The Road Ahead For China Autos

The combination of a housing slump and oil at about $140 per barrel is proving to be the straw that is breaking the back of the U.S auto industry. U.S. auto sales plunged in June as the economic slowdown and high gasoline prices have hit all U.S. carmakers hard. Sales were down 28 percent at Ford and 18 percent at General Motors. Hardest hit was Chrysler, whose U.S. sales fell 36 percent after it discontinued some models in an effort to increase profit margins. Even the Japanese carmakers who have been gaining market share in the United States market at the expense of the former “Big Three” suffered sales declines. Toyota was down 21 percent and Nissan 18 percent. Only Honda managed a small gain. June was merely the worst of the months this year. Through the first half of 2008, sales were off 16.3 percent at GM, 14 percent at Ford and 6.8 percent at Toyota.

Poor sales have caused equity valuations for US assemblers and components companies to be slashed. The equity value of Ford, a $172 billion sales company, is just over $10 billion, while General Motors, with slightly higher sales of $180 billion, can be bought lock, stock and barrel for $5.3 billion. Stock market valuations of companies that supply the U.S. automakers are being taken down as well. Visteon, an $11 billion company which has a large amount of its sales to Ford, is only worth $285 million, while American Axle, with over 70 percent of its $3.0 billion of sales to GM, is trading at $326 million.

Detroit, which has already gone through one round of bankruptcies and restructurings several years ago, is beginning to brace for another. Rumors are swirling in the marketplace about Chrysler; Kirk Kerkorian is in discussions with the Ford family about the future of their company; and General Motors is scrambling for cash. General Motors today outlined further cuts in its salaried workforce and spelled out its plans for preserving cash. John Casesa, managing partner of Casesa Shapiro Advisors, said that General Motors will likely suspend its dividend payments. “I don’t see how the company can keep paying a dividend given the loss it’s racking up,” he said. A Merrill Lynch & Co. analyst went even further, saying on July 2 that GM may need to raise $15 billion and bankruptcy is “not impossible” should demand continue to deteriorate.

What does all this mean for Asian, and specifically Chinese, auto companies? It essentially means that the center of gravity in the massive global auto industry is now accelerating its shift to Asia and China. Over the medium and long term, the Japanese, Korean and Chinese carmakers will be the major beneficiaries of the turmoil in the U.S. auto industry. Caught with a high percentage of gas guzzling models in their product portfolios and running out of cash, General Motors, Ford and Chrysler, however they emerge from their current set of problems, will never be the same. That leaves approximately 40 percent of the large U.S. market up for grabs. While Toyota, Nissan, Honda and Hyundai are best positioned to benefit in the short term, a market for more affordable cars from China will undoubtedly develop.

In the meantime, China’s auto industry continues to grow at double digit rates. While tighter government monetary policies and record high oil prices are contributing to somewhat slower growth, passenger car sales nonetheless increased by 17.7 percent to 3,003,347 units in the first half of 2008, according to the China Association of Automobile Manufacturers. That’s why the $9.2 billion market value of Dongfeng Motor Group, only China’s third-largest automaker, is almost twice the value of General Motors, still the world’s largest car producer. Interestingly, Dongfeng Motors’ revenues of 180 billion are the same as General Motors. However, Dongfeng Motors sales are in renminbi, not U.S. dollars!

Apart from sales that they might ultimately get from the North American market, there has been speculation that some of the Chinese carmakers may be “white knight” candidates for all or parts of the troubled assemblers. For example, it has been rumored that Dongfeng may be in discussions to buy Volvo, a unit of Ford. So far, all of these rumors have been denied.

With the market the way it is, even the extremely low valuations for U.S. components companies may prove to be pricey at the moment. One person I spoke to equated buying a U.S. components company today to buying a “melting ice cube.” However, there is a great deal of hard-to-get technology tied up in these companies, and once the market settles down, Chinese components companies may find some interesting bargains to be had. With the market for cars now ending up in the hands of the Asian carmakers, the flow of a lot of technology in this industry to Asia will not be far behind.

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