Drop in China auto demand will hurt VW and GM the most

Article by Andrew Christian, on July 23, 2015

The steep drop in the demand for vehicles in China has had a major impact on many global automakers, particularly Volkswagen and General Motors. China is where a huge chunk of the profits of these two brands come from. VW and GM are heavily exposed to the Chinese market.

While it continues to grow, Barclays (a prominent trade group) has downgraded its forecast for 2015 sales throughout the auto industry. Both VW and GM fail to provide a convincing plan on how they will offset the sluggish growth in the Chinese market with other business segments.

Last Thursday, Barclays reduced GM's stock to "equal weight" from "overweight” because it was expected to be the worst hit among the U.S. automakers of the drop in Chinese demand. Its analysts downgraded the entire U.S. sector to "negative.” They wrote that GM has “a lot to lose” and that there are “few catalysts” in the vicinity.

Auto industry analysts said that more than 50% of Volkswagen’s net profit is derived from China. Meanwhile, 71% of its free cash also originates from China, including income from joint ventures and royalties. Barclays said that 40% of GM’s net income last year came from China while 20-30% of its operating cash flow also came from this market.

Foreign brands continue to dominate the passenger car market in China. At the top is VW. It is followed by GM, Hyundai, Toyota and Nissan. However, the share of sales of domestic auto producers like Great Wall is increasing.

The demand in China has shifted towards more fuel-efficient cars as Beijing frowns on outlandish displays of wealth and as more affordable locally built cars are preferred by first-time car buyers in the second-tier cities. VW’s profits have mostly relied on Audi, which has been doing poorly in China during the last seven months.

Another factor is that VW doesn’t have new SUVs and crossovers, which are the segments with the quickest growth in China. Audi said last Thursday that the downturn in the country is worse than anticipated and so it is now re-examining its 2015 Chinese sales target.

According to IHS automotive analyst Henner Lehne, Chinese bureaucrats have been favouring Audi but this status has now become a disadvantage. He said that premium brands BMW and Audi have taken a beating due to the drop in luxury auto sales.

He pointed out that about 70-80% of the premium market is controlled by Audi, BMW and Mercedes-Benz. About 30-50% of the profits come from this segment.

However, foreign mass-volume producers are now also feeling the impact of this downturn. A bigger share now goes to the local producers. The China Association of Automobile Manufacturers recently cut its vehicle sales growth forecast for 2015 from 7% to 3%.

Topics: vw, gm, china

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