What China's Luxury Vehicle Market Has In Store For Audi In 2016

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Summary

The backlash from the emissions scandal might dent Volkswagen AG and its luxury division Audi's sales volume this year, making 2016 another year where Audi's growth trails that of its chief competitors and compatriots, BMW and Mercedes-Benz.

In 2015, Daimler AG's Mercedes-Benz passed Audi as the world's second-highest selling premium automaker, behind BMW, beating the latter's smaller 3.6% year-over-year volume growth by posting a solid 13.4% volume growth.

Audi's total sales volume remained 3.6% shy of Mercedes's net sales volume.

We have a $33 price estimate for Volkswagen, which is above the current market price.

The backlash from the emissions scandal might dent Volkswagen AG (OTCPK:VLKAY) and its luxury division Audi's sales volume this year, making 2016 another year where Audi's growth trails that of its chief competitors and compatriots, BMW (BAMXY) and Mercedes-Benz (OTCPK:DDAIF). In 2015, Daimler AG's Mercedes-Benz passed Audi as the world's second-highest selling premium automaker, behind BMW, beating the latter's smaller 3.6% year-over-year volume growth by posting a solid 13.4% volume growth. Audi's total sales volume remained 3.6% shy of Mercedes's net sales volume. Let's look at how 2015 panned out for Audi in crucial markets:

Volkswagen Q&A 11

In particular, lower than expected sales in China dragged down Audi's overall volumes last year, and a simultaneous massive rise in the country for Mercedes helped it secure the second spot in global rankings. China alone forms almost one-third Audi's sales volume, and the brand holds the dominant position in the country's premium vehicle market. However, Audi's growth trailed both BMW's and Mercedes's growth, as well that of the overall passenger vehicle market in China last year.

We have a $33 price estimate for Volkswagen, which is above the current market price.

In fact, a massive rise in China for Mercedes due to more than 15 new or revamped models, expansion of dealer network to approximately 500 dealerships, extension of local production capacity, where in addition to the C- and E-Class, the two SUVs GLA and GLC started to be built, ensured that China became the automaker's single largest market last year. In addition, what bode well for Mercedes all through last year was the 27% rise in sales volume of SUVs, which formed roughly 30% of the brand's total volumes last year.

2015 has been the year of SUVs. Besides the large rise in the U.S., SUVs showed a massive 52.4% rise in China as well. The market for luxury SUVs in China, in particular, is expected to double to 1.2 million units by 2020, further boosting growth prospects of Audi, BMW, and Mercedes-Benz in the country. Just for reference, less than 200,000 units of luxury SUVs were sold in China in 2010. Seeing the large demand for luxury SUVs, Audi will have to step up its game in this segment, one would think. Audi sold more SUVs than Mercedes last year, but its sales volume in this segment grew only 6%, compared to the latter's 27% rise, as aforementioned.

Audi's lower sales last year might have been affected by product launch cycle factors, China's slower economy, and the dieselgate scandal. However, seeing how the dieselgate scandal surfaced only in September, with most of the impacted vehicles in Europe and the US, Audi's China sales are expected to have been impacted mainly by the product launch cycle and the general macroeconomic environment. But things could be better in China for Audi going forward, and here's why:

Rise Of The Upper Middle Class Should Boost The Premium Market

The Chinese economy has grown at a slower pace in the last year, with slowdowns in the manufacturing, real estate, and infrastructure sectors. The stock market fall also posed a threat to customer spending in the country. However, spending on luxury goods, including automobiles, should remain solid going forward, and here's why:

  • Chinese consumption isn't rising as fast as it was earlier, but it is still expected to grow by $2.3 trillion in the next five years. To put this into perspective, this growth alone is more than the estimated consumer market sizes of Germany and the U.K. in 2020. Moreover, 81% of this growth is expected to come from the upper-middle class and the affluent households, the target market for luxury automakers.
  • The shift in a service-driven economy from a manufacturing driven economy will see the rise of the upper middle class. The number of upper middle class and affluent households is forecast to double to 100 million and comprise 30% of all urban households by 2020, compared with 17% presently, and only 7% in 2010. This should help boost sales of premium vehicles.
  • Consumption of young generation consumers (ages below 35) is growing at 14% annually, which is twice that of consumers older than 35. The newer generation also typically has a more sophisticated taste, and is more free spending. The growth in the upper middle class and the emergence of the new generation is expected to increase sales of high-value products, including automobiles.

Audi Could Benefit From The Structural Change In China And New Model Launches

Premium vehicle demand is expected to remain strong in China, despite the structural change, with the rise of the upper middle class, as opposed to the ascent of poverty-ridden people to middle class seen in the last few years. Audi has maintained its number one position in China's luxury vehicle market, but suffered a sales drop last year that could be cause for concern. Nonetheless, the positive points that support Audi's growth in the country are as follows:

  • One reason why Audi's year-over-year growth in China appears weak is because of the successful launch of the locally produced A3 sedan in late 2014, which inflated sales volumes, especially as the compact A3 sedan is a high volume model. By mid-2016, Audi will launch successors for all models that represent approximately 60% of net Audi sales in China. A fresh model lineup could boost the brand's sales in its single largest market.

  • What also supports Audi's prospects in China is the growing upper middle class, especially in low-tier cities. Audi, BMW, and Mercedes-Benz have a widespread dealership network, which should give these automakers an advantage over smaller luxury companies. Half of the additional upper middle class and affluent households that will emerge by the end of this decade are estimated to be located outside the top 100 cities - tier 4 or lower. In addition, given that the new generation is more brand conscious, world-renowned luxury brands, including Audi, have an advantage.

China is crucial to Audi's growth, which is evident from the fact that a dip in sales volume in the country caused a slip to the third position in the global luxury vehicle market for the brand. However, we expect China's premium vehicle market to continue its strong growth, and given Audi's vast presence and lined up model revamps, the brand could return to growth in the country in 2016.

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