China Meltdown Leaves Global Carmakers Burned
When a chemical warehouse in Tianjin, China, exploded this month, destroying some 10,000 parked vehicles, cynics suggested that the disaster might actually be for the best, given the massive glut of unsold cars sitting on Chinese lots. Yet with the turmoil in China's stock markets continuing to pummel the troubled auto sector, it seems that any true industry correction will require a considerably larger explosion. The situation leaves the world's biggest automakers torn between their desire for short-term dominance in China and the need for a painful correction to stabilize the world's largest car market for them.
There is no understating the importance of China to the big car producers: With only 106 cars per 1,000 Chinese right now, analysts say demand still has the potential to exceed 35 million units by 2020. Yet rising inventories have been putting pressure on new-car dealers, resulting in severe price-cutting and open rebellion between the China Automobile Dealers Association and manufacturers late last year. By last month, when China's stock market began melting down, import car dealers were facing as much as 143 days of supply. With new car sales falling nearly 7 percent in July and headed toward their first net-negative year in recent memory, it seems likely that oversupply will haunt China's auto market for the foreseeable future.
Global automakers have begun responding by cutting production at existing plants, and Toyota has extended production stoppages at its Tianjin joint venture. An index of 23 major Chinese automotive joint ventures shows they are operating plants at less than full capacity for the first time ever. (The Chinese government mandates that all foreign investors have domestic joint partners.) The two biggest foreign players, GM and Volkswagen, have also slashed prices in hopes of turbocharging demand. But the effectiveness of these moves will depend on how large of a hole the automakers have dug for themselves. It seems pretty clear that Volkswagen has been overstating its Chinese sales numbers by booking 60,000 to 100,000 vehicles per year as “unsold deliveries.” In the race to dominate Chinese and global sales rankings, automakers seem to have been delivering cars without buyers, potentially creating an oversupply time bomb.
On the strength of these overheated numbers and the frantic competition for sales volume in their last great growth market, automakers have been investing in joint ventures for years, which now seem likely to run at undercapacity for the indefinite future. GM has announced it will put another $5 billion into China through 2018 -- for a total of $16 billion -- moving to increase production from 3.5 million units annually to 5 million units. Volkswagen plans a similar 40 percent growth through 2019, also to 5 million units per year. Even less China-dependent firms, from Toyota to Hyundai, are locked into new plant capacity there. Unless demand picks up, the market's most dominant firms could find their aggressive growth strategies turned into anchors, as rule of thumb holds that profits turn to losses when plants operate at below 80 percent of capacity.
Yet automakers seem intent on ramping up production. It's true that the long-term fundamentals still look incredibly bullish by global standards. And with only one in five Chinese car buyers relying on credit -- a welcome alternative to the boom in subprime loans in the U.S. -- there does seem to be bandwidth to bring more demand into the market. The catch is that automakers would be best off now aggressively working to curb oversupply and to keep prices from spiraling downward; then a strong market correction could lay the foundation for a long-term return to growth. But if cutthroat competition for volume sales persists, exacerbated by weakness in the other once-promising BRICS markets, automakers could be headed toward a massive pileup in China.
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