It was a slow start to the summer on assembly lines at Japanese automakers across China. Production of Camrys, Accords, Teanas and other models made in the Chinese joint-venture factories of Toyota (TM.NYSE, 7203.TYO), Honda (HMC.NYSE, 7267.TYO) and Nissan (NSANY.NYSE, 7201.TYO) ground to a halt as workers at parts suppliers went on strike.
After all, cars could not be assembled without transmissions, exhausts, suspension systems and other parts made by factories owned by suppliers like Denso (DNZOY.NYSE, 6902.TYO), NHK Spring (5991.TYO) and Toyoda Gosei.
Striking employees at Foshan’s Honda Auto Parts Manufacturing were soon imitated by their counterparts at car parts factories across the country as strikes spread throughout May and June.
"Once people see that their peers in other factories are successful with striking, they repeat it," said Klaus Paur, TNS China’s automotive director for North Asia.
The success was relative: While some workers demanded raises of more than 50%, Honda agreed only to increases of up to 24%, bring average wages to around RMB1,900 (US$280). However, analysts predicted that even this concession would cost up to 5% of the company’s net income. Toyota-invested Toyoda Gosei lifted wages at a plant in Tianjin 20% from an average of RMB1,500 (US$221) per month, and boosted allowances for perfect attendance and work on hot summer days. Production resumed across all the factories following the wage hikes.
The increases came at a time of slowing growth in China’s domestic auto market. New passenger car sales rose 10.9% year-on-year in June, down from 25% growth in May and 34% growth in April. For Honda, which derives 20% of its global car sales from China, a lagging market at a time of increasing wages and other costs – and now a gradually rising renminbi – is a worrying combination.
But while automakers in China may not be able to continue to enjoy the rapid expansion they’ve seen in recent years, there’s still hope for the industry. The size of China’s car market – the largest in the world last year – and the strong position of its major players will minimize any negative impact on automakers.
"What we have now is a necessary adjustment," Paur said. "The truth is the growth before was too high and [rising] too quickly."
This growth was sparked by government subsidies introduced in January 2009, which led to 48% annual growth in car sales last year. A lower comparison base for the early months of this year also inflated growth figures.
In the short term, the automakers hit by strikes will have to contend with the direct effect of the strike action. Stopping its assembly lines in Guangdong reduced Honda’s China production by 15.7% year-on-year in May. The impact on production in June for Toyota and Nissan is likely similar, though the companies have not released exact figures.
The situation may appear worse than it is. Noting that the automakers had sufficient inventory of assembled vehicles to cover production gaps – and that they would likely work overtime to make up for the stoppage – ratings agency Fitch said in a statement that the labor actions and subsequent pay rises would have minimal impact on the companies’ ratings. It warned, however, that manufacturers faced a broader risk.
"The recent spate of worker unrest may lead to a sustainable labor cost increase in China, given that wage levels are still considerably lower compared to other developed markets, while supply of low-cost labor is shrinking," Fitch said.
The earnings risk posed by higher labor costs has been brought into focus not just by strikes, but also by provincial-level minimum wage increases. In early July, nine provinces and cities, including Beijing and Henan, China’s most populous province, announced they would be raising their minimum wages. More than 20 municipalities and provinces have announced minimum wage hikes this year.
Although overall wage growth will help to encourage domestic consumption, a long-time goal of the central government, it also threatens to hurt corporate earnings while other inputs rise.
A clear sign of the growing pressure can be seen in China’s Producer Price Index (PPI) of factory-gate prices, which grew at 7.1% in May, up from 6.8% in April and 5.9% in March – and which has consistently outpaced increases in consumer inflation this year. Higher prices of raw materials and energy have been behind much of the rise in input prices.
The extent to which this is a real problem is debatable, said Brian Jackson, senior emerging markets analyst at RBC Capital Markets in Hong Kong.
"The corporate sector has had pretty strong profits in recent years and there’s probably a bit of room for them to erode [and] still be in a pretty strong position," he said.
Other areas that might seem to pose threats may also have been overstated. Inflationary pressures appear to be easing: The PPI moderated to 6.4% in June. And while many, including Beijing, have warned that a rising currency could have significant costs, the reality is less dire.
After the renminbi’s relatively fast 0.8% rise in its first month after unpegging, the central bank will be intent on limiting further appreciation and any negative effects on manufacturers and exporters. In addition, Jackson notes that large companies would typically have currency hedges in place to cope with the impact of a stronger renminbi.
For foreign automakers, the joint-venture requirement for participating in China’s domestic auto industry provides an additional element of protection.
"They are working here in joint venture corporations, so the risk is half and half between the international car manufacturer and the Chinese company," said Paur at TNS.
Share the burden
The small number of domestic automakers also spreads the risk for local partners like Dongfeng Motor (600006.SH, 0489.HK). A 20% month-on-month drop in sales of Dongfeng-made Hondas in May was softened by 6% declines in sales of cars produced by joint ventures with PSA Peugeot Citro?n (UG.PAR) and Nissan, as well as its own-branded vehicles.
If automakers are reasonably well-insulated from risks, the same cannot be said for parts suppliers, the source of this summer’s labor disputes.
"To secure big enough profit margins, the car makers are trying to reduce their costs by putting pressure on suppliers," said Paur.
Forced to increase wages while providing parts at low prices, the road ahead for suppliers is looking increasingly bumpy, even as continuing – if lower – auto sales growth reinforces the market strength of major car makers.
A potential operational impact may be to encourage auto firms to expand parts inventories to weaken the disruptive effect of future supplier strikes, but the effects will be limited. Japanese companies in particular, known for close management of costs and vertical integration of suppliers and assemblers, will seek to maintain the status quo as much as possible.
What will change for certain is worker wages – and observers say it’s about time.
"Productivity gains in the last few years have been pretty good and wages haven’t really kept pace over that period," said RBC’s Jackson. "So in some ways it’s a bit of a catch-up."