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  • Sep 21, 2014
  • Updated: 2:46am
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PUBLISHED : Friday, 15 March, 2013, 4:22pm
UPDATED : Friday, 15 March, 2013, 4:22pm

China car sector set to overheat

China's car sector is headed for a supply glut of up to 20 per cent in the next five years, fueled by an overzealous build-up led by major foreign automakers.

BIO

Doug Young has lived and worked in China for 15 years, much of that as a journalist for Reuters writing about Chinese companies. He currently lives in Shanghai where he teaches financial journalism at Fudan University. He writes daily on his blog, Young’s China Business Blog (www.youngchinabiz.com), commenting on the latest developments at Chinese companies listed in the US, China and Hong Kong. He is also author of a new book about the media in China, “The Party Line: How the Media Dictates Public Opinion in Modern China.”
 

I frequently criticize Chinese firms for a herd mentality that often sees them rush blindly into emerging industries, but this time I need to redirect my criticism on foreign companies that are taking the same approach to the nation's massive car market. The latest media reports cite Volkswagen (Frankfurt: VOWG) saying it will look to China to offset its slowing sales in the west, with plans to nearly double its Chinese production capacity over the next five years.

I doubt this plan is completely new, as VW and most other foreign automakers have been talking about massive expansions of their China capacity for much of the last 2-3 years, after China officially passed the US to become the world's biggest auto market in 2010. But this kind of mentality from VW and the others is looking increasingly dangerous, as each seems to be trying to outdo the other with bigger and bigger China expansions that look increasingly aggressive.

If others follow a similar path, we could see China's overall car production capacity double over the next five years, meaning sales would have to grow by around 20 per cent annually over that time to absorb all the new output. While China has posted that kind of rapid growth in the past, I doubt it will be able to maintain that pace over the next few years as the market becomes saturated.

What's more, most big cities are also trying to ease demand for new cars as part of their effort to reduce road congestion and combat air pollution. As a result, I suspect we'll see a relatively big glut of overcapacity emerging over the next five years, with much of that extra capacity at big foreign names like VW and their China joint ventures.

Let's take a closer look at the latest reports, which have VW saying it is aiming to expand its annual car production capacity in China to 4 million units by 2018. If all that capacity was used, it would equal nearly half of the 9 million cars that VW sold last year. It's no huge surprise why VW and other global automakers are looking to China as a bright spot for their future.

VW's China sales jumped nearly 20 per cent last year to more than two million cars, and its operating profit there rose by an even bigger 42 per cent to 3.7 billion euros. VW's growth was the biggest among major global automakers, who still managed to post strong growth in the 10-15 per cent range. The one exception to that were the Japanese car makers, whose sales dropped sharply in the fourth quarter due to consumer boycotts at the height of a territorial dispute between Tokyo and Beijing.

But even the Japanese are following major Chinese expansion plans, similar to aggressive new build-ups by the big European, American and Korean automakers. US giant Ford (NYSE: F) announced two major China expansions last year totaling $1.36 billion (HK$10.55 billion) in new investment, and Nissan (Tokyo: 7201) made three similar announcements with a total new investment of $1.46 billion (HK$11.33 billion). Most of the other major players have made similar announcements, including many of the German luxury carmakers and Jaguar Land Rover, which last year formed a new China joint venture with local partner Chery.

Nearly all of China's other major domestic automakers like Dongfeng (0489.HK) and SAIC (Shanghai: 600104) will also get caught in this huge new capacity build-up, as most get a big majority of their sales through their joint ventures with the foreign companies. As I've said above, this kind of investment frenzy looks more like what I usually expect from Chinese companies, which often flock blindly to new emerging industries.

Such investment has led to boom-bust cycles in a number of sectors, including TVs, cellphones and most recently the solar panel space that is currently struggling with massive excess capacity. I doubt the automakers will get hit quite so hard when their own bust cycle begins in the next 2-3 years. But look for their China profit growth to slow sharply or even start to decline, as they learn a lesson that's already well understood by many Chinese firms who are all too familiar with these boom-bust cycles.

Bottom line: China's car sector is headed for a supply glut of up to 20 percent in the next 5 years, fueled by an overzealous build-up led by major foreign automakers.

To read more commentaries from Doug Young, visit youngchinabiz.com

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