu says. "In a developed market people typically replace their cars after 7 years, but in a developing market it is often faster, so in 2007 or 2008 we could see a lot of replacement sales."