Chinese Auto Glut Erodes Earnings

Sales are rising but profits aren't keep pace

By Bloomberg News

(Bloomberg) — Ai Li's Buick may help push China past the U.S. as the world's largest car market this year. That may be little consolation to General Motors Co. and Volkswagen AG as overcapacity in the country saps profits.

Ai, a 30-year-old Beijing book editor, stopped saving for an apartment and bought a Buick Excelle in September, lured by a tax cut of 6,000 yuan ($880) for the car.

"I wouldn't have bought the car if it wasn't for the tax breaks," Ai said.

Government support has helped cause a 42 percent jump in China vehicle sales this year. The country is set to surpass the U.S. as the world's largest auto market and is drawing investment from Ford Motor Co., Hyundai Motor Co. and GM. Next year, growth will slow to less than 15 percent, according to Volkswagen and SAIC Motor Corp., threatening profit margins in an industry that can already build more cars than it can sell.

"Automakers have been relying on surging sales growth to offset profit margins that are falling because of rising competition," said Jenny Tian, a Beijing-based partner at Springs Capital, which manages $160 million in assets. "That won't work next year."

China's full-year auto sales may be about 13 million, compared with industrywide capacity to build 15 million vehicles, according to Booz & Co., which advises carmakers and investors in China. By 2015, output may reach 15 million, while capacity may be 20 million, according to Koji Endo, managing director of Advanced Research Japan in Tokyo.

Low Margins

"Automakers need to make sure they have the right size and the right models in the China, otherwise they will be left with overcapacity and lower profits," he said.

China's 100-plus automakers are wrestling with low margins because of competition and a preference for low-priced models. Carmakers get an average profit per vehicle of between $1,000 and $3,000 in China, depending on model size, compared with about $10,000 in the U.S., according to Endo.

"There's a huge gap in profit between China and the U.S.," said Yale Zhang, a Shanghai-based director at CSM Asia, an auto consulting company. "It may take China three to five years to surpass the U.S. in terms of profit."

About 20 percent of China's auto sales are low-cost commercial vehicles that sell for as little as $5,000, Zhang said.

U.S. Slump

Automakers face possible overcapacity in China after expanding to offset sales slumps in the U.S., Europe and Japan. U.S. vehicle sales dropped 24 percent to 9.4 million in the first 11 months because of recession and rising unemployment, forcing General Motors Corp. and Chrysler LLC into bankruptcy. China vehicle sales rose to 12.2 million.

Chen Bin, who oversees regulation of China's auto industry, also said in September that automakers should "keep their heads cool" to prevent excess expansion.

China's auto subsidies and tax cuts, part of a 4 trillion yuan stimulus package that also includes measures for electronics, appliances and houses, were due to expire around the end of the year. That caused consumers to rush out to make purchases before the incentives ran out.

"It's safest to buy now," Ai said about her Buick.

The government today said it will extend vehicle subsidies and tax cuts until the end of 2010. Trade-in subsidies will be increased to as much as 18,000 yuan, Premier Wen Jiabao said in statement posted on the government Web site. Tax cuts will be reduced. Vehicles with engines of 1.6 liters or less will be taxed at 7.5 percent next year, compared with 5 percent this year and 10 percent before the stimulus measures were introduced.

"In the short term, because of the tax incentives, there is some cannibalization now of future sales" in China, said Yoichi Hojo, Honda Motor Co.'s chief financial officer.

BMW, Daimler

Bayerische Motoren Werke AG, the world's largest maker of luxury cars, said last month it plans to build a new factory in China to meet rising demand for premium products.

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