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China auto market to focus on low-cost, not luxury

Consumer demand
By Paul Hodges on 31-Jul-2014

China autos Jul14aThe key to forecasting China’s auto demand since 2008 has been the level of bank lending, as the chart above shows.  This was critical in making China the world’s largest auto market.  Official data shows average disposable income was just Rmb 10k ($1600) in H1 2014, making it impossible for most people to buy a car out of income:

  • Purple period, 2008, saw auto sales of ~600k/month and lending of Rmb 400bn/month ($65bn)
  • Blue period, 2009, of panic stimulus saw auto sales increase 50% and lending almost treble at one point
  • Black period, 2010-2013, was more stable with auto sales at 1400/month and lending Rmb 600bn/month
  • Brown period, 2014, has seen auto sales stabilise at 1600/month, and lending at Rmb 900bn

Since 2005, total auto lending has thus risen 4700%  from just Rmb 6bn to Rmb 282bn by Q1 2014.  Direct retail loans to customers grew 15000% from Rmb 1.3bn to Rmb 195bn over the same period.

This highlights how China has seen the auto industry as being key to maintaining employment, and thus a priority area for support.

However, there are increasing indications that the nature of this support is changing.  Past performance may well prove an unreliable guide to the future.

One sign is that many more cities are introducing purchase restrictions on new car sales to reduce pollution.  Beijing, for example, will only allow an extra 400k cars on the road between now and 2017, for a total of 6m.

At the same time, the auto association has warned that demand for commercial vehicles slumped in HI, adding:

“We believe the economy hasn’t shown obvious signs of improvement in the second half.  It’s hard to say whether more local governments will issue restrictions this year but this is definitely one of the risks we have to take into account.”

A second sign is the decision to strip most officials of their government car, and replace it with an allowance of $80-$210/month, depending on rank.  This will be bad news for overseas brands, which have held 80% of this $675m market.  Audi will be badly hit as it supplies around a third of the volume.

A 3rd challenge is that China now has 137m cars on the road, as a result of this hectic sales expansion:

  • Used car sales will start to become more significant for the first time
  • Their volume will double from just 5m/year last year to 10m next year
  • Equally, of course, new domestically-oriented markets for servicing and maintenance will also develop

There are also signs that dealers may gain power versus manufacturers – at the moment, they can often be forced to hold vast inventory. China Daily reports this has been rising rapidly in recent months, with some dealers now holding more than 5 months stock.

The final challenge also relates to pollution.  The government currently plans to take 6m high-polluting cars off the road this year, and we can assume it will subsidise their replacement – thus helping to maintain volumes.  But it is likely that much of this support will be tied to the use of electric cars, with refuelling costs set to be 30% below gasoline prices.

Urban areas with fixed routes for official cars will now have to buy electric cars, whilst those suffering extreme cold can buy hybrids.  And subsidies (including exemption from the 10% vehicle tax) will only be offered for cars costing up to Rmb 180k ($29k).

International car companies, and their suppliers, will need to move fast to realign themselves with this new direction.  In the past, the money was made by selling high-priced cars to government officials and those benefiting from the property bubble.

In future, as GM have confirmed, growth will focus on  the low-cost market of cars selling for $7k in poorer areas outside the major cities, where car ownership is still relatively low.  Electric and hybrid vehicles will be the other main growth driver,