How Sustainable Are China’s Car Sales And What Do They Mean for Volume and Location of Gasoline Demand?
- China’s market for new passenger cars is maturing, but the overall outlook for car fleet expansion remains bright for at least 5-7 more years.
- Even in a pessimistic scenario, Chinese are likely to buy more than 18 million passenger cars in 2020—a nearly 30% increase over the number of cars likely to be sold in 2013.
- The greatest market and growth potential lies in (1) “mid-level” cars—250,000-800,000 RMB (US$ 40,000-130,000) for larger cities and (2) lower cost vehicles for inland regions.
- Luxury vehicles (RMB 800,000-1,000,000+/US$ 130,000-165,000) are likely to remain an important-but-niche market that grows significantly yet does not become a large slice of the overall market.
- Areas where new car sales will likely outperform the national average include Henan, Hubei, Sha’anxi, Shanxi, Hunan, Sichuan, Anhui, Yunnan, and Chongqing.
- As new car sales numbers begin to plateau, carmakers will come to rely increasingly on sales of certified used vehicles and on providing maintenance services to vehicles of their respective brands.
- China’s used car market has great growth upside over the next decade. 370,000 pre-owned vehicles were traded in 2001, 2.4 million in 2010, and 4.8 million in 2012.
- China Automotive Dealer Association forecasts that used car sales could reach 20 million units by 2018. This suggests that new and used car sales could be at 1:1 parity within five years.
- EVs are unlikely to displace gas-powered auto sales, particularly in China’s interior.
- While most major Chinese cities have basic restrictions on car use, they are unlikely to dampen car sales significantly on a nationwide basis.
- Continued strong overall growth in car ownership will drive significant increases in gasoline and crude oil demand.
- Rubber (for new and replacement tires) and platinum group metals (for catalytic converters) will also benefit from a larger car fleet.
- China’s evolving auto sector is also likely to create multiple large publicly traded and private equity investment opportunities in used car dealers and auto price information vendors.
- There is very significant room for additional passenger car fleet growth and greater gasoline consumption in the inland cities.
- The car fleets of Chengdu, Wuhan, and Zhengzhou—only three out of dozens of sizeable inland cities—would need to grow by 3.5 million vehicles to reach the 25 cars per 100 residents level we believe approaches likely market saturation.
- Even if composed solely of the smallest economy cars, such a fleet addition would still likely boost Chinese gasoline consumption by 42 thousand barrels per day (kbd)—worth roughly 200 kbd of additional crude oil demand.
- The 70 million new passenger cars sold in China since January 2009 have likely displaced older vehicles. We believe this switch is now largely completed, however. Each additional car sold thus drives future gasoline demand more directly.
- Each million small economy cars sold will likely add about 14 kbd of incremental gasoline demand.
- Each million large luxury vehicles with high-displacement engines will likely add at least 33 kbd of incremental gasoline demand.
- Sinopec, China’s largest refiner, reported that in the first nine months of 2013, gasoline production was up nearly 15% YoY, while diesel production remained stable.
- This report is based on extensive Chinese- and English-language sources, as well as interviews with Chinese government and private sector specialists and consumers with on-the-ground experience in diverse locations throughout Mainland China.
Data and Analysis
Passenger car sales in China have continued on a strong upward trend throughout 2013, rising 11.5% YoY in November 2013, when 1.63 million new passenger cars were sold (Exhibit 1).
Continuing robust sales numbers raise the question of how sustainable China’s level of new vehicle sales is. Car ownership rates in Taiwan are a good proxy for where things will likely go in mainland China. Indeed, we re-affirm our prior view that 25-30 passenger cars per 100 residents is a likely saturation level for most Chinese cities. Absolute sales numbers will likely remain solid, but with lower growth rates.
Exhibit 1: China New Passenger Car Sales, through November 2013
Units per month
Per capita passenger car ownership rates in wealthier cities on China’s East Coast—including Beijing, Shanghai, Guangzhou, and Xiamen—are rapidly approaching Taiwan levels and we expect sales slowdown there as sales structure transitions to a more “maintenance level” number like that which we see in more mature car markets like the U.S. or Japan.
Indeed, mainland China’s affluent coastal enclave of Xiamen—opposite Taiwan—now has a per capita private passenger car ownership rate of just under 31 cars per 100 residents. These are also the cities where restrictions on new car sales are most likely.
One experienced businessman we spoke with believes mainland Chinese cities could potentially stabilize at even higher car ownership levels than Taiwan, driven by the following factors: urbanization policy emphasized under President Xi Jinping, faster economic growth combined with heightened societal competition than in Taiwan, a high degree of multiple car ownership in big coastal cities, and policies promoted by Xi that will allow more working-class people to buy small, basic cars.
The areas we now watch for sales growth that outperforms the national average include such inland provinces and municipalities as: Henan, Hubei, Sha’anxi, Shanxi, Hunan, Sichuan, Anhui, Yunnan, and Chongqing. These boast a combined population of nearly 500 million and most of their cities (with the notable exception of Chengdu) have car ownership rates far below the 25-30 per 100 persons level.
Exhibit 2 (below) shows data for 36 large and medium-sized Chinese cities of which roughly ¾ are Tier 2 or lower cities—many of them in the provinces mentioned above. Of these cities, the vast majority are well below the saturation range. Moreover, cars offer a greater array of benefits in these cities because many inland cities do not have nearly as extensive public transit access as their coastal cousins like Beijing, Shanghai, and Guangzhou do.
Smaller inland cities will miss the subway construction boom currently engulfing their larger counterparts, as 3rd and 4th tier cities aren’t receiving the mass transit investments that larger cities are. Car sales benefit from this if people continue to obtain the financial means to upgrade from e-bikes to cars.
Exhibit 2: China Per Capita Passenger Car Ownership by City, Year-end 2012
Cars per 100 residents, non-Tier-1 cities shaded red
Overall, we see three core themes that investors with exposure to China’s automobile market should consider.
First, China’s lower tier cities still have very robust car sales growth upside and will increasingly drive national gasoline demand growth. Such areas are ideal markets for car sales because many residents are beginning to reach income levels at which motor vehicle ownership becomes feasible. They also tend to feature significantly lower rates of car ownership than many of the bigger coastal cities, some of which—such as Xiamen—are likely at or near the market saturation point.
Here it is worth assessing how rapidly vehicles may be added to local car fleets. To assess this, we analyzed five years of passenger car fleet data disclosed by the Chengdu Statistical Bureau. The data show that during Chengdu’s recent 2009-11 auto sales boom, the city’s private passenger car fleet grew by an average of 2.4 vehicles per year for every 100 residents (Exhibit 3). The baseline rate for non-boom times is between 1.2 and 1.3 additional passenger cars per year for each 100 residents.
Exhibit 3: Chengdu Passenger Car Fleet Addition Rate per 100 Residents
Sources: Chengdu Statistical Bureau, China SignPost™
Chengdu is an outlier, a “dragon head” (龙头) that easily dominates the less-developed areas surrounding it. It developed early, helped in part by “Third Line” relocation of military and strategic industries. While auto sales and ownership are still rising in Chengdu, the real pockets of opportunity are in other Chinese auto markets that are several years behind Chengdu on the private car ownership curve.
To reveal how these important emerging car markets are becoming steady demand drivers, we plot Chengdu’s car fleet data against those for Wuhan. Wuhan is a major industrial and river transport hub—a Chinese analogue to St. Louis in its prime. In 2012, both cities had per capita disposable income of ~27,000 RMB. Yet Wuhan is on a different car ownership trajectory than Chengdu. At year-end 2012, Wuhan residents owned 9.3 private passenger cars per 100 residents—roughly 65% less than the 15.3 cars per 100 residents that the denizens of Chengdu own (Exhibit 4).
Exhibit 4: Private Passenger Car Fleet Annual Additions—Wuhan vs. Chengdu
Vehicles per 100 residents
Sources: Local statistical bureaus, China SignPost™
Wuhan’s trajectory suggests it has not yet experienced the boom in private car ownership that Chengdu underwent between 2009 and 2011. Chengdu’s previous growth pattern—with growth cresting in 2010—and the fact that Wuhan appears not to have reached its peak growth rate yet, suggests that cities with less developed auto markets can sustain several years of increases. Growth of their local car fleets will likely accelerate to at least 2.0 vehicles per 100 residents each year, then transition to several years of adding 1.5 or more cars per each 100 residents.
Data for Zhengzhou, another major inland second tier city market, show that car fleet growth accelerated from 0.91 cars per 100 residents in 2008 to 2.70 cars per 100 residents in 2012. Cities that are closer to the coast, but are not Tier 1 metro areas on a par with Beijing, Guangzhou, or Shanghai, are also still enjoying robust car fleet growth. Suzhou, for instance, went from adding 1.46 cars per 100 residents in 2008 to adding 3.8 vehicles per 100 residents in 2012 (Exhibit 5).
Exhibit 5: Private Passenger Car Fleet Annual Additions—Suzhou vs. Zhengzhou
Vehicles per 100 residents
Sources: Local statistical bureaus, China SignPost™
Suzhou’s private car ownership rate per 100 residents is now 22.3 and we believe the city will surpass the 25 cars per 100 residents benchmark by mid-2014, if it has not done so already. The Suzhou example suggests that car ownership rates in many of the large Eastern Chinese car markets that are satellites of larger metro areas may be rapidly nearing saturation, with perhaps 2-3 years of relatively robust car sales growth remaining.
The inland areas are a different story, however. The car ownership rate in Zhengzhou—a fairly developed inland market with a 2012 per capita GDP of 63,300 RMB—stood at 14 cars per 100 residents at year end 2012. Less developed markets have substantially lower ownership rates. For example, local data show that Xiangtan, Hunan had a 2012 ownership rate of 4.2 cars per 100 residents while Nanchang, Jiangxi had a 2012 ownership rate of 7.1 cars per 100 residents at a per capita GDP of 58,715 RMB.
The room for additional passenger car fleet growth in these inland cities is very significant in volume terms. Indeed, for the examples we charted above—Chengdu, Wuhan, and Zhengzhou—reaching 25 cars per 100 residents would require net car fleet growth of 3.5 million units. Assuming these are the smallest economy cars, such fleet augmentation would still likely boost Chinese gasoline consumption by 42 kbd—worth roughly 200 kbd of additional crude oil demand.
Passenger car fleet growth in the inland and lower tier markets also has a substantial time dimension. For many such markets, approaching the 25 cars per 100 residents saturation level would likely require a growth runway of at least 5-7 years beyond the present. By that point—in the 2020 timeframe—the first wave of retirements will begin for vehicles sold beginning in the 2009 car boom, and the mid-maturity auto markets will likely move into a more maintenance-/replacement-oriented level of new car sales.
Sustainability of Heightened Vehicle Demand
The abovementioned trends suggest that while present new car sales rates are likely to slow somewhat, growth will remain high overall, particularly in lower tier cities. The reason we anticipate some softening is that current auto sales rates may not be fully sustainable. They are arguably heightened slightly but temporarily by pessimism about China’s economic and real estate price growth that reduces the opportunity cost of addressing a concrete secondary priority—a nice car—for households that might otherwise seek to maximize financial and housing investments.
While China’s most widely recognized car owning cities are located on the country’s Eastern Seaboard, a significant number of large inland metro areas have per capita private passenger car ownership rates nearly as high as coastal cities’. For instance, Chengdu has car ownership rates of nearly 20 cars per 100 residents, while Urumqi and Xi’an each fall just shy of 18 cars per 100 residents. Other large, booming inland cities have much lower ownership rates—12.27 cars per 100 residents in Changsha and 11.20 per 100 residents in Hefei.
Most notably, populous areas that are predominantly rural in layout (the so-called Tier 3, 4 and 5 areas) tend to be poorer and typically have much lower rates of car ownership. If economic growth that drives personal incomes continues, these locales are likely to be centers of car sales growth moving forward.
For instance, Honghe in Yunnan Province presently has a car ownership rate of only 3.03 per 100 residents—less than half the national average rate for private passenger cars. Current sales trends indicate that the Honghe-type cities are already seeing significant car sales increases. The China Automobile Dealers Association says that in 2012 sales volumes increased by only single digits in the first-tier cities (albeit from a high baseline), but rose 131% in second and third-tier cities.
There appears to be a “fan out” effect whereby a region in China first sees car sales in its largest cities and then smaller municipalities also evolve into demand centers. For example, in 2006, Chengdu was home to 92.7% of Sichuan’s private passenger car fleet but now houses around 70% of the province’s private passenger cars, a clear sign that sales are taking off strongly in Sichuan’s smaller cities and townships.
We expect such geographical diversification of sales to continue as places like Beijing and Shanghai enforce increasingly restrictive policies on car sales and use. China’s domestic car brands already focus their sales efforts heavily on the smaller and inland cities and now the Western automakers and their Chinese JV partners are following suit.
For example, GM plans to expand its dealership network in China by more than 34% by 2015, adding 1,300 additional dealerships and focusing much more heavily on Tier 3 and Tier 4 cities. Other carmakers are also striving to expand their sales networks in Central and Western China.
In the near term, this sets dealers up for thinner margins and tough price competition. But in the 3-5 year timeframe, growing dealer networks signify that, along with road and highway construction, the elements are aligning for a significant rise in car sales and ownership in China’s interior, a diverse region nearly as physically large as, and more populous than, the U.S.
Gasoline Demand Impacts of the “Wuhan Trajectory” vs. the “Chengdu Trajectory”
Wuhan’s car fleet growth appears to be driven by steadier “organic” demand. In contrast, Chengdu’s fleet expansion hit its apogee amidst nationwide stimulus measures that Chinese auto industry observers believe may have driven roughly 20% of sales in 2010.
Comparing the “organic” versus “boom” sales models raises interesting gasoline demand questions. In an organic demand environment, one expects buyers to be purchasing a vehicle that they intend to begin driving right away because they need or want it and may have planned the purchase for some time.
Boom sales, however, arose in China’s case from a combination of general national economic stimulus beginning in late 2008 and specific measures such as tax cuts and trade in subsidies that were targeted directly at encouraging purchases of new passenger cars.
It is likely that many of these boom sales were opportunistic and not underpinned by an immediate need for a vehicle. Accordingly, cars tend to be driven less immediately after being purchased and sales growth in such circumstances yields a delayed gasoline demand increase.
In contrast, when sales are driven organically, as they appear to be thus far in Wuhan, we expect a closer leverage between car sales number and gasoline demand increases. This is especially true because the 70 million new passenger cars sold in China since January 2009 have likely displaced a great number of older alternative gasoline burners such as the smoky single cylinder trikes previously ubiquitous in many cities.
During the initial burst of sales in 2009 and 2010, the fact that some buyers were swapping old vehicles for new ones muted the total gasoline demand growth that one would normally expect from high volume sales of new cars.
We believe this switch is now largely completed. Indeed, Sinopec (China’s largest refiner) reported that in the first nine months of 2013 gasoline production was up nearly 15% YoY while diesel production was basically flat. China’s passenger car fleet is overwhelmingly gasoline powered.
Therefore, we expect the steadier organic passenger car ownership growth occurring in Wuhan and other inland and lower-tier markets to drive gasoline demand that is closely leveraged to overall growth in local vehicle fleets.
Second, China’s new car market will still grow, but more slowly than has been the case in the past five years. Volkswagen, the largest single holder of market share in China’s new car market (~20%), has stated since at least 1Q2012 that China’s passenger car market is “stabilizing.” We interpret “stabilizing” as a code word for “expect slower growth rates moving forward.” Likewise, in 2Q2013 General Motors announced that it foresees China’s new passenger car sales volumes growing at 7-9% YoY in 2013.
Absolute new car sales volumes will remain robust because China’s baseline is already enormous (more than 15 million units per year). In addition, given China’s relatively low national car ownership levels, this will be a “plateau with Chinese characteristics.” On this basis, we project that over the next two years, new car sales volumes will increase in the 7% range and for the next five years after that (i.e., out to 2020), they will increase by 4-5% per year. Exhibit 6 (below) shows our base, pessimistic, and optimistic forecasts for passenger car sales in China.
Exhibit 6: China Passenger Car Sales Outlook Scenarios
Vehicles per year
Sources: China Association of Automobile Manufacturers (CAAM), China SignPost™
Even in the pessimistic scenario, Chinese are likely to buy more than 18 million passenger cars in 2020—a nearly 30% increase over the number of cars likely to be sold in 2013. Rising car sales numbers, and corresponding growth in oil dependency, understandably make Beijing increasingly attuned oil security and potentially open to measures to reduce dependence on imported crude oil.
Third, the overall growth in the size of China’s car fleet will remain closely leveraged to new car sales numbers over the next 3-5 years. China’s car market is young, with the real jump in sales coming only four years ago.
Roughly 70% of China’s fledgling car fleet is estimated to be five years old or less. Used car sales are thus only now beginning to play a significant role in the market. Yet enough new consumers are entering the car market that the used cars becoming available are almost certainly insufficient to satisfy demand.
Indeed, China’s used car market has great growth upside over the next decade. 370,000 pre-owned vehicles were traded in 2001, 2.4 million in 2010, and 4.8 million in 2012. China Automotive Dealer Association forecasts that used car sales could reach 20 million units by 2018. This suggests that new and used car sales could be at 1:1 parity within five years.
To be sure, there is significant segmentation within aggregate statistics. Buyers in top-tier coastal cities prefer new cars, and their used cars are often resold in smaller inland cities where many consumers’ more limited incomes dictate focus on price.
Chinese drivers’ affinity for frequent vehicle changes fuels these dramatic growth rates. Cultural and sociological factors inspire Chinese to continue to buy newer and better cars. Subways, while proliferating, are crowded. Particularly given China’s rapid modernization, people tend to crave the newest, most high-tech cars and options that they can afford. Even old cars may be outfitted with GPS; their owners may go so far as to remodel and decorate the interior.
Brand names matter, particularly to more affluent consumers. In wealthy coastal areas, most people want to upgrade their car every 3-5 years. “Entry level cars” (入门车) tend to be lower quality; people seek to show off their subsequent economic achievement with larger, more expensive vehicles.
Researchers at the Shanghai University of Engineering Science’s College of Automotive Engineering believe that as many as 60% of Chinese car owners replace their cars every three years. If true, this would be a much higher rate than is typical in other car markets. For example, in the U.S., new car buyers typically retained their cars for approximately four years before the 2007-08 downturn and now keep them for nearly six years.
Even if the actual number is lower than the Shanghai researchers estimate, it still suggests that Chinese car owners tend to turn vehicles over relatively quickly, which will help accelerate overall fleet growth as wealthier buyers purchase new cars and send their old ones into the used car market at discounts that make them affordable to less well-off buyers.
As used cars become a larger proportion of the market, this will help accelerate the plateau in new car sales. However, fuel demand will still grow because as current car owners sell their autos into the used market and acquire new vehicles, overall vehicle fleet numbers will rise. Indeed, we do not anticipate significant scrapping activity until the 2020 timeframe, when the age of the 2009 sales class exceeds the venerable decade mark.
Potential Headwinds for New Car Sales
Most major Chinese cities have some basic form of restrictions on car use (e.g., by license plate number), though specific approaches vary. In some cases, violators’ license plates are captured on cameras connected to a nationwide database, and tickets mailed to their residence.
Where specific cities impose harsh restrictions successfully, local effects can be significant. In Beijing, where administrative restrictions on the number of new license plates that can be issued have helped slash new car sales from 920,000 in 2010 to 240,000 last year (Exhibit 7).
Exhibit 7: Beijing’s Restrictions Have Slashed New Car Sales
Sources: Reuters, China SignPost™
Evidence to date suggests that inland cities may be more willing than their coastal cousins to tolerate car congestion and pollution as a price of development, and hence less willing or able to enforce restrictions. Xi’an, which is rapidly becoming one of China’s largest car-owning cities, had planned to emulate Beijing, Shanghai, and Guangzhou and restrict license plate issuance to control car fleet growth, but had to rescind the plan in August 2012 following vociferous public outcry against the proposed restrictions.
More broadly, residents of 3rd, 4th, and 5th tier cities will still probably be able to buy cars with few limitations. Indeed, on a nationwide basis, restrictions appear unlikely to suppress auto sales meaningfully, and demand will continue to grow regardless. Restrictions are widely viewed as annoying but unlikely to deter car purchases, and paradoxically may even accelerate them in some cases.
The last is true because annoyance at restrictions inspires preemptive or maximalist purchasing to hedge against the possibility of greater subsequent constraints and hassle. When consumers finally obtain license plate numbers, they often buy the nicest car possible to maximize the opportunity. On the parking front, parking lots gain considerable revenues, but fees and difficulty don’t deter car purchases significantly.
Electric Plugin Cars Unlikely to Penetrate Market in Large Numbers
Increasing availability of electric vehicles (EVs) likewise seems unlikely to displace gas-powered auto sales, particularly in China’s interior. Overall, “Beautiful China” environmental conservation and resource pricing initiatives appear poised to be an area of significant achievement for Third Plenum reforms for three major reasons. First, China’s leadership realizes that the tremendous environmental damage wreaked by three decades of meteoric economic development exacts increasing health and economic growth costs. Second, stemming environmental degradation has become a key objective for preserving the Party’s legitimacy.
Pollution is an increasing source of both urban and rural protests. It is also one of the greatest disappointments of privileged urban dwellers, whose priorities have evolved to the point where they would support trading some economic growth for environmental improvement—a common dynamic that has driven the cleanup of other nations’ environments after they initially profited from developing their economies dirtily.
Third, environmental and resource issues lend themselves to the sorts of statistical metrics, engineering solutions, and green technology development opportunities with which China’s technocratic leadership is comfortable and which its system is oriented to support. “Air security” has thus become so important in Chinese society today that it can compete successfully with “oil security” for Beijing’s attention.
One important environmental consideration is how to handle China’s continued increases in auto sales and use. Here, environmental concerns about cars are somewhat misguided at the fundamental level—one coal-fired power plant emits more than thousands of cars. Car tailpipe emissions are more easily cleaned up. This is happening already in China through better employment of emissions control technology in vehicles and higher refining standards for the gasoline they consume.
The government also promotes electric vehicles to incubate green technology exports, but substituting them for gas-powered vehicles actually hurts China’s air pollution profile at present by exchanging foreign oil consumption for electric power generation, still fueled largely by cheap but highly-polluting coal. We estimate that each million plug-in electric passenger cars would create an additional 1.4-1.9 million tonnes per year of coal demand in China.
This “road to grid” linkage increases coal demand and air pollution and could disrupt local electrical grids where there are higher concentrations of such cars, although the national level impact is not large. Additionally, EV infrastructure likely cannot be easily or cheaply socialized and hence will represent a barrier to entry for consumers. Expenses, inconvenience, range limitations, and the costs of chargers and other supporting systems fall on the individual owner whereas liquid-fueled system costs like gas stations are distributed across society because so many people use them.
Rounding out the alternative vehicle picture, liquefied natural gas (LNG) buses and trucks and compressed natural gas (CNG) taxis are growing in certain cities. While valued for their ability to limit air pollution, they suffer from reduced internal cargo space due to the need for bulky compressed natural gas tanks. Specialized fleet vehicles may move incrementally toward greater use of LNG and CNG, but for at least the next 5-7 years, passenger cars will remain gasoline dominant, with some diesel engine use on the margins.
Electric vehicle bottom line: China’s technocratic leaders likely understand the abovementioned realities. EVs may thus catch on as niche vehicles in large coastal urban centers, but the lower tier markets that are coming to drive passenger car sales in China will be harsh environments for EVs and we don’t see them making significant inroads within the next 5-7 years.
Potential Gasoline Demand Impacts of Changing Consumer Tastes and Buying Power
To date, smaller economy cars have dominated Chinese car sales in volume terms. This in itself represents a potent dynamic as China develops a “car culture.” Cars are already status symbols at all levels of society from middle class on up. In the lower-tier and rural areas, car ownership will likely be “sticky” and contagious as people realize how much convenience a car affords.
However, larger vehicles are creeping in at the margins. With their higher fuel consumption rates, they can move the gasoline demand needle at a significantly lower sales figure. For example, we estimate that based on a mean annual kilometers driven figure determined from academic studies of Chinese drivers, each million small economy cars sold (as calculated using the BYD F0’s characteristics) will add about 14 kbd of incremental gasoline demand. At the other end of the spectrum, large luxury vehicles with high-displacement engines (as calculated using the Porsche Cayenne’s characteristics) would add at least 33 kbd of incremental gasoline demand per million vehicles sold (Exhibit 8).
Exhibit 8: Gasoline Demand for Different Vehicle Classes Sold in China
Thousand barrels per day of gasoline (left axis), vehicle engine size in liters (right axis)
Sources: Chinaauto.com, GM, Audi, Honda, Fueleconomy.gov
What, then, is the potential for the larger vehicles to seize market share from the small cars and make Chinese passenger car sales proportionally more gasoline intensive over time? To help elucidate possible future sales directions, we focus on SUV and luxury vehicle sales drivers.
SUV sales will probably be driven the most by the “cool” factor. Imagine the Chinese equivalent of “urban cowboys” such as those seen in the U.S.—for instance, the suburban professional who drives the heavy-duty diesel truck that can tow 20,000 lbs. To such a potential buyer, what others think of his vehicle matters more than whether or not he actually needs its maximum capabilities.
China’s heavy investments in new roads suggest that China will not be like Russia, where SUVs are almost a necessity in many areas to cope with atrocious road conditions. While Chinese roads can be an adventure due to risk-tolerant fellow motorists, the road surface itself is typically decent enough. Furthermore, the more rural and mountainous parts of China where an SUV’s high clearance, stiffer suspension, and 4WD would be legitimately useful also tend to be poor enough that few residents can afford one—particularly the bigger, more fuel-thirsty SUVs that check the status box.
Foreign cars, especially SUVs, enjoy substantial advantages for the foreseeable future (at least the next 5-7 years). We believe foreign SUVs have a leg up over Chinese competitors because they are perceived as being (and typically are) of better quality than many locally made machines. Chinese consumers typically want the superior quality and status of foreign brands if they can afford them. Great Wall SUVs, for instance, are widely viewed as unreliable, with a tendency to “go bad” after as little as one year.
China does not yet—and may never—enjoy an off road, outdoors culture that supports private off-roading and racing programs like North America’s Baja truck racing that yield design insights applicable to mass market vehicles. Technology transfer and/or strategic acquisitions could help offset this, but the gap is currently wide. If SUV sales begin to account for a significantly larger portion of the market, then we would expect Chinese manufacturers to compete more aggressively in the space. They might seek to force foreign JV partners such as GM to transfer more SUV-focused technology as a condition of remaining able to do business in China. Hurdles to such an approach include trade regulations and foreign automakers’ lobbying power.
Foreign SUV launches may thus take share from local brands, particularly in wealthy areas where consumers select on quality in addition to price. Some reputable global companies are offering relatively cheap SUV options. A prime example is the Ford Kuga compact SUV, which is almost as cheap as the closest competitors offered by Great Wall. It is likely more fuel efficient (44.1 mpg), produces lower emissions (169 g/km; 6.41 L/100 km; 36.7 mpg-U.S.), and boasts a better safety reputation.
Meanwhile, Third Plenum reforms may make it slightly more difficult to protect local car manufacturers in response to such competition. Further Sino-Japanese tensions are likely to shift consumer preferences away from Japanese car brands, but not necessarily to Chinese car brands. American and European automakers stand to benefit on both counts.
Luxury Cars: Valuable Niche Market
Luxury vehicles (RMB 800,000-1,000,000+/US$ 130,000-165,000) are likely to remain an important segment that grows significantly in absolute number terms but remains small as a percentage the overall passenger car market. Chinese society under Xi is experiencing less dramatic minting of nouveau riche and less tolerance for conspicuous consumption by corrupt officials. To be sure, one countervailing factor is increasing cultural preference for some degree of luxury. Therefore, the best investment bet involves top-quality brands that enjoy partial mass-market penetration as well.
Sustainability of recent, robust sale increases is an important strategic issue for companies like BMW whose global sales portfolios are becoming increasingly leveraged to China. For instance, China is now BMW’s single largest market, accounting for approximately 20% of BMW’s global vehicles sales in 2013 (as of October).
China had around 1.3 million millionaire households in 2011, according to Deloitte. These households could support multiple Mercedes/BMW/Audi/Porsche-type vehicles. Beyond the dollar millionaires, there are likely many “RMB millionaires” who are wealthy, but not quite dollar millionaires. Nonetheless, they aspire to own a high-end foreign mark vehicle, making people in this economic demographic very likely to become luxury car customers, especially in prestige-obsessed China.
We believe that there might be ~2-3 of these “$500k to $999k” households for every true dollar millionaire. We thus estimate that there are ~4-5 million households in this range in China now, rising to ~10 million or more such households by 2020.
Luxury car bottom line: Chinese manufacturers will not be able to compete with BMW, Mercedes, or other foreign manufacturers in the luxury segment for at least five years. This offers a significant window of opportunity for high-end car sales into China.
Mid-Level Cars: Watch This Space
The greatest market and growth potential lies in (1) “mid-level” cars—250,000-800,000 RMB (US$ 40,000-130,000) for larger cities and (2) lower cost vehicles for inland regions.
This makes mid-level vehicles a particularly interesting segment. Here, Chinese consumers typically select first on quality, second on fuel economy. Here, generational evolution in consumer preference is important to watch. Later generations (particularly individuals born after 1990 who will be buying their first cars over the next decade) are more discerning and culturally sophisticated than their predecessors. They tend to want higher quality, starting from a relatively high entry point—“affordable luxury.”
Here, car purchases and real estate prices are linked in ways that largely support growth in vehicle ownership. Young people who can afford to purchase an apartment but have limited additional resources will prioritize purchasing it over a car. Young people who can afford an apartment with significant money to spare also want to buy a car as soon as possible. The increasing number of youths of some means who nevertheless can’t afford to buy an apartment for the foreseeable future will still want to buy a car in the meantime.
Key Commodity and Investment Impacts
We estimate that overall, each million new private passenger cars sold in China create 20 kbd of gasoline demand. Based on the average gasoline yields of Sinopec and PetroChina’s refineries, approximately 100 kbd of crude oil are needed to produce 20 kbd of gasoline.
The China car value equation is shifting from new cars to used cars, auto parts and services, and crude oil. Used car sales rising fast. New car sales may continue to focus on larger metro areas. As those vehicles reach the 3-5 year age mark, they will then be resold used to less affluent consumers in lower tier cities and rural areas where cost concerns outweigh strong Chinese/Asian societal preferences for new vehicles as status symbols. What this means in practice is that fuel and oil demand will continue to rise substantially, but that the OEM auto makers may not capture as much value as they might otherwise from growth in the lower income areas.
As new car sales begin to plateau, carmakers will come to rely increasingly on sales of certified used vehicles and on providing maintenance services for vehicles of their respective brands. Margin compression will affect carmakers across the segments—even for luxury cars. BMW believes luxury car margins will shrink by 1-2% per year in coming years as buyers favor smaller luxury vehicles.
Used car sales and aftermarket services tend to offer substantially higher margins than new car sales. For example, U.S. used car superdealer Carmax consistently records gross profit margins in the 13% range. Carmax generates these profits even in a market environment in which consumers have abundant access to information on the value of used cars. We therefore see no reason why a Chinese equivalent of Carmax could not generate similar returns from discerning Chinese consumers.
Aftermarket services are also much more profitable than selling new cars. For example, China-based dealership operator Yongda Automobile Services reports that in the first half of 2013, its gross profit margin on aftermarket sales and service was 46.4%, roughly 10 times the profit margin that a large carmaker like Ford makes from selling new vehicles in the China market.
Gabe Collins and Andrew Erickson, “Counting Cars: Rising Private Automobile Ownership in Chinese Cities Paves Road for Gasoline Demand,” China SignPost™ (洞察中国) 71 (24 June 2013).
Gabe Collins and Andrew Erickson, “Electric Bikes are China’s Real Electric Vehicle Story,” China SignPost™ (洞察中国) 49 (7 November 2011).
Gabe Collins and Andrew Erickson, “Dying for a Spot: China’s Car Ownership Growth is Driving a National Parking Space Shortage,” China SignPost™ (洞察中国) 17 (10 January 2011).