Broker's View

Chinese car makers make hay while tax break in force, but sales could stall in 2017

Chinese giants Geely, Great Wall Motors and Chery Automobile see a rush in sales before a government tax break expires at end of the month

PUBLISHED : Wednesday, 07 December, 2016, 6:52pm
UPDATED : Wednesday, 07 December, 2016, 10:04pm

China’s domestic car sales soared in November, ahead of the expiry of a government tax break on cars with engines below 1.6 litres.

Geely Auto, one of the country’s largest privately owned car manufacturers and the owner of Volvo Cars and the London Taxi Company, has reported record sales for the month, thanks to a rush by customers to buy before a government reduction in purchasing tax expires at the end of the year.

However, the same reason could leave the car maker vulnerable to a downturn in 2017, according to analysts.

Geely’s November sales soared 99 per cent year-on-year to a record 102,422 cars, of which only 1,721 were exports.

Last October, China cut the purchase tax in half on cars with engines below 1.6 litres — from 10 to 5 per cent, aiming to boost sluggish sales.

Geely’s November growth was also partly driven by the popularity of its new SUV models as well as consumer enthusiasm to buy smaller engine cars before that tax cut expires at the end of the month, said analysts from Morgan Stanley in a recent research note. Nearly 80 per cent of Geely’s cars have engines no larger than 1.6 litres.

“Strong SUV models and the ‘pre-buying’ effect should continue to support Geely’s sales into December,” they said.

Great Wall Motors also announced on Tuesday that its November sales jumped 43 per cent on-year to 129,087 units, while smaller rival Chery Automobile said its October sales rose 39 per cent to 50,780 units, again attributed to buyers taking advantage of the tax break.

However, according to a latest survey from Market News Internationals Indicators, the bumper end-of-year sales run contrary to other declines in consumer sentiment.

Its MNI China Car Purchase Sentiment Indicator edged down to 88.3 in November from 90 in October, weighed down by a noticeable rise in expected petrol costs.

Industry analysts now have serious concerns China’s car market could stall badly early in 2017.

“We view Geely as the most vulnerable within what could be an industry downturn in 2017,” Morgan Stanley analysts said, as purchase tax rates return to normal.

An aggressive capacity expansion plan by some makers in 2017 to 2018 could also drag down margins, they add, while more intense competition in China’s SUV segment could put further pressure on the company’s pricing and margins.

We view Geely as the most vulnerable within what could be an industry downturn in 2017
Morgan Stanley analysts

As a result, it has maintained its “Underweight” rating on Geely’s Hong Kong-listed stock, with a price target of HK$6 in the next 12 to 18 months, down 26 per cent from the current level.

Credit Suisse analysts have also downgraded China’s car sector as a whole to “Market Weight” from “Overweight”, due to the deceleration in sales growth from the fourth quarter and added margin pressures next year.

They actually reckon the tax cut policy could be extended into 2017, but warn the rate may increase as some point from (the current) 5 per cent to 7.5 per cent.

Looking ahead, Credit Suisse analysts expect Chinese passenger vehicle sales growth to slow to 3 per cent in the first half of 2017, as consumers are put off buying when the tax is reintroduced, describing the fourth quarter as benefiting from “front-loading demand”.

They also expect increased margin pressure on traditional car makersr, because of tougher fuel efficiency rules being introduced on petrol and diesel engines.

Lou Jia and Eric Hu, analysts from Bank of China International, however, predict quite the opposite to their peers, and expect the government to further scale down the vehicle purchase tax break from 5 per cent to 2.5 per cent, to maintain the recovery in domestic car demand, which would certainly benefit Chinese car makers.

They argue that Geely Auto, especially, could be less vulnerable than other domestic peers to potential tax policy changes, given that one of its key SUV models does not qualify for the tax benefit and will continue to drive its revenue growth, regardless of any cut or rise.