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Can China's Car Buyers Save GM?
05/04/2010 10:37 am EST
The world's most populous nation is experiencing huge growth in auto sales. For General Motors, the hitch is that all other carmakers on the planet know that, too.
So what do you do if you're a carmaker with a market at home that's not buying as many cars as it used to? If you're General Motors, you invest in making and selling cars in China as fast as you can.
So great that Toyota Motor (NYSE: TM) and Nissan Motor (OTC: NSANY) and Volkswagen (OTC: VLKAY) and BMW (OTC: BAMXF) and Honda Motor (NYSE: HMC) and Hyundai Motor (OTC: HYMLY) have 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 shakeout 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 GM, working to emerge from bankruptcy, or companies such as Toyota, struggling to rebuild profitability, will have put away cash for a rainy day.
The collapse is likely to be even more brutal than that of the US 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 this blog post from my Web site.)
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 in the world by sales, having passed the struggling US car market in 2009. Car sales in China jumped 45% last year and are projected to rise 20% in 2010.
As stunning as that rate of growth is, some individual carmakers are doing even better. For example, General Motors' sales in China in March 2010 were up 65% from a year earlier. For all of 2010, GM (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 rose 61% in the first quarter of 2010, and that was a disappointment; the overall market in China grew 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 1.3 billion, with as many as 300 million belonging to the middle class. But only 41 of every 1,000 Chinese own a car, Goldman Sachs estimates. That compares with more than 500 cars per 1,000 inhabitants in Germany and 780 cars per 1000 in the United States.
There's a lot of room for car sales between 41 cars per thousand people and 500 or 780 cars per thousand.
Autos, Autos Everywhere
The problem for GM, and for Volkswagen and every other company selling cars in China, is that the growth in demand is only part of the story. There's also the supply-side story. And that's where things get ugly.
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Everybody wants a piece of the growth in China's auto market, and everybody is building plants in a bid to capture that growth.
Volkswagen, for example, announced April 26 that it would add about $2.2 billion to its capital-spending budget to build two plants in China. That brings the company's capital-spending plans to $8 billion for the next three years.
BMW, currently number four 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 Holding Group from Ford Motor (NYSE: F), has added $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 carmakers 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, is building three plants for passenger cars and two for commercial vehicles, as well as an engine factory. Total production capacity will be 1.3 million vehicles a year.
ChinaCarForums.com lists 45 major Chinese car companies. I've seen estimates that put the total number at more than 100.
Did I mention that GM wants to increase its sales in China to three million units by 2015 from two million in 2010?
And that total car sales in China are forecast at just 16.5 million in 2010?
You can see where all of this is going, can't you?
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JD Power & Associates estimates that by 2015, carmakers 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 about 80% to cover fixed costs, according to JD Power.
Too Much Creation, Not Enough Destruction
If that estimate is accurate, 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 could come pretty close. As Detroit demonstrated in the run up to the collapse of the US auto 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 because, 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 column "The Key Ingredient of Market Bubbles.")
Of course, at some point Chinese and overseas carmakers operating in China will attempt to export their way out of their problems. By that point, Chinese cars will almost certainly be high enough quality to tempt US 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 oversupply and underdemand.
The workings of the market could fix this problem by forcing the least efficient manufacturers out of business until supply matched demand. Except various national governments have decided that many of these global car companies are worth supporting with government funds as a matter of national interest.
The next crisis won't be any different. Government support will help a large number of car companies survive, ensuring that the industry won't reduce capacity enough so that the survivors can make a decent profit, and setting up the industry for a new wave of investment in some other "solution" to the industry's problems. Such action will also ensure 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 the full boom and bust cycles are included. And with major players that have been through one or two bankruptcy reorganizations and that seem headed for more.
Yep, the global car industry looks increasing like the airline industry. Not exactly a model I'd pick to emulate.
And it's a scary one to contemplate if you're running or working at General Motors, because it argues that the company's current bankruptcy reorganization isn't likely to be its last.
At the time of publication, Jim Jubak did not own or control shares of any company mentioned in this column.
Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.
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