November 2012 management briefing: world markets review (China)
China's rapid pace of economic growth has led to the growth of megacities such as Shanghai with their affluent consumption hungry populations; the Chinese car market could grow to 25m pa by the end of the decade, according to forecasters
In this month's management briefing we take a look at the latest developments in major vehicle markets around the world. In this first instalment, we take a look at China.
The world's largest car market is continuing to grow this year, but growth is slowing. All things considered, that's probably a good thing, in line with other sectors of China's economy. The last couple of years have seen worries grow over the pace of China's economic growth and the measures that might be needed to prevent a speculative bubble turning into generally rising prices. At the same time, attention has turned to a hoped for rebalancing of the economy so that domestic demand starts to take over from the export-led growth of manufacturing that has led China's rapid economic growth over the last ten years. And, all the while, China watchers are keeping a close eye on political developments and any signs of unrest that would upset the economy. It's not so much the secessionist movements that bother them, as any sign that rising unemployment in urban areas is leading to widespread dissatisfaction or dissent. Any drop to China's economic growth rate needs to be seen in that context.
There is also the not insignificant matter of the once a decade big transfer of power at the top and speculation about what could change. The signs are that Mr Xi Jinping – who will take over, in the usual Chinese stage managed fashion, as President from Mr Hu Jintao in March – is in favour of managing a steady ship, rather than rocking the boat.
2012 brings slower growth
For the automotive industry, the big challenges ahead remain. If demand weakens, the pressures are going to be felt – and by some more than others. There can be little doubt that real demand has already weakened in 2012 as the economy has slowed (growth moderated to 7.4% in Q3 as opposed to 10-12% of recent years). Car manufacturers are having to work harder to secure sales. Some parts of the market are suffering more than others. In the mass market segments, the big European and US brands working off local joint ventures continue to do relatively well. Consumers are attracted to foreign brands that come with a better reputation for quality. And local brands have been squeezed over the past few years.
China's domestic automakers reported sharp profit declines in the first half of this year as the vehicle market slowed. FAW and BYD were among those reporting a significant fall in sales in the Chinese car market. Local makers report decreasing vehicle prices and growing operating expenses as well as poor sales of local brands and so-called 'sub-brands'.
There is, however, some comfort derived from the fact that the overall market this year continues to show growth. According to data issued by the China Association of Automobile Manufacturers (CAAM), vehicle sales in October were 1,606,000 units, up 5.3% compared with the same period of last year. Among main automobile categories, passenger car sales was 1,298,900 units, up 6.4% on last year. From January to October, Chinese auto sales exceeded 15,700,700 units, an increase of 3.65% from a year earlier. Passenger car sales increase 6.9% year-on-year to about 12,571,100 units.
The association's statistics also showed that most of the automakers failed to reach their sales target in the first half of the year with the exceptions of the big joint ventures - Shanghai GM, FAW Volkswagen, Shanghai Volkswagen and Chang'an Ford.
Chery Automobile Co, China's biggest homegrown automaker by sales, reported a sales decline of 9% from the previous year to 265,500 units in the first six months.
Over-optimistic manufacturer projections for the year are now being revised down. "The manufacturers should think over their previous sales target for the whole year, and consider seriously how to adjust their production and sales plan for the second half," said Dong Yang, CAAM secretary-general.
There are also problems in the retailing sector. About one-third of car dealers in China missed their sales targets in the first half of 2012 and 49% posted losses, according to a JD Power survey. China's auto market had a sudden drop in demand in 2011 but the number of auto dealers grew percent year-on-year to 16,300, resulting in large inventories. Some analysts say that the sales structure in China needs to change. For a typical domestic dealer, 90% of operating income comes from sales of new cars, while in a mature market the figure is around 55%, with the rest coming from other revenue streams such as used car sales and after-sales service. These areas remain underdeveloped in China, so any easing of demand is immediately felt by dealers on their bottom lines.
Japanese brands plummet, provide relief for others
While 2012 has seen some manufacturers struggle, there has been some relief for domestic makes as a by-product of the acute problems being felt by Japanese brands in the Chinese market. The big story right now is the hammering for the Japanese brands – principally Toyota, Nissan and Honda - that has been a consequence of a high-profile diplomatic dispute between China and Japan (disputed islands in the East China Sea). That, it appears, has provided a market opportunity that some local Chinese brands have seized.
"The sales of Japanese-branded vehicles dived 56.5% in October due to the Chinese consumers' anger against Japanese products," said Rao Da, the secretary-general of the China Passenger Car Association.
As a result, Japanese car makers are now cutting shifts or even halting production. The recent tough actions from Japanese government and right-wing politicians are likely to make the situation even worse in the coming months, some commentators say.
Meanwhile, Chinese consumers have gravitated to other brands. GM and Ford reported record high monthly sales figures in China in October. GM and its joint ventures sold an October high of 251,812 vehicles in the country, a 14.3% rise on an annual basis, while Ford sold 60,518 vehicles during the month, a 48% increase from last year.
While the European, American and Korean car makers (Koreans also benefiting from new model introductions) have all gained market share in 2012 at the expense of the Japanese brands, the biggest beneficiary in the long-term may be Chinese companies. In October, sales of the local brands grew by 16% year-on-year. The SUV segment, which was up by more than 50% during the month, was the growth driver for the local players, with the big winner being Great Wall which registered a 77% increase in unit sales.
It is still too early to say how permanent the damage done to Japanese brand sales will be in China, but the impact of recent months suggests that it's far from being a short-lived impact. For the next twelve months, however, the impact will be significant.
Toyota has said it expects to sell 200,000 fewer vehicles in China in the second half of its fiscal year and in October alone, Toyota saw its sales in China drop 44% from a year earlier. Honda has cut its full-year sales forecast in China to 620,000 vehicles, from 750,000 units. Nissan and its China joint venture with Dongfeng Automobile Group sold 64,300 vehicles in China in October, down 4% from a year earlier. Nissan now expects to sell about 1.18 million vehicles in China this fiscal year (to end March 2013), down from a previous target of 1.35m units.
The president of Fuji Heavy Industries, maker of Subaru cars, has said its vehicle sales in China will remain sluggish for some time. "The situation (in China) is quite severe... I am sure (sales) will recover in the future but it's going to be hard for the time being," Yasuyuki Yoshinaga said.
For now, non-Japanese automakers are benefiting from the sales slump of Japanese cars. There are concerns over longer-term impacts. For example, investment in China's components industry from Japan could suffer as Japanese companies look to invest in other parts of Asia. And trade between Japan and China in automotive parts could also be hit and there could be supply-chain issues that would impact the Chinese automotive sector generally.
Car market heading for 25m pa by end-decade
As we look ahead to 2013, prospects for vehicle sales in China appear reasonably bright, the dispute with China notwithstanding. The Chinese economy has slowed in line with Beijing's plans and there are tentative signs that demand will pick up next year as China's economy and manufacturing sector is increasingly driven by rising domestic demand. Replacement demand will be building from the sizeable markets of 3-4 years ago. The spread of vehicle sales from so-called tier 1 cities to the tier 2 and tier 3 cities continues.
Inside China, hopes are high that car sales will rise by around 10% in 2013. Industrial output and exports picked up sharply in October. The Economist notes that growth is unlikely to slow further in this cycle. The worst of the risks associated with the real-estate boom may have passed, even if they are not gone completely. The professional forecasters acknowledge the short-term risks associated with the global economy and its impact on China's economy, but also point out that China's economy is in transition and that domestic consumption is rising.
John Zeng, Managing Director of LMC Automotive Consulting (Shanghai) Co.,ltd, says that China has a unique economy structure, shaped and tightly linked with China’s political business cycle. Investment has been the primary driver for Chinese economy growth in last two decades, and the rotation of central government has had significant impact on the investment cycle. “2012 is the year of leadership transition, therefore government eyes are on stable growth. Investment has slowed down and consumption will overtake investment this year to be the primary driver for growth, for the first time since 2001,” he says. “However, investment level has been gradually picking up since Q3 and is likely to ramp up toward the next peak from 2013 under the political business cycle, and this will provide a strong tail wind for the Chinese economy.”
Therefore despite the rising concerns on the short term economic slowdown and the anti-Japanese sentiment brought by the Japanese bilateral diplomatic dispute, LMC's long-term forecast remains bullish. “Chinese passenger car market is in its early stage. Car density per thousand population only stood at 50 in 2010, and the percentage of first time buyers in 2011 is as high as 82%. Many Chinese people are still eager to get their first car in their life, and the passenger car market could reach 25m units by the end of 2019,” Zeng maintains.
A study by consultants Frost & Sullivan forecasts that China is set to become the largest economy in the world by 2025 with a nominal GDP value of US$38 trillion. Fuelled by a strong urbanisation rate, a favourable corporate environment, huge infrastructure investment and the largest working age population, the Chinese economy will finally transform itself from being the manufacturing site of the globe to one of the biggest and largest consumer markets in the entire world.
The make up of the market and industry in China will be changing in the medium-term. A study by consultants Arthur D Little also points out that as the vehicle market in China matures, there will be a change in the ratio of first-time to second-time car purchasers. Today, about 80% of customers are first-time purchasers; by 2019, there will be more second-time purchasers than first-time purchasers, they say. Opportunities lie ahead in the parts aftermarket and in used cars as the fleet of vehicles in use rises and average age of vehicles lengthens.
European premium brands doing well
The German premium brands are continuing to perform well in China, although there are signs of higher levels of discounting in premium segments of the market, too. BMW has maintained its full-year guidance on its financial projections because it has been buoyed by Chinese revenues – to offset 'headwinds' elsewhere. On releasing its Q3 results, BMW noted that previous growth rates of 50-70 per cent in China would not be been seen in the future and instead China would become a 'normal' market for BMW, with lower double-digit percentage growth. But volume growth for BMW remains high this year. In October, mainland China sales rose 51.7% to 27,828 as local production of the BMW X1 and 3 series rose. Year-to-date, 264,884 vehicles have been sold, an increase of 35.2%.
Sales by Audi in China grew almost a third to 330,582 units in the first 10 months of this year, its biggest single market in the world. Audi's three locally made models -the A6L, A4L and Q5 mid-sized sports-utility vehicle - remain its biggest sellers in China.
Audi is aggressively aiming to add models through localisation. The brand will introduce the Q3 compact SUV and A3 compact sedan through local production. Audi's plan calls for the Q3 to be made at Sino-German joint venture FAW Volkswagen's plant in the northeastern city of Changchun at the end of 2012. Local A3 production will begin next year at the joint venture's new factory in Foshan in South China's Guangdong province. Audi is also studying feasibility of putting an A6 plug-in hybrid sedan on the Chinese market with FAW Volkswagen.
Official subsidies designed to encourage sales of small or environmentally beneficial cars in China have had limited impact on the market. One problem is the level of discounting and incentives in the market generally at the moment. Also, Chinese companies and consumers have been drawn to the dominant technologies employed by the foreign OEMs, seen as a model. But some companies see growth ahead for alternative powertrain technologies, especially electric vehicles and hybrids, helped by government policy initiatives.
For example, Wang Chuanfu, president of BYD, has said that the company expects its business in new energy vehicles to be profitable in the fourth quarter this year, though with a small margin. He added profitability is likely to increase in 2014 when the market may take a turn to larger-scale use of new-energy vehicles.
The Chinese government has been calling for more new energy vehicles on the roads to save energy and cut emissions. An industry plan released in June by the State Council set the 2020 target for total production and sales at 5m pure-electric vehicles and plug-in hybrids, with annual production capacity then reaching 2m such vehicles.
SAIC Motor Corp has also just launched its first mass-produced all-electric car, the Roewe E50. And the first product from BYD's joint venture with Daimler for electric vehicles is set to hit the market next year. There are also suggestions that Tesla is preparing to enter the Chinese market, first with a showroom planned for Beijing.
China’s severely fragmented car industry has long been considered in need of rationalisation to encourage greater use of scale economies and help companies become internationally competitive. There are some signs that the pressures at work now – demand slowing and overcapacity – are nudging the industry in that direction. A deal is expected to be signed soon between Guangzhou Automobile Group and Chery Automobile to share technology as well as cooperate on sales and marketing.
Chinese media reports said the deal involves sharing engines and platforms but does not involve equity stakes or the joint ventures both have with foreign carmakers. Although there have been small mergers and takeovers in the past, there have been few collaborative agreements. The problem is the involvement of stakeholders in China's provincial and municipal governments. They have encouraged China's auto industry to develop a strongly regional character, rather than national. Many in China will be hoping that the next few years will see greater consolidation so that the emerging large automotive groups are competitive, both in China and outside China. But the experience in the market of the last two years suggests that the foreign partners remain very important to domestic Chinese players, especially in terms of technology and broader know-how. The smaller independents are moving up the quality and value curve, but they are still some way off international benchmarks.