Falling Auto Sales Signal Over-production In China

To counter swelling inventories, the China Automobile Dealers Association plans to establish an inventory warning system by the end of this year

China's auto production and sales hit record highs of 8.47 million units and 7.18 million units, respectively, in the first half of this year, up 44.37% and 30.35% from 2009. However, signs of overproduction appeared in April, when monthly sales dropped 19.8% from the March record of 1.7 million units.

Sales continued downward in the following months, declining 13.95% in May and another 5.25 % in June, as shown in statistics compiled by the China Automotive Technology & Research Center (CATRC). Overall, according to China's Ministry of Industry and Information Technology (MIIT), Q2 sales dropped 43%from the previous quarter.

China, however, remains the world's largest auto market. Auto production there expanded at a particularly rapid pace following the global financial crisis, thanks mainly to a sales boom resulting from government stimulus measures such as tax reductions and “autos to the countryside” and “cash for clunkers” programs. The stimulus measures have been extended a couple of times during the past two years but will finally expire at the end of this year.

“Auto sales may continue to slide through the rest of the year, but they will continue growing at a double-digit rate for the year as a whole thanks to booming sales in the first quarter,” said Saicgroup CEO Hu Mao-yuan. “Sales may reach 15.5 million units this year, up 12.6% from the 13.6 million units sold in 2009.”

Observers generally believe the current market correction may continue throughout the third quarter, but they anticipate another buying spree in the fourth quarter before the stimulus measures expire.

China's auto market has maintained an annual growth of 30-40% for two years. “In fact, such an annual growth is abnormally high,” commented a ranking executive of the Tong Yang Group, a Taiwan-based auto parts supplier which runs 18 production sites in China. “It's normal for such an abnormally growing market to adjust to a more normal level.”

China surpassed the United States as the world's largest auto market in 2009, with sales of 13.64 million units (compared to sales of 10.43 million units in the U.S.). Despite the current decline, China's State Information Center expects auto sales there to continue growing at an annual rate of 13-15% until they reach 16 million units or so.

Growing sales are being recorded by both foreign and domestic carmakers. General Motors sold 1.2 million units in China during the first six months of 2010, surpassing sales in its home market (1.1 million units) for the first time. The SAIC Motor Group, a domestic carmaker, recorded a year-on-year growth of 30% percent during the six-month period.

Swelling Inventories

Statistics show that total auto inventories in China topped 1.17 million units in May, and the expectation is that they may continue to pile up in coming months. This is in sharp contrast to situation a year ago, when inventories stood at zero, and it imposes heavy pressure on auto retailers and parts suppliers. Some automakers take the inevitable adjustment in stride, saying that it's the time for the overheated auto market to cool down.

China's average inventory period for cars stretched from 41 days in February to 55 days in June, similar to the 46-60 days in the U.S. and Europe.

In light of the swelling inventory, China Automobile Dealers Association is planning to establish an inventory warning system by the end of this year. “A reasonable ratio of sales to inventory should be around 1:1.5, but now many retailers have seen their ratios swollen to 1: 2 or even 1:3. The ratio of some dealers of Saicgroup and Volkswagen even soared to 1:5 or so.

The warning system that the China Automobile Dealers Association plans to establish is generally seen as necessary to curb the country's unbridled production growth. The top 12 Chinese automakers are now estimated to have a total annual production capacity of 32 million units.

Shrinking Prices

The swelling inventories, and the sharp gap in sales between the first and second quarters, worry automakers and dealers alike. “The store was full of people in March, but in May they were all gone,” lamented a retailer. If the sales chill continues, retailers anticipate price cuts in an effort to stimulate sales.

In fact, some retailers have already marked down their stickers. Mazda was the first to announce a price cut, of 30,000 yuan, in early May. Later, Dongfeng-Nissan cut the Teana's price by 20,000 yuan, and Toyota's Guangzhou's plant cut the price of its Camry by 30,000 yuan.

If sales remain sluggish during the summer, a price war is expected in the third quarter. Overall, according to official statistics, auto prices dropped 0.24% in May, marking the third consecutive month of price declines.

China is not the only market to experience a summer sales lull. The U.S. auto market also began cooling down in May, with a sales shrinkage of 10.8%, and the European market is still struggling to overcome the debt crisis.

Good Prospects for the Service Business

While new-car sales are declining, the auto service market is expected to boom now that car ownership in China has hit 60 million. Assuming annual spending of 10,000 yuan per car, the service market is worth around 600 billion yuan per year; and it is expected to continue growing, at an annual rate of 20% or so.

Foreign companies have tried, but failed, to penetrate the auto service market; Autobacs and Yellow Hat of Japan, and Jiffylube and Honeywell of the U.S., have withdrawn after giving the Chinese market a go.

The auto service business encompasses maintenance, car washes, and replacement parts. Most such businesses in China operate on a small scale; only one, New Focus Auto Tech Holding, is listed on the stock market. New Focus currently runs 45 stations around China and expects to expand that number to 60 stores by the end of the year; it could grow faster, but is hesitating because of fears that franchise partners might copy its business model.

T-Station, a chain with a Korean parent company, runs 20 outlets in Dalian, Shanghai, Nanjing, Xingjiang, Fujian, and Xian. Plans are under way to expand to 30 outlets in the near future.