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Can China's auto market save GM? Do pigs fly?
05/04/2010 8:30 am EST
If you’re General Motors (GM), you invest as fast as you can in making and selling cars in China.
So great that Toyota (TM), and Nissan, and Volkswagen (VLKAY), and BMW (BAMXF), and Honda (HMC) and Hyundai (HYMLY) have all adopted the same plan.
The result is a capital spending spree so large, and resulting new manufacturing capacity so great, that it could be the cause of the next collapse and shake out in the global auto industry. And the best guess is that this shakeout could arrive as early as 2015. That’s long before companies such as General Motors that are still working to emerge from bankruptcy or companies such as Toyota that are struggling to rebuild profitability have put away cash for a rainy day.
The collapse is likely to be even more brutal than that of the U.S. car industry in the recent recession. (The auto industry story is just an extreme version of what I’ve called the danger of a profitless economic recovery. For more on what that means across the global economy, see my post http://jubakpicks.com/2010/01/19/get-your-portfolio-ready-for-the-profitless-global-economic-recovery/ )
I don’t think there’s any way that the auto industry can avoid this collapse. The logic behind expanding in China is just too irresistible.
The Chinese market is already the biggest by sales in the world, having passed the struggling U.S. car market in 2009. Car sales in China grew by 45% in 2009 and are projected to grow by 20% in 2010.
As stunning as that rate of growth is, some individual car makers are doing even better. At General Motors, for example, sales in March 2010 were up 65% from March 2009. For 2010 General Motors (and its local partners) could sell 2 million cars in China. Last year the company sold 2.1 million cars in the U.S. market. At Volkswagen, the market leader in China, sales grew in the first quarter of 2010 by 61% and that was a disappointment since the overall market in China grew by 72% in the quarter.
And it’s very easy to spin a story that says sales growth—if not at the 45% rate of 2009, then at the 20% rate projected for 2010--will continue for years and years as China gets wealthier.
The growth story goes like this: China has the world’s largest population at 1.37 billion with, by some estimates, as many as 300 million belonging to the Chinese middle class. But only 41 of every 1,000 Chinese own a car, Goldman Sachs estimates. That compares to more than 500 cars per 1,000 inhabitants in Germany and 780 cars per 1000 in the United States.
There’s are a lot of car sales between 41 cars per thousand people and 500 or 780 cars per thousand.
The problem for General Motors, and Volkswagen and every other car company selling cars in China is that the growth in demand is only part of the story. There’s also the supply side story in China. And that’s where things get ugly.
Everybody wants a piece of the growth in China’s auto market and everybody is building new plants to capture that growth.
Volkswagen, for example, announced on April 26 that it would add about $2.2 billion to its capital spending budget to build two new plants in China. That brings the company’s capital spending plans to $8 billion for the next three years.
BMW, currently No. 4, in the Chinese market, announced in November that it and its Chinese partner would invest $728 million to build a second plant in China. The company is already counting on expanding production at its first China plant to 100,000 vehicles a year by 2012—the company is looking to sell 120,000 cars in China in 2010 but many of them will be imported from BMW plants outside China. With the second plant, BMW will be able to produce 300,000 cars a year in China by 2015.
Volvo, which is being purchased by China’s Geely Automobile Holdings from Ford Motor (F), has added another $2.1 billion to its spending on car plants.
Toyota’s new plant in Changchun will start production in late 2011 with a capacity of 100,000 cars a year.
Nissan is investing to raise production capacity in China to 900,000 vehicles a year by 2012. That would be a hefty increase from the 535,000 it can produce now.
Hyundai is adding a third plant in China that will increase production capacity by 50% to 900,000 vehicles a year by 2012.
And that’s just the foreign car makers that are expanding in China. China’s own automakers are also revving up production.
For example, the company that bought Saab from General Motors, Beijing Automotive Industry Holdings, is building, three plants for passenger cars, two for commercial vehicles, and one engine factory. Total production capacity 1.3 million vehicles.
China Car Forums (Chinacarforums.com ) lists 45 major Chinese car companies. I’ve seen estimates that put the total number at over 100.
Did I mention that General Motors wants to increase its sales in China to 3 million units by 2015 from 2 million in 2010?
And that total car sales in China are forecast at just 16.5 million in 2010?
You can see where this is all going can’t you?
JD Power & Associates estimates that by 2015 car makers will have built so much production capacity in China that plants will be able to meet domestic Chinese demand by running at just 66% of capacity. A rule of thumb is that it takes capacity utilization of around 80% to cover fixed costs, according to JD Power.
If that estimate is true, we’ll first see companies try to keep factories running at something like full capacity by offering steep discounts and price incentives. Not “Buy one, get one free” probably. But cheap credit deals that come pretty close. As Detroit demonstrated in the run up to the collapse of the U.S. industry, you can prop up sales for quite a long time if you give consumers the cash to buy your product.
The Chinese auto companies will win that game since unlike General Motors or Volkswagen, they will have access to bank loans at low interest rates even when those loans are clearly simply propping up companies that are bankrupt in all but name. In China a company isn’t bankrupt until the government says it is. (For more on the effects of cheap money see my post http://jubakpicks.com/2010/04/16/cheap-money-is-the-root-of-all-financial-bubbles-and-its-still-at-work-now/ )
Of course, at some point Chinese and overseas car makers operating in China will attempt to export their way out of their problems. By that point Chinese cars will almost certainly be good enough in quality to tempt U.S. and other developed world buyers if the price is right. But remember that developed economy car companies rushed into China to escape falling demand in their home markets. Exporting back to those markets isn’t exactly a solution to over-supply and under-demand.
Other developing economies won’t be much of a market for cars built in China either since just as once every country had to have a national steel industry, now every country has to have a domestic auto industry.
The workings of the market could fix this problem by forcing the least efficient manufacturers out of business until supply matched demand. Except that various national governments have decided that many of these global car companies are worth supporting with government funds as a matter of national interest. It’s what the U.S. has done and France and Italy for the industry in the last crisis and the one before that.
The next crisis won’t be any different. Government support will help a large number of car companies to survive, assuring that the industry won’t reduce capacity enough so that the survivors can make a decent profit, and setting the industry up for a new wave of investment in some other “solution” to the industry’s problems, and assuring that the next crisis is just a few miles down the road.
Does this sound like any other industry you know? Awash in excess capacity. With competitors who will cut any price to keep capacity filled. Without profits when you include the full boom and bust cycle. And with major players that have been through one or two bankruptcy reorganizations and that seem headed for another.
Yep, the global car industry looks increasing like the airline industry.
Not exactly a model I’d pick to emulate.
And scary to contemplate if you’re managing or working at General Motors because it argues that the company’s current bankruptcy reorganization isn’t likely to be its last.
Full disclosure: I don’t own shares of any company mentioned in this post.
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