Talking Point

Running out of gas?

Why surge of sales in June did not boost confidence in China’s car market

Car-Main-w

The Chinese name for Pangda Automobile means “very large” and Pangda was once the world’s most valuable car dealership, with a market value that came close to Rmb100 billion ($14.5 billion) when it was the first of its kind to go public on the A-share market in 2011.

More recently Pangda’s financial problems have made less welcome headlines, after the 800-store dealership declared bankruptcy protection (its market value has plunged to Rmb8 billion). That led to questions about whether its so-called “4S” (sales, service, spare parts and surveys) dealership model had run its course in China.

Much of the answer hinges on the health of the world’s largest car market, which stopped growing last year for the first time in nearly three decades.

How did car sales fare in the first half of 2019?

The official report came in last week and it wasn’t pretty. According to the China Association of Automobile Manufacturers (CAAM), 12.3 million vehicles were sold over the first six months of 2019, or 12.4% less than in the same period last year.

Many analysts had been expecting tougher times after sales dropped 2.8% to 28.1 million vehicles in 2018, the first annual decline in 28 years. But according to Car Commune, a WeChat blogger widely followed by industry insiders, few had expected things to get even uglier this year as well.

“After a cold winter that has lasted for 12 consecutive months, those who were expecting the car market to return to growth have given up their hopes,” the blogger wrote this week.

Car sales hit reverse gear in May last year but the slide has accelerated during the January-to-May period in 2019, with the year-on-year declines exceeding 15% each month.

There were some signs of recovery in June as retail sales rose 4.9% to about 1.8 million units but analysts say the growth spurt won’t last because it was driven by a one-off factor: dealers were unloading older stock before new emissions standards took effect this month (more on this later).

Eighteen provinces and regions – which account for most of China’s car sales – required vehicles to meet the new standard as of July 1.

“Everyone’s realistic about the rocky road ahead,” Car Commune admitted. “The year-long consolidation is set to reshape the Chinese car market and its ecosystem entirely.”

Which carmakers disappointed most?

At the beginning of the year, CAAM was expecting zero growth in 2019. Now the consensus view is that the market is heading for a back-to-back drop – and probably a hefty one.

With sales already struggling in China amid slowing economic growth, American car firms were on the receiving end of a double whammy, thanks to Donald Trump’s trade war with China, which has further eroded Chinese consumer sentiment and stoked an anti-US mood.

General Motors said last week that sales in China for the three months ending in June dropped 12.2%, while Ford’s sales slumped by 21.7%. The duo reported falls of 17.5% and 35.8% respectively in the first quarter.

South Korean carmakers like Hyundai were also hard hit. Through its joint venture with BAIC, the Korean firm sold more than a million vehicles in China before South Korean brands took a buffetting from a diplomatic spat about the deployment of the American THAAD anti-missile system two years ago (see WiC354). Its affiliate Kia Motors also sold 650,000 units in 2016. Hyundai managed to sell another 790,000 units last year while Kia’s sales dropped to about 370,000 units. The slowdown forced Hyundai to cut about 1,000 jobs in China last year, with Kia laying off 300 employees, Korea Times reported last week.

The situation continues to look grim as the duo’s sales dropped a further 22% during the January-to-May period this year.

Most of the Chinese carmakers have also reported disappointing sales. Of the top 15 local brands, 10 have seen sales declines for the first half. Geely, the top-selling local brand, sold nearly 654,000 vehicles during the period, or 14.5% down year-on-year. Great Wall, the runner-up last year, reported a 23.2% decline to 374,500 units.

That prompted a profit warning last week from Geely’s Hong Kong-listed unit, which told investors in a stock exchange circular that its profits for the first half will take a 40% dive from the Rmb6.7 billion ($973.9 million) made last year.

At the same time Geely cut its 2019 sales targets by 10% to 1.36 million cars. Geely’s share price has dropped nearly 40% in the past three months to a near two-year low (as of this week).

Is anyone doing better?

Among the companies which have already published their first-half results, most failed to pass their mid-term-exams, Guangzhou Daily said, in achieving half of their full-year sales targets by the end of June.

An exception were a couple of Japanese carmakers working with Chinese joint venture partners. As of June, Honda’s JV with Guangzhou Auto Group (GAC) had sold more than 394,000 vehicles in China. That is 16% higher than last year and comprises 51% of its 2019 performance target. Likewise, GAC Toyota completed nearly 52% of its sales goal this year by selling more than 380,000 units, a 6% year-on-year improvement.

Toyota’s other joint venture (with state-owned FAW Group) is the only other outperformer, reporting a 22% rise in first-half sales to about 311,000 units.

Why the sales revival in June?

The June rebound stirred little optimism in the broader market. Volkswagen, for example, openly attributed its stronger sales in June to changes in China’s vehicle emissions rules, which saw dealers offer steep discounts to cut inventories of vehicles that fell short of the new tougher requirements.

The so-called “State VI” standard went into effect on July 1 in many Chinese cities. The new format is equivalent to the Euro VI threshold and it’s designed to slash emissions of major pollutants by half from the previous standard. The central government previously planned to implement it by July 2020. However, policymakers decided to speed up the schedule amid increasing public concern about air pollution (see WiC178).

The new rules have made it illegal to sell vehicles that do not comply with the State VI standard. As a result, Caixin Weekly reported last month that as many as three million cars were sitting on dealership forecourts across the country needing to be offloaded fast.

That equates to Rmb500 billion in inventory value with 4S shops like Pangda rushing to sell the now sub-standard vehicles via a range of incentives.

Reuters reported the frantic efforts at a Shanghai-based Buick dealership from late April as it sought to sell almost 80 older sedans and SUVs that couldn’t be sold after the June 30 deadline, for instance. “Customers didn’t know how long they could drive China-5 cars or whether they would be able to resell them in the future. And to be honest, we didn’t know either,” its boss admitted. To clear the stock, he had already cut prices by as much as 30%, he said.

In other words, last month’s sales rebound was driven by dealers selling many of their vehicles at a loss. Even so Caixin Weekly cited a survey by the China Auto Dealers Chamber of Commerce (CADCC) that two-thirds of the 4S shops wouldn’t be able to sell their full backlogs of State V cars. Worse, some are locked into long-term contracts with the automakers that compel them to keep buying the vehicles – even though they won’t meet the new emissions standard.

Thousands of 4S shops are suffering, with car industry journals using phrases such as “a deadly turn” and “the darkest moment” to describe the dealerships’ situation.

How grim is the 4S market?

Photos of an unusually large rice noodle restaurant went viral among car fans last month. Situated in a prime shopping district in Shenzhen, the shop was set up as a 4S store but after struggling to survive its owner decided to change track.

“I make more money selling a bowl of rice noodles than selling a car,” he ominously said.

The first 4S store was set up in 1999 by GAW-Honda in Guangzhou. Following China’s accession to the World Trade Organisation, more car brands arrived in the Chinese market and the new dealerships – as the major retailing channel – enjoyed explosive growth.

But this is a capital-intensive industry. Apart from large showrooms and parking spaces, dealers have to find the finance to prepay the carmakers, which typically sell their stock to 4S stores at a discount. In a booming market, running a 4S was a surefire way of making money but Daily Auto News reports that many of the shops are now struggling to survive. According to the CADCC, the number of 4S stores nationwide numbered 29,249 last year, a small increase on 2017. But a little over half were lossmaking and 27% of them have been in the red for three consecutive years.

The aforementioned Pangda looks like it could be the first domino to fall. During its heyday in the early 2010s, Pangda ran more than 1,000 stores and its sales topped Rmb70 billion a year. Last year it cut its retail network by 229 stores to about 800. The downsizing included selling five Mercedes-Benz 4S stores to market leader Guanghui Automobile for Rmb1.2 billion, plus another nine of its profitable 4S shops to the Hong Kong-listed Zhongsheng Group (the second largest car dealer) for Rmb1 billion.

The asset sales were a bid to offset the weaker performance in its underlying business. Pangda reported a 40% decline in revenues in 2018 to Rmb42 billion (ranking 9th after selling about 251,000 new vehicles). That resulted in a Rmb6 billion loss.

With weaker cashflows, there had been reports of liquidity trouble. The pressure was confirmed last month, when Pangda had problems paying back a Rmb17 million loan, Beijing News says. Despite what seems like a relatively small liability, the company opted for bankruptcy protection.

The Shanghai-listed firm could still survive by engineering a successful restructuring or bringing in a new controlling shareholder. But Beijing News said the industry has been wondering more “who might be the next Pangda”. Acknowledging these concerns, the Shanghai stock exchange sent a number of queries to similar firms such as Guanghui last month, asking for more information on their financial situations.

Will the government help out?

After the 2008 global financial crisis Beijing saw the car market as a way of boosting domestic growth and it dished out a slew of tax incentives and subsidies to encourage buying. The result was a 45% spike in sales the following year but the worsening of traffic congestion and urban air pollution over the past decade has spurred a series of contrary views on supporting the sector.

For example, when Zhu Rongji published a compilation of his prime ministerial speeches, he highlighted his 2003 speech on public transport as the concluding chapter. Zhu’s point: he had sternly opposed subsidising passenger car purchases with public money (i.e. tax rebates).

Policymakers seem still to be conflicted on their approach to the car market. At the beginning of this year, government officials and state-run media outlets were talking up the prospect of a generous stimulus plan. However, these hopes were largely dashed when the policy measures were unveiled last month. The government did offer help to vendors in a few large cities such as Guangzhou and Shenzhen, promising to issue more new car licence plates, but the cream of the stimulus measures were confined to new energy vehicles (NEVs), not cars with gasoline engines.

Industry analysts such as Car Commune think the central government is going to take a harder line, applying the principle of survival of the fittest in what is already an oversupplied market.

“Take State VI, for example. At first many people thought the policy was set out to protect the blue sky but we now realise that it is a battle to consolidate the car market,” it noted. “If you complain over a mere emission standard upgrade you probably don’t deserve to survive at all.”

The sales crunch is just one of a number of changes coming to the 4S market. Foreign carmakers such as BMW have been trying out new sales channels, including their own internet platforms. Then there’s Tesla, which will start trial production at its new Shanghai factory in September. The American firm plans to add to the disruptive mood in the market with a direct sales model that bypasses middlemen i.e. 4S dealers.

After many years of cruising along in fifth, the sector’s executives are discovering that the China market has another significant gear too – reverse – and that their businesses aren’t so well engineered for that.


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