It's Time To Take A Fresh Look At China's Auto Industry

by: Jeffrey Friedland

News stories reporting U.S. auto sales for August indicated that a total of 1.19 million cars, trucks and sport utility vehicles were sold in the United States, a 13% increase from August of 2011, and the highest sales rate in four years.

But the real auto industry story should be about China. The China Passenger Car Association has published data indicating that 18.5 million vehicles were sold in China in 2011. The Association also projected sales of 20 million vehicles for this year. China continues to be the world's largest auto market. Confirming the size and importance of the China auto market, General Motors' (NYSE:GM) Chief Executive, Dan Akerson, stated that China's auto market will reach 30 million annual vehicle sales by the year 2020.

A slowdown in Chinese economic activity is continuing to be led by a decrease in exports, primarily to the U.S. and Europe. China's manufacturing has now contracted for 11 consecutive months. China's auto industry, including the entire automobile supply chain, has definitely been impacted by the country's economic slowdown.

But, even with the well-publicized slowdown of business activity in China, the Asian Development Bank (ADB) recently announced that China's GDP growth would be 7.7 percent for the year, compared to 9.24 percent for last year. But comparisons are in order. It's generally acknowledged that the Eurozone is in a recession with negative GDP growth. U.S. economic activity, despite Friday's slight decrease in the unemployment rate, is relatively stagnant, with estimated GDP growth of 1.7 to 2.2 percent growth for this year.

The growth of the Chinese economy, with GDP growth above 7 percent is impressive and is worthy of investor attention. The continued economic growth of China will benefit a number of industries, with China's auto industry being a key beneficiary.

China's recently announced infrastructure stimulus, totaling US$158 billion, with its focus on the domestic economy should stimulate consumer spending and the country's important manufacturing sector. After the November 8th change in senior leadership of China's government, I expect additional measures will be taken to stimulate the country's economy. A beneficiary will be China's auto industry.

China's auto industry has also benefited from a specific stimulus program. Earlier this year, China enacted a RMB6 billion (US$952 million) stimulus program consisting of a subsidy program for the purchase of fuel efficient automobiles with engines smaller than 1.6 liters in rural areas.

Chinese Protests against Japanese Brands

The tensions in the East China Sea between Japan and China over disputed islands are having repercussions affecting Japanese brands in general and specifically Japanese auto manufacturers with Chinese operations. The Japanese auto companies affected include Japan's three largest, Honda Motors (NYSE:HMC), Nissan (OTCPK:NSANY) and Toyota (NYSE:TM), as well as three smaller manufacturers, Mazda (OTCPK:MZDAF), Mitsubishi Motors (OTCPK:MMTOF) and Suzuki Motor Corp. (OTCPK:SZKMY).

While no official announcement has yet been made by Toyota Motor Corp. regarding the company's September auto sales in China, reports have surfaced that the China sales decreased to approximately 50,000 vehicles in September, a decline of approximately 40 percent from the 86,000 sold in August. Reuters has indicated that due to the decline in sales, Toyota will not achieve its goal of selling 1 million vehicles in China this year.

In late September, Nissan announced a suspension of automobile production in China. As reported Friday by Marketwatch, a senior Nissan executive indicated that anti-Japanese sentiment "may" have had an impact on the company's September sales.

A relatively minor participant in China's auto industry, Mitsubishi Motors reported huge declines in its Chinese auto sales for the month of September. The company announced minimal sales of 2,340 vehicles; down almost 63% from the number of vehicles sold in September of 2011, and one-third lower than the almost 3,500 vehicles sold by Mitsubishi in August.

Another small participant in China's auto industry, Mazda, reported 13,258 vehicles sold in September, a decrease of 35% from the number sold in September of 2011, and 20% less than the number of vehicles the company sold in August.

China's Passenger Car Association has indicated that it is likely that the anti-Japanese sentiment in China will have a greater effect on sales by Japanese auto makers than Japan's tsunami and Thailand's massive floods last year.

With China being the world's largest automobile market, an ongoing sales slump in auto sales in China by Japanese manufacturers could have a significant adverse effect on the manufacturers' global financial results. The impact on the Japanese auto manufacturers could be especially significant since, China, as the world's largest automobile market, has been accounting for an increasing percentage of total global auto sales by Nissan and Toyota as well as some of the smaller manufacturers.

But, if the Chinese-Japanese tension continues or escalates over the Senkaku/Diaoyu islands, Japanese auto manufacturers are not likely to continue to participate in the short-term growth of China's auto industry. If Japanese auto manufacturers will not be the beneficiaries, it's important to look at who the beneficiaries will be. At the top of the list are global auto manufacturers with significant China operations including Bayerische Motoren Werke AG (BAMXY.PK), Daimler AG (OTCPK:DDAIF), Ford (NYSE:F), General Motors, Hyundai Motor Company (OTC:HYMTF), and Volkswagen (OTCPK:VLKAF).

BMW (Bayerische Motoren Werke AG)

There was definitely a surge in BMW's September auto sales in China. For the first nine months of this year, BMW's China sales increased to 237,056 vehicles, a 34 percent increase from the number of vehicles sold in August 2011.

Daimler AG

Daimler, through its premium brand, Mercedes Benz, posted record sales for September. This was driven by U.S. and China vehicle demand. Sales of its Mercedes brand totaled 16,806 cars and SUVs in China in September, an increase of 10 percent.


Ford is a relatively small participant in China, with only a market share of around 2%. Ford's China sales in August were a record of almost 49,000 vehicles, an increase of 39% over the number sold in August of 2011. Ford has indicated that it intends to increase its China production to 1.2 million cars annually by 2015.

General Motors

China is a very important market for General Motors, which generates 10% of its global sales from the country.

General Motors' China operations primarily consist of a joint venture for the manufacture of Chevrolet, Wuling, Baojun, Jiefing, Opel and Buick models. GM is also launching new products, including SUVs and luxury vehicles.

In August, the last month for which data is available, General Motors sold 221,000 vehicles in China, an increase of more than 11% over 2011.

In late September, GM announced that it had reached 2 million vehicle sales in China so far this year. 2012 will be the third consecutive year that GM has exceeded 2 million vehicle sales in China. But what is most notable is that September was the earliest month of the year that the 2 million vehicle sales benchmark was reached. GM says it reached 2 million in sales on October 17th last year, and on November 4th in 2010.

For all of 2011, GM sold 2.5 million vehicles in China, up from 560,000 in 2005. It's likely that 2012 sales by GM will exceed the 2.5 million vehicle sales of 2011.

When one compares GM to other Chinese auto manufacturers, GM's performance is impressive. GM's China sales so far this year were up 11.2 percent, compared with a 4.1 percent increase for China's entire auto industry.

Hyundai Motor Company

Hyundai Motor Company's joint venture in China, sold the fourth largest number of vehicles in China, in August, a total of 63,400 vehicles, according to China's Passenger Car Association.


Volkswagen has made major commitments to China's auto market, and views China as a major focus of its global growth strategy. The Company's China joint venture, sold 114,700 vehicles in China in August. Through August, Volkswagen, including its Audi brand, sold almost 1.5 million vehicles in China.

Audi saw its China sales rise by a third to 261,548 units. This year, Audi has maintained a comfortable sales lead over luxury car rivals BMW and Mercedes-Benz in China. Audi also indicated that its September sales in China increased 20 percent to 35,512 vehicles.

Volkswagen's Chairman, Ferdinand Piech has stated that the company's China sales will grow at least 9 percent next year, which he indicates is a direct result of Chinese buyers purchasing their first cars. He also indicated that China's auto industry will grow 10 percent over last year. Piech said that Volkswagen's sales in China will finish this year up 10 percent and that the company was projecting an 11 percent increase in China sales for 2013 over 2012. He also indicated that Volkswagen intended to increase annual Chinese production capacity to 4 million vehicles by 2018.

In an interview from the World Economic Forum in Tianjin, China, which Piech attended, he discussed China's auto market and stated, "The growth is tremendous. You have so many people without cars and we expect a few buyers for our products."

Of interest to investors are other opportunities in companies who are part of China's auto supply chain or peripheral beneficiaries of the country's auto market. This list includes auto parts manufacturers, tire manufacturers and suppliers to auto manufacturers, here are a few I believe who are worthy of investor consideration:

China Automotive Systems (NASDAQ:CAAS)

Through eight joint ventures in China, China Automotive Systems sells and manufactures power steering components and systems to China's automotive industry.

For the first six months of this year, the company's net sales were $161.3 million, down slightly compared to the net sales of $164.6 million for the first six months of 2011. For the second quarter of this year, the company's income was $8.6 million, up from an income of $7.2 million for the second quarter of last year. The company's shares closed Friday at $4.28, with a market cap of $121 million and with a PE of almost 6.

In late August, China Automotive Systems' management announced the approval of a share repurchase program of up to $5 million of its common shares periodically over the next 12 months. It's nice to see company management taking this kind of action, as it's an indication that management believes that its shares are undervalued.

China Yuchai International Limited (NYSE:CYD)

NYSE listed China Yuchai International Limited manufactures light-duty, medium-sized and heavy-duty diesel engines for construction equipment, trucks, buses and cars in China. In 2011, the company sold over 500,000 diesel engines.

For the second quarter of this year, the company's net revenues were RMB3.43 billion, corresponding to over $540 million, down from RMB4.02 billion for the second quarter of 2011. Net income for the quarter was off substantially, from RMB67.1 million, corresponding to US$10.6 million, compared to RMB155.1 million for the same quarter of 2011.

The company's shares closed Friday at $13.42, with a PE of 4.74 and EPS of 2.83.

As a manufacturer of diesel and natural gas engines, despite the downward trend in revenues and net income, China Yuchai is likely to be a direct beneficiary of China's latest economic stimulus. While I think it's likely that the company's full year 2012 revenues and net income will be off substantially from 2011, I expect the company to start showing increases in revenue starting with the first quarter of next year, as China's economy, I believe improves.

China Zenix Auto International Limited (NYSE:ZX)

China Zenix Auto International Limited is the largest commercial vehicle wheel manufacturer in China. The company sells wheels for both the aftermarket as well as to original equipment manufacturers.

For the second quarter of this year, the company's revenues were RMB1,131.5 million, corresponding to US$178.1 million, which was about the same as the company's revenues of RMB1,131.2 million for the second quarter of 2011. The company's profit and comprehensive income increased to RMB122.8 million, corresponding to US$19.3 million, compared to RMB118.9 million for the same quarter of last year.

China Xenix Auto's shares closed Friday at $3.13, its market cap is $161.5 million, its PE is a low 2.24 and the company's earnings per share is $1.40.

What's impressive for China Zenix Auto International is that it has so far this year been able to maintain not only its revenues, but also its net income, compared to the same period of last year.

GITI Tire Group

Based in Shanghai, GITI Tire Group has five manufacturing faculties throughout the country. The company's shares trade in Shanghai and there is no trading market for the shares in the U.S.

As China's largest tire manufacturer, it's as good a surrogate for China's overall auto industry as any company. While exporting to over 80 countries, the company is well positioned to grow as China's auto industry grows.

For the second quarter of this year, GITI Tire's revenues were approximately $161 million, with a net income of approximately $4.742 million.

The company's shares are currently trading around RMB7.75.The company's PE is almost 20, with an EPS of RMB.395.

Asia Carbon Industries (OTCPK:ACRB)

China based Asia Carbon Industries produces carbon black. With the rubber industry accounting for almost 90% of worldwide carbon black output, most of Asia Carbon's revenues and growth are tied to China's tire industry, and as a result to China's auto industry.

Asia Carbon Industries' revenue for the second quarter of this year was $13.2 million, which, on an annualized basis, is slightly more than the $49.12 million reported for all of 2011. Despite the downturn in China's economy, which has affected virtually every company in China, the company's net income for the second quarter of this year was $1.87 million.

Asia Carbon's shares are currently trading based on a P/E of approximately 1.52. The company's earnings per share are $.13.


China's auto industry will be a definite beneficiary of the country's recently announced economic stimulus program targeting infrastructure projects. It's also likely that China's new administration will announce new stimulus measures after it comes to power on November 8th.

A key beneficiary of China's stimulus efforts will be the country's automobile industry.

Until there is a resolution to the China-Japan confrontation over the disputed islands and a change in Chinese consumers' sentiment toward Japanese brands, Japanese auto manufacturers, including Nissan and Toyota, will continue to have major decreases in vehicles sold.

Non-Japanese global auto companies, including General Motors, Hyundai, BMW, Ford, Daimler and Volkswagen will likely be beneficiaries of China's economic stimulus, general growth of China's auto industry as well as the anti-Japanese sentiment.

Other beneficiaries will include Chinese auto part and component manufacturers including, China Automotive Systems, China Yuchai International Limited, and China Zenix Auto International Limited . Of these, both China Yuchai International and China Zenix Auto International have maintained revenues and net income during a tough operating environment in China. These two companies are particularly well suited to reap major benefits as China's economy improves and as China moves towards annual sales of 30 million vehicles.

An additional beneficiary be China's tire manufacturers, including GITI Tire Group, as well as Asia Carbon Industries, a raw material supplier to China's auto industry.


Investing in smaller-capitalization companies, as well as investing in companies in emerging markets including China, is not suitable for all investors, and can be risky. It's important that investors thoroughly perform their own due diligence and analyze the potential risk.

The companies mentioned, while including major global companies such as Ford, Daimler, Hyundai, General Motors, BMW and Toyota, also includes smaller capitalization companies with operations based in China. While two of these smaller capitalization companies trade on the NYSE, their operations are based in China. But those traded in the U.S. are all U.S. reporting issuers, and subject to the reporting requirements of the U.S. Securities and Exchange Commission, so U.S. transparency and disclosure is available to investors.

Disclosure: I am long OTCPK:ACRB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I may invest in CAAS, ZX and CYD in the next 72 hours. Currency conversions to US dollars are approximate.

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