China Autos: The Race To The Bottom

ChinautosalesWSJ8May2014

 

By John Richardson

CHINA’S autos market is not behaving in the way that it did in 2008-2013, when, as the chart above further illustrates, demand growth was nothing short of staggering.

In Q1 of this year, sales growth moderated to 10% – and we think it will go much lower. This 10% compares with 16% in the first quarter of last year.

Here is why:

  • The great credit drawdown is in full swing, making it harder to obtaining financing to buy a car.
  • China’s “war against pollution” involves city-by-city measures to limit auto sales, in response to the environmentally ruinous demand growth of the boom years.
  • “It’s too expensive to own a car,” a 29-year-old Shanghai school teacher told the Wall Street Journal. The cost of living in general has risen very steeply in China’s big cities in particular – and the headline consumer price inflation numbers do not fully reflect the real costs of living. One wonders how China can rebalance its economy towards much-greater domestic consumption unless it, somehow, reduces the real costs of living.

Meanwhile, as these trends develop, foreign and domestic auto makers continue to add capacity.

Volkswagen and its Chinese partners will, for example, invest $25.3bn by 2018 to increase their annual production capacity to 4 million vehicles from 3.3 million vehicles, adds the same WSJ article.

Foreign auto executives, who attended last month’s Beijing Automotive Exhibition, were nevertheless upbeat.

They talked about making cheaper cars to get past the budget problems of people like the 29-year-old Shanghai teacher, which we referred to above. Honda, for instance, plans to unveil a new Fit Sedan with a price starting at $11,272.

But will $11,272 be cheap enough?

We think this will be nowhere cheap enough, because, when you take away the “wealth effect” of excessive credit creation, you are left with the reality that China remains, essentially, a poor country.

The data tells us this – this is not an opinion.

Average per capita urban incomes were Yuan9547 ($4769) in 2012, according to the Chinese government’s National Bureau of Statistics (NBS). Per capita rural incomes averaged just $1276 in 2013, added the NBS.

Executives attending last month’s auto exhibition in Beijing also made great play out of the potential for demand growth in China’s third and fourth-tier cities – where auto ownership levels are much lower than in China’s bigger first and second-tier cities.

But the trouble is that income levels in these less-developed cities are often lower than the nationwide averages we quoted above.

Fellow blogger Paul Hodges identified this trend in July 2013, when he wrote in this post:

Increasing restrictions on new car sales in the Tier 1 cities lead analysts Neilsen to suggest 70% of car buyers will have to come from Tier 3 and 4 cities next year, compared to 50% today.

Lower incomes in these cities will mean demand is for smaller, cheaper cars – more likely to be supplied by Chinese rather than foreign manufacturers. 

Or, perhaps, if they can make it viable, foreign companies such as Nissan-Renault might also seize a share of this incredibly low cost, but big-volume market. In late 2012, it announced it would re-launch the Datsun brand for emerging markets, where the price tag would start at only $3,000.

But, given the extent of oversupply amongst China’s local auto producers, it seems likely that the domestic companies will lead the market on its race to the bottom.

China’s overcapacity in the passenger-vehicle market could total 8 million vehicles, most of which will be on the books of local companies, estimates UBS. By comparison, globally, Ford produced 6.3 million cars in 2013.

Plus, we think it likely that further preferential financing cannot be ruled out for some companies,even though the government is driving consolidation in the autos sector. Job creation may, in some regions, come before restructuring – resulting  in further downward pressure on prices.

What does this mean for the chemicals and polymers that goes into autos? In our next post, we will look at the implications for impact copolymer polypropylene (PP).

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