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