China's Auto Sector in 2009

 |  Includes: CAF, DDAIF, FXY, GM, GXC, PGJ, TM, VLKAY
by: Shaun Rein

Bernie Lo from Bloomberg TV recently interviewed me about the auto sector in China. With GM (NYSE:GM) and Ford (NYSE:F) begging for tax payer money while still spending obscene amounts on private jets and sports marketing (did you know GM spent over half a billion dollars this year on sports marketing?!), attention has been focused on the Chinese auto industry and whether it can still provide a growth engine for the auto sector in Detroit and for European players like Volkswagen (OTCPK:VLKAY). You can see the full Bloomberg TV interview here.

Having recently enjoyed steady growth at over 20% a year, the auto sector in China hit a slow patch in the last few months, and we expect growth to fall to 6-8% in 2009. However, the situation is very different in China than in the US where consumer spending has completely stopped with the fear hitting the American consumer and where auto loans have shrunk along with the rest of the credit markets, which leaves for more optimism long-term in China.

In China, retail sales are growing at a 20.8% year on year clip, confounding all those Wall Street analysts who literally emailed me to say I was stupid for being optimistic and said that Chinese would certainly stop spending last September… as consumer optimism remains fairly high. In research my firm conducted, we found that 70% of Chinese consumers expect to continue spending the same if not more in 2009 than they had in 2008. However, consumers indicated that they would delay purchases in 2 sectors – real estate and auto. They are delaying purchases not so much out of fear or an inability to get loans but because they expect prices to continue to drop… which they have in recent months.

There will be real winners and losers next year in the auto sector in China. Companies like Mercedes (DAI) (which saw a 50% + increase in sales in 2008 in China) will do well long-term as they target they niche of affluent buyers well as companies that are well-branded and have created emotional connections with consumers like a BMW or great value products like Toyota (NYSE:TM). Companies like a Fiat or Peugeot that have odd brand positions and ugly cars as well as commodity-type companies like Buick will get hit. A real shake-up in the industry is coming.

However, we think that the auto sector here can re-start much faster than in the US, where the industry is waiting for both better consumer sentiment and a warming of the credit markets. A major difference between China and the US is that most consumers here pay in cash in full for their autos, so increased sales will rely on consumer sentiment more than a return to functioning credit markets. Also, many cars here are bought by corporations (many companies keep salaries low but have very high benefits), which means that there is another pillar of sales that can be jumpstarted with government regulations. If the government implements tax breaks rather than amortization over many years look for corporate sales to go up. A key to overall sales will be getting companies to continue buying corporate cars for their executives.

What is interesting is how Chinese auto players like Chery are looking to move abroad or developing electric cars like the BYD, backed in part by Warren Buffet. Chery just received a billion dollar plus loan that must be used to expand international operations. Look for Chinese firms to take advantage of weakening American and European firms and low valuations to move abroad and become global players. My firm just wrote a report on Chinese national champions plans that are looking to move abroad in 10 sectors. You can read more in this commentary I wrote for BusinessWeek entitled Lessons for Chinese Companies as They Go Global.

China's auto sector will definitely slow down in 2009 and will not be able to save Detroit. Poorer branded auto manufacturers will be hit hard and might even need to leave the market to shore up home operations. But the better branded auto companies will survive and will come out stronger. It is critical that auto companies get the right marketing communication and design strategies in order to capture the long-term auto sector in China which I remain optimistic in. In a commentary I will write for Seeking Alpha soon, I will discuss more about what the Chinese consumer is thinking about now.