The Unnerving Thing Global Automakers Just Said About China’s Economy

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Global automakers, still intoxicated with their own optimism after years of white-hot growth that transformed China’s auto market from a backwater to the largest market in the world, have an increasingly chilling message.

The auto industry is a huge force in driving economic growth in China. Most vehicles sold in China are manufactured in China. The component industry has been booming. The distribution and dealer network has been growing in leaps and bounds. Every new plant and dealership means more construction, more equipment, more jobs. Then there’s finance and insurance and all the other elements that make up the car business. But now there’s a slowdown.

Today it was BMW. China has been BMW’s largest, most promising, nirvana-like market. Not that BMW’s results for Q2 were that bad. The euro’s swoon produced a year-over-year sales gain of 20%. Yet, due to soaring costs, despite the weak euro, net profit fell 1.1%.

The problem: China’s market is “normalizing” and “becoming increasingly competitive,” BMW said in a statement. “In the medium and long term, we remain utterly convinced of China’s potential for growth,” it said. But it warned, “If conditions on the Chinese market become more challenging, we cannot rule out a possible effect on the BMW group’s outlook.”

China’s contribution to BMWs operating profit dropped 23% in Q2, echoing Volkswagen’s report last week. BMW has cut production in China by 16,000 vehicles this year, CFO Friedrich Eichiner explained. He blamed the stock market. As it crashed, it kept customers from making large purchases; others demanded hefty discounts.

“Normalization” means the Chinese market is in the transition from Nirvana to a rough-and-tumble saturated market where brands have to fight each other for market share to get any sales increases. But no problem: “In the medium and long term, however, we remain utterly convinced of its potential for growth…” he said.

Luo Lei, deputy secretary-general of the China Automobile Dealers Association, also blamed the stock market for the deteriorating auto sales, according to Automotive News China. “A stock market plunge hurts consumer confidence,” he said Friday. “People wouldn’t want to spend on cars when the market keeps on declining. Dealers are sacrificing their margins and giving out big incentives to help attract buyers.”

If the stock market slump continues, auto sales in 2015 could drop below the level of 2014, the association said. Even if the market stabilizes and if the economy recovers, vehicles sales might only rise 1% or 2%.

And that in a market accustomed to double-digit growth rates! The entire equation falls apart when the auto market stalls, or worse, declines.

Last week, it was Ford that threw in a dose of reality, when CEO Mark Fields fretted: “It’s clear we’ve seen a … slowdown in the market there in the industry.”

Given deteriorating demand, Ford lowered its projections for the industry to a range of 23 to 24 million passenger vehicles, buses, and commercial trucks. At the high end, it would be a measly 2% increase. That’s the rosy scenario! At the low end, industry sales would drop 2%. It would be the first annual drop since at least 1998 (when sales figures, rather than just production figures, became available).

He too was suffused with optimism: “We’re still very bullish on China, but it’s going to go through its fluctuations and that’s what happens in emerging markets and we’re going to work our way through it in a positive way and grow the business.”

But here’s the thing: The downdraft predates the stock market rout. It began last year with smaller and smaller sales increases, even as stocks were booming. In 2015, after the volatility around Chinese New Year had subsided, the downdraft worsened, with sales increases sharply deteriorating until they turned negative in June, dropping 3.2% from a year ago, according to China Passenger Car Association. July deliveries haven’t been published yet, but they’re going to be tough.

And inventories at dealerships were high in June. Normally dealerships in China have on average from 24 to 36 days’ supply on their lots. In June, they had 50 days’ supply, with imported vehicles at 73 days, China-built foreign-brands at 45 days, and Chinese brands at 55 days. Among them, Chery had a catastrophic 101 days’ supply.

Hence the price wars. They were instigated with big discounts by VW, whose sales plunged 17% in June and are down 3.9% for the first half, and by GM, then followed by other automakers. Profit margins are getting pressured even as industry volume declines. A toxic mix.

“There’s excessive competition, and carmakers are building excessive capacity, and to raise utilization of the plants, they will engage in excessive selling,” said Fumihiko Ike, chairman of the Japan Automobile Manufacturers Association and chairman of Honda. He saw a “downward spiral” that would eventually hit Japanese automakers.

They had a terrible time after the anti-Japanese protests in 2012. But finally, the Chinese are buying Japanese again. So far, 2015 has been good for Japanese automakers. Their combined market share reached 20%, last seen before 2012.

“But sooner or later, as the overall demand cools, they will also be affected by excessive competition,” Ike said. “We can’t be optimistic.”

This was echoed on Tuesday by Toyota, which reported record profits of ¥646.4 billion in its first quarter, but only because of the devaluation of the yen. For every yen that the dollars rises in value, Toyota expects its annual operating profit to increase by ¥40 billion. Without the devaluation of the yen, Toyota’s operating profit would have declined, on slowing demand in Japan and Southeast Asia.

Then there’s China. According to the Wall Street Journal:

The recent slowdown in China isn’t fully reflected in Toyota’s first-quarter results because, like rival Nissan Motor Co., there is a lag of one quarter in incorporating China-related figures in the company’s earnings because of accounting methods.

In China, Toyota has booked a 10% unit sales increase during the first half from the crummy sales in 2014. But it has been offering larger incentives for its dealers to get there – about $200 million, according to the China Automobile Dealer Association. Tetsuya Otake, Toyota’s managing officer, echoed Ike when he said, “We can’t be optimistic when it comes to profits.”

And the bane of the auto industry – overcapacity – is appearing. Average capacity utilization across international auto brands in China has dropped to 94.3% in the first half, from 100% when automakers were still producing all they could, according to Sanford C. Bernstein analysts.

Yet, automakers are still building new plants and expanding existing plants. The announcements by proud local officials hail down on a regular basis.

On Monday, it was the port city of Qingdao that announced on its website that Volkswagen would start construction on an assembly plant with an annual capacity of 300,000 vehicles, to be operated by the FAW-Volkswagen joint venture. Just when Volkswagen faces not only an industry slowdown but also its own sales fiasco in China.

The auto industry is so big in China that any shrinkage will hammer overall economic growth. And it’s not just the stock market’s fault, though clearly, the crash didn’t help. Signs of a slowdown have been getting more worrisome, such as electricity consumption, whose growth rate has dropped to a 30-year low. Read… What China’s Electricity Consumption Just Said about the Economy

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  18 comments for “The Unnerving Thing Global Automakers Just Said About China’s Economy

  1. steinm88299
    Aug 5, 2015 at 12:27 am

    China is the only hope for most of these companies. So they will keep plowing money into it blindly. Europe is a zombie and the U.S. is in an asset bubble. If companies speak honestly about China their stock will get whacked so they keep preaching how great it will be. Funny thing is AAPL is getting killed because of China fears but the rest of these companies aren’t.

    • d
      Aug 5, 2015 at 3:08 am

      AAPL = Canary.

    • Vespa P200E
      Aug 5, 2015 at 9:42 am

      It’s kind a amusing to hear the global stalwart companies in unison blaming China for its recent revenue and profit woes. What IF China is about to go thru wrenching hard landing mired in excess capacities of all kinds of assets and mislending filled with soon to be billions on non-performing loans thanks to mother of all lending binge unleashed in late 2008? Guess China will be blamed for Great Recession II or something.

      As for car mfg in China – there was this orgy of which global maker is out to outdo the other company of adding capacity when the auto industry itself is mired in global over capacity. Good luck trying export cars outside China too.

  2. PL
    Aug 5, 2015 at 4:49 am

    Funny.

    I’ve been reading in the MSM that the stock market fall in China is irrelevant to the broader economy.

    That’s why reading the MSM is only good if you want to make yourself feel better.

    Because the Ministry of Truth would like you to feel better

  3. MC
    Aug 5, 2015 at 6:39 am

    Carmakers at the moment have three serious problems on their hands.

    First is their sales have become completely dependent on a low interest rate environment. The present automotive boom in Europe is wholly the product of the ECB QE program which allowed big consumer oriented banks such Santander and Credit Agricole to “open the taps”.
    Second is they are literally drowning in the same overcapacity they were drowning in in 2008. If all the situation has become worse because more capacity has been added, both in China and in countries such as Slovakia, Thailand and Mexico to supply developed markets.
    Third is automotive CEO’s and CFO’s are still the same crew that peddled completely unrealistic long term growth numbers in 2005, causing all sorts of mayhem. They are still peddling the same numbers because they know they’ll get away with it. Blame the weather, blame the Chinese stock market, blame the Martians… shareholders rarely, if ever, obtain a head on a platter these days.

    Now, back in 2005 I predicted carmakers would manage to completely saturate the Chinese market in 15-20 years. I was wrong. They managed to do so in a decade. As usual, far from these people to display moderation in any way, shape or form.
    Now China will rapidly “devolve” in a large copy of the European car market, completely dependent on periodic bouts of monetary insanity/government incentives and with the Damocles’ Sword of consumer leveraging on its head.
    Because you can bet the Chinese government, to attempt turning things around, will soon leave no stone unturned to push their own citizens into consumer credit very much like they pushed them into stocks. If everything else fails, shopping malls will save the day: both the US and Europe have gone down that road and China has plenty of (semi-deserted) shopping malls.

    • Walt
      Aug 5, 2015 at 3:52 pm

      MC, you left out one other factor of note. Our domestic market exhibited pent-up demand the last few years, but now we are at the point where that has been filled and sales numbers will drop.

  4. ERG
    Aug 5, 2015 at 8:33 am

    Well of course the Chinese auto market is saturated. They have the same demographic problem as the US: an aging population. Only they are further along than we are. The problem with Socialism is not that eventually you run out of other people’s money. The problem is that eventually you run out of people.

  5. michael
    Aug 5, 2015 at 10:58 am

    My father used to by used cars and drive them until the wheels fall off. My 9 year old car runs just fine. Not that I cannot afford a new car, I just choose not to buy.

  6. NY Geezer
    Aug 5, 2015 at 11:17 am

    China is a mystery. Their economic numbers have been suspect for as long as I can remember. Rumors appear to be as reliable or more reliable than the governments numbers.

    The rumors I have heard is that when the Chinese economy slowed in 2014 and the PBOC pumped a massive amount of liquidity into the system to get businesses to borrow, expand and hire, businesses did borrow the virtually free money but did not invest it in their businesses because they viewed that as a waste in a slowing economy. Instead, just as US corporations have done, they bought stocks.

    This corporate stock buying forced the stock market higher, of course. And then unexpectedly(?) the public and foolish first time buyers jumped in with both feet and everything they could borrow and pushed the market much higher until recently when it crashed.

    The surging market was not an indication that the economy was good or improving. In fact it sucked even more money out of the consumer economy and consumer demand.

    The surprise expressed here by the auto companies is probably real, but very late.

  7. NotSoSure
    Aug 5, 2015 at 1:30 pm

    I still think there won’t be any Chinese economic crash soon. Things will just wobble along as they were.

  8. Vespa P200E
    Aug 5, 2015 at 1:47 pm

    Coming soon to Volvo dealer near you is the FIRST Chinese-made car to be exported to US.

    Volvo had to increase the legroom of rear passenger by few inches on S60 model and called it S60L since the well to do in China don’t drive themselves. I own ’12 S60 myself and would NOT buy Chinese made Volvos as next up might be Audis, VW, BMWs made in China making its way to US.

    • MC
      Aug 5, 2015 at 2:49 pm

      Well, I got news for you.
      Toyota and FCA set up a joint venture in China to manufacture chassis for small cars assembled in Europe and Thailand.
      BMW has their single cylinder motorcycle engines (G-series) manufactured in China by a local contractor.
      Chinese cars have already arrived in Europe. To get around import tariffs they stole a page from Chinese scooter manufacturers and have their vehicles assembled locally using knockdown kits (which are considered “components”, very much like the aforementioned Toyota and FCA chassis). To get around emission requirements on the cheap they usually put Mitsubishi engines in them.

      If we want to look a little further in Asia…
      All Toyota pickup trucks sold in Europe are now manufactured in Thailand.
      Most Honda motorcycles now sold in Europe are also made in Thailand. All Honda power equipment engines sold in Europe are made in either China or Thailand (again!).
      The popular Nissan Micra is built in India (European market).

      Looks like the flood has already started…

  9. Julian the Apostate
    Aug 5, 2015 at 2:48 pm

    I’ve been expecting a Chinese car since the Yugo. So far I’ve been disappointed. Always wondered what they would name the various models. A huge SUV called the Dragon King? Something to compete with the Camry/Sonata/Taurus called the Five Year Plan? I can hear the jokes now, plan on junking it in 5 years. A minivan for soccer moms called The Jade Gate ( yes I did) or a peppy sub compact for the youngsters called the Cultural Revolution? The mind runs wild. Welcome to Chinatown Motors a free fortune cookie with every test drive. Your salesman is here in the showroom but your closer knows Kung-fu and 3 other Chinese words. Your F&I man? Red, white and blue American! Nobody can load you up with things you don’t need like an American Bankster! On Mao Tse Donkey Kong Dr. , just look for the giant Fu Manchu Balloon!

    • Aug 5, 2015 at 3:54 pm

      For US car buyers: Volvo, owned by Zhejiang Geely Holding, has started shipping its China-made S60 Inscription to US dealers this year. They don’t even have a fanciful Chinese name. Just “S60 Inscription.” In China it’s called “S60L.” L for long wheelbase.

    • Nick Kelly
      Aug 9, 2015 at 10:30 am

      I too have been very skeptical of Chinese manufactures but am open to new data.
      I am dating myself here but exactly the same mockery was made of early Japanese stuff in the 60’s-70’s.
      (Going further back- the English expression ‘jerry built’ is an aspersion of low quality German work and the ‘Made in…’ label on everything today is a British invention to warn the buyer that he is buying low quality German stuff.
      Speaking as the holder of a British passport I guess we can say that kind of backfired. )

      However the Japanese were intent on giving the customer more than he paid for whereas with China there is a tendency to fool the customer. World famous travel writer Paul Theroux ( Riding the Iron Rooster etc.) heard this saying in Chinese “We can fool anyone’ at a swank reception of some kind and told the guy it was a dangerous saying because it wasn’t true.
      Speaking of world famous as a young guy i once sent away for a pair of ‘world famous’ binoculars – a manufacturer it hinted who needed to dump excess but didn’t want to use their name.
      So they arrive and they are from Chinese maker “World Famous’ and as I recall they were field glasses not true binos.
      But World Famous turned into a reasonable maker of budget tents etc.
      Japan once did something similar with a town called usa- so made in USA.
      I’m just saying that it is possible for China to close this gap. And some transplant manufacturers will control every detail

      • d
        Aug 9, 2015 at 9:31 pm

        chinese cars for chinese consumption have the same issue as Brazilian cars for Brazilian consumption.

        However chinese branded, export cars, will always have this issue, continuously or erratically, as there is profit in it.

        If you are willing to risk your children or grandchildren. Travelling in a Chinese Exported car, that may have a fraudulent “crash test certificate”. Then the potential catastrophic results are your responsibility. For chinese brand cars this “Issue” will never completely go away.

        GM with its global badge engineering, has been caught more than once, producing a car to a high crash standard, developing the brand name, Exporting it to Australia. Then producing it in Korea, For export to Australia, at a much lower crash standard, still trading on the former high crash standard of the brand name. (The Holden Barina Saga)

        GM taught the Koreans, Brazilians, and chinese how to increase profits in this way. china and Brazil, simply took the concept to level two, and three, three being fraudulent “crash test compliance certificates”. This is done simply by varying the power settings on the welders, until you crash test the car, or destructive test parts of it, you will not know.

        They can build 2 full strength, 2 medium strength, and 2 weak, in cycle, on the same assembly line, continuously, put top class “Crash test certificates” on all of them, and the consumer will not know. In Europe or America they can not get away with this, in china, if caught, the will simply blame a computer error and some Techie Employee without connections, will be offered up as a “Sacrifice”.

        Check why exactly the same car manufactured in Brazil and Germany has a different “crash test” rating. The relate the issue to the” Brazilian Road Toll”. The above is not a fairy story.

        Put Your Children, in a chinese brand name car, at your own risk.

  10. Julian the Apostate
    Aug 5, 2015 at 6:10 pm

    Wolf, the average Joe can’t tell the players without a scorecard. Not that I have any great burning desire to run out and buy a Volvo, but Good Grief. So many of the companies have been snapped up by the conglomerates. Just among our shippers Leaf Brands, Keebler, Ralston-Purina, and Iams pet foods all no longer free standing but just someone else’s divisions. Bummer.

  11. Cashboy
    Aug 5, 2015 at 7:24 pm

    You don’t have to be a genius to work out what is happening with China.
    1) West has run out of credit.
    2) Western goods are manufactured in China.
    3) China therefore has a reduction in demand for their goods from the West.
    4) Chinese companies have over capacity and lay off staff and reduce wages.
    5) Chinese people hence have less money to spend.
    6) Therefore a slow down in demand for goods in China from Chinese (go back to 4)

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