China's Car Makers Faced With Folding

Nov 13, 2015

Every industrialized country knows how important the auto industry is to development. It keeps people employed in well-paying jobs. It has tons of derivative industries, from auto parts manufacturers to car dealerships to roads and restaurants set up along the assembly lines.  In China, where an unspeakable full employment policy has been in the works for the past 20  years, local states got in on the act by building car companies from scratch. They got jobs. They got taxes. They got oversupply.  And now, the time has come from China’s world leading auto market to consolidate.

Number two auto market U.S. only has two domestic automakers, not counting Tesla.  Number one China has dozens. It’s time to let the strong survive, J.D. Power says.

China auto sales are in decline. Light vehicle sales in China—which grew at a compounded annual rate of 14.6% over the last decade—have actually contracted on a year-over-year basis for several months, with the full-year sales forecast for 2015 of 24.1 million units, or roughly 2% more than 2014 . New-vehicle sales in the U.S. are forecast to reach 17.3 million in 2015, according to J.D. Power.

As the industry contracts, local car makers will either be bought out or fold. Seeing how the government has very little appetite for unemployment, and municipal governments still have power over their states, it is likely that the glut in the auto market will remain for some time.

China may be despised by financial pundits these days, but the economy is too big to be ignored. For guys like General Motors and Ford, China is more important than Western Europe, Japan, India and Brazil. Chinese car buyers are as important, if not more so for brands like Buick, than American ones. It accounts for over 25% of all new light vehicles sold annually, and generating approximately $470 billion in revenue so far this year.

China is home to more 40 car makers and more than 90 car brands — almost three times more than the U.S. market. Automakers in China are either individual domestic brands or larger state-owned enterprises (SOE) which a have formed joint ventures with foreign automakers. In these SOE joint ventures, current policy restricts foreign ownership to no more than 50%.  Yet, these SOEs account for 11 of the top 15 passenger-vehicle manufacturers by volume in China, according to J.D. Power.

Foreign branded vehicles account for 65% of annual passenger vehicle sales.

Automakers have been forced to reduce prices to move inventory. It’s barely working. Middle class and wealthy Chinese will gravitate towards the foreign brands, as they are perceived to be of a superior quality. That will keep Volkswagen and General Motors alive and kicking in China. But smaller Chinese companies will have to keep lower prices to compete with their domestic rivals. In cases were car makers are entirely local, with little true competition, lower prices will hurt margins, ultimately making these firms unprofitable and hurting lenders left holding the bag of debt these companies won’t be able to finance.

According to J.D. Power’s 2015 China Dealer Attitude Study, 47% of auto dealers in China said they lost money on new-vehicle sales in 2014 up from 28% in 2013. This trend continued in 2015 because automakers are still churning out vehicles that no one is buying.

Vehicle production capacity in China today is estimated at more than 35 million units in a market that is forecast to sell about 23 million locally-built vehicles this year, says John Humphrey, senior vice president in the auto group at J.D. Power in Westlake Village, Calif.

“With such a favorable underlying cost structure, many Chinese domestic automakers are able to operate at

levels of inefficiency and low profitability that would either cause them to go out of business or be acquired by

competitors in a market economy,” he writes in a report published on Thursday. “Only by allowing market-based dynamics to play out will the industry be able to escape a prolonged period of price-cutting, and the accompanying effect that this would likely have on automakers’ bottom lines. The risk to taking no action is the possibility of creating an automotive industry inundated with zombie companies, both foreign and domestic, which have little hope of making a sustained profit, or of producing high-value products.”

China’s recent response to the slowdown has been cuts to sales taxes. It’s been welcomed by some in the industry, including investors.

Geely Automobile is up 28% in the last three months. Great Wall is up 23.3% over the same period, and both are outperforming the Hang Sang.

But the tax break is just a short-term solution and does not address China’s oversupply.

“Beijing has an opportunity to change policies to make the auto sector stronger in the future,” says Humphrey. “The question is that with jobs, revenue and pride on the line, will they let free market forces do their work, or will inaction and delay cause a good opportunity to pass by?”

 

Source: FORBES