Q1 2014 China: Autos Report

Q1 2014
www.businessmonitor.com
CHINA
AUTOS REPORT
INCLUDES 5-YEAR FORECASTS TO 2017
ISSN 1748-9830
Published by:Business Monitor International
China Autos Report Q1 2014
INCLUDES 5-YEAR FORECASTS TO 2017
Part of BMIs Industry Report & Forecasts Series
Published by: Business Monitor International
Copy deadline: October 2013
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CONTENTS
BMI Industry View ............................................................................................................... 7
SWOT .................................................................................................................................... 9
Political ................................................................................................................................................. 10
Economic ............................................................................................................................................... 11
Business Environment .............................................................................................................................. 12
Industry Forecast .............................................................................................................. 13
Production and Sales ............................................................................................................................... 13
Table: China Autos Sector - Production And Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Trade ................................................................................................................................................... 14
Passenger Vehicles .................................................................................................................................. 21
Table: China Autos Sector - Passenger Cars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Alternative Fuel ..................................................................................................................................... 25
Auto Financing ...................................................................................................................................... 27
Commercial Vehicles ................................................................................................................................ 28
Table: China Autos Sector - Commercial Vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Motorcycles ............................................................................................................................................ 31
Table: China Autos Sector - Motorcycles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Company Developments .......................................................................................................................... 32
Suppliers ................................................................................................................................................ 34
Industry Developments ............................................................................................................................ 34
Macroeconomic Forecasts ............................................................................................... 36
Economic Analysis ................................................................................................................................... 36
Table: China - Economic Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
Industry Risk Reward Ratings .......................................................................................... 41
Company Monitor .................................................................................................................................... 41
Company Profile ................................................................................................................ 45
Company Monitor .................................................................................................................................... 45
Shanghai GM .......................................................................................................................................... 49
Volkswagen ............................................................................................................................................ 51
Ford Motor ............................................................................................................................................ 53
Daimler ................................................................................................................................................. 55
Regional Overview ............................................................................................................ 59
Table: Vehicle Sales Sep 2013 (Cbus) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Global Industry Overview .................................................................................................. 66
Business Monitor International Page 4
Demographic Forecast ..................................................................................................... 70
Demographic Outlook .............................................................................................................................. 70
Table: China's Population By Age Group, 1990-2020 ('000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
Table: China's Population By Age Group, 1990-2020 (% of total) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
Table: China's Key Population Ratios, 1990-2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
Table: China's Rural And Urban Population, 1990-2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
Methodology ...................................................................................................................... 75
Industry Forecasts .................................................................................................................................. 75
Sector-Specific Methodology .................................................................................................................... 76
Sources ................................................................................................................................................ 76
Risk/Reward Ratings Methodology ............................................................................................................ 77
Table: Automotive Risk/Reward Ratings Indicators And Weighting Of Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
BMI Industry View
Sales
According to the China Association of Automobile Manufacturers (CAAM), vehicle sales in September
2013 surged 19.7% y-o-y, to 1,935,800 units, bringing sales for the first nine months of the year to
15,882,449 units, an increase of 12.7% y-o-y.
Slowdown View Still There, Just Delayed
While we had originally said that auto sales will suffer a slowdown in H213, as a slowing economy would
hurt consumer sentiment, we now believe the slowdown in the car market will come in 2014 when the
current economic bounce gives way. This is because as our Country Risk team crucially points out, this
latest surge in credit through the informal channels in the system will not be positive for economic growth
in 2014, not least as it delays the painful but necessary rebalancing away from stimulus driven growth.
Passenger Car Segment Will Outperform
As the Chinese economy rebalances over the coming years to one where consumption makes up a larger
share, the outperformance of the passenger car segment vis-a-vis the CV segment will persist. Over our
2013-2017 forecast period, we expect car sales to grow 8.4% a year on average versus 4.8% a year average
growth for the CV segment. Therefore, we believe there is greater value in passenger car brands, which are
industry leaders, rather than pure play CV manufacturers.
Comeback Of Japanese Brands Aids Monthly Performance
The strong print in passenger car sales figures is attributable to broad-based strength in the sector. Besides
the continued outperformance of the SUV and MPV segments, which is in line with BMI's long-held view,
the recovery in Japanese automakers' sales also contributed to the surge.
Indeed, anti-Japanese sentiment generated by the Sino-Japanese dispute was at its peak during September
and October 2012, leading to sharp sales declines for Japanese carmakers in those months (see 'Escalating
China-Japan Tensions Spell Trouble', September 18 2012). We warned that the comeback for Japanese
brands would take a while, due to the deep rooted cultural underpinnings of the dispute. True enough,
consumer misgivings towards Japanese brands have started to abate 12 months later, and these carmakers
are now enjoying surging growth rates from a low base (see 'Weakening Yen Possible Trump Card For
Japanese Autos', January 17 2013).
Shanghai FTZ Could Be Positive For Exports
We believe the Shanghai FTZ could go on to boost China's auto parts exports. While exact details on the
economic incentives within the zone still remain sketchy and it is likely that the FTZ's full potential will
take years to materialise, its set up is a step in the right direction. According to CAAM, the gross value of
auto parts exports rose 4.6% y-o-y in H113. If regulators manage to attract more suppliers to set up shop
within the FTZ and take advantage of its preferential tariffs, component exports can be further boosted.
SWOT
SWOT Analysis

Strengths

Investments continue to flow into the market from both automakers as well as
suppliers.
Underpenetrated nature of the market means that plenty of growth potential remains.
The automotive industry remains a bright spot in the face of slowing economic growth
faced by China, with new vehicles sales continuing to grow strongly.
While the auto industry is the fourth largest industrial sector by revenue, it remains the
most profitable among all the 41 industrial sectors, with earnings for H113 up 20% y-
o-y, to CNY233bn.
Weaknesses

Lack of strong incentives for hybrid vehicles is hampering the country's ability to
tackle its air pollution woes.
Plenty of small and unprofitable domestic carmakers in the market suggests that
some consolidation will be necessary in the sector.
Opportunities

China's air pollution problems coupled with the renewal of government incentives for
electric vehicles (EVs) will create long-term opportunities for automakers in the EV
space.
Improving quality and brand names have seen certain Chinese carmakers such as
Geely and BYD making a name for themselves overseas.
Threats

Another global downturn or a China hard landing could see a lot of automakers
getting hurt, given the presence of almost every global carmaker in China.
Political
Political SWOT Analysis

Strengths

The CPC, which has governed for over 60 years, remains secure in its position as the
sole political party in China.
China's expanding economy is giving it greater clout in international affairs, which will
allow it to build politically important ties, especially with the developing world.
Weaknesses

As with any other one-party state, China's political system is inherently unstable and
unable to respond to the wider changes taking place in society.
Provincial governments often fail to enforce central government directives.
Although bilateral ties have warmed in recent years, China's relationship with Taiwan
remains problematic, with Beijing refusing to rule out the threat of force in the event of
a declaration of independence by Taiwan.
Opportunities

China is actively expanding its political and economic ties with major emerging
markets in Latin America, Africa and the Middle East.
A new generation of leaders (the so-called 'fifth generation') took power in 2012. This
should ensure the continuation of reform and modernisation.
Threats

Growing corruption, widening inequalities, increasing rural poverty and environmental
degradation have led to an increase in social unrest in recent years.
The Communist Party is facing increasing factional rifts based on ideology and
regionalism. While greater political debate would be welcomed by many, internal
regime schisms could prove politically destabilising.
Economic
Economic SWOT Analysis

Strengths

China has a massive trade surplus and its huge foreign exchange reserves serve as a
major cushion against external shocks.
China's economic policymakers are committed to continuing their gradual reform of
the economy.
Weaknesses

China's economic growth boom has led to major imbalances and environmental
degradation.
The country's dependency on investment to boost growth has made it vulnerable to a

slowdown in credit growth. Private consumption remains weak at less than 40% of
GDP.
The close relations between provincial leaders and local businesses are fostering
corruption, making it harder for the central government to enforce its policies.
Opportunities

China's economic growth is slowly becoming more broad-based, with domestic
consumption likely to rise in importance vis--vis exports and investment.
As China moves up the value chain, it will develop its own global brand name
companies, fostering innovation and growth.
Threats

We believe that we have witnessed a permanent end to China's double-digit annual
growth rate.
The economy will face difficulty in continuing to increase its share of the global export
market, and efforts to move up the value chain will be fraught with problems.
Business Environment
Business Environment SWOT Analysis

Strengths

China is continuing to open up various sectors of its economy to foreign investment.
With its vast supply of cheap labour, the country remains the top destination for
foreign direct investment in the developing world.
Weaknesses

Foreign companies continue to complain about the poor protection of intellectual
property in China.
Chinese corporate governance is weak and non-transparent by Western standards.

There is a considerable risk for foreign companies in choosing the right local partner.
Opportunities

China's ongoing urbanisation and infrastructure drive will provide major opportunities
for foreign investment in landlocked provinces as well as the transfer of skills and
know-how.
The Chinese government is giving more protection and encouragement to the private
sector, which is the most dynamic in the economy and accounts for most of the
country's job growth.
Threats

China's government will block attempts by foreign firms to take over assets of
national importance.
China is experiencing rising labour costs, prompting some investors to turn to
cheaper destinations such as Vietnam.
Industry Forecast
Production and Sales
Production
As Chinese wages have continued rising over the years, China's attractiveness as a manufacturing and
export hub, on the back of cheap labour, is diminishing (see 'Rise Of Robots As Industry Moves Up Value
Chain', December 4 2012). Our long-term auto production forecasts take that into account and we see them
growing in line with our auto sales forecasts, mostly to satisfy domestic demand.
Table: China Autos Sector - Production And Sales

2010 2011 2012 2013f 2014f 2015f 2016f 2017f
Total Production (CBUs, mn) 18.103 18.255 19.272 21.204 22.781 24.477 26.348 28.146
Motorcycle Production (CBUs, mn) 26.690 27.005 23.630 23.039 23.500 23.970 24.689 25.430
Total Sales (CBUs, mn) 18.060 18.530 19.306 21.201 22.737 24.473 26.299 28.001
Motorcycle Sales (CBUs, mn) 26.590 26.928 23.651 23.059 23.521 23.991 24.771 25.452
f= BMI forecast. Source: CAAM, Organisation Internationale des Constructeurs d'Automobiles (OICA)
Sales
According to the CAAM, vehicle sales in September 2013 surged 19.7% y-o-y, to 1,935,800 units, bringing
sales for the first nine months of the year to 15,882,449 units, an increase of 12.7% y-o-y.
Slowdown View Still There, Just Delayed
While we had originally said that auto sales will suffer a slowdown in H213, as a slowing economy would
hurt consumer sentiment, we now believe the slowdown in the car market will come in 2014 when the
current economic bounce gives way. This is because as our Country Risk team crucially points out, this
latest surge in credit through the informal channels in the system will not be positive for economic growth
in 2014, not least as it delays the painful but necessary rebalancing away from stimulus driven growth.
Passenger Car Segment Will Outperform
Trade
Shanghai FTZ A Positive For Auto Exports
BMI View: The new Shanghai FTZ, in our opinion, has the potential to boost component exports from
China, which grew 4.6% y-o-y in H113, due to preferential trade tariffs within the zone. While Chinese
vehicle exports remain mired in a downtrend due to the country's rising cost of production, the provision of
investor friendly incentives and world-class port infrastructure within the FTZ could attract more vehicle
export oriented investment in the country.
SAIC Motor Corp recently launched a subsidiary based in China's first free trade zone (FTZ) located in
Shanghai. The subsidiary will be a trading company and use its 100,000 square metre warehouse to source
auto parts worth CNY20bn (US$3.3bn) annually within five years. The Shanghai FTZ offers lower duties
and faster custom clearance for trade activities.
We see this development as a positive for the automaker. SAIC is China's largest carmaker and has been
looking to diversify its sales out of the country for some time. Furthermore, the firm has been setting up
production bases in overseas markets such as Thailand (see 'Thai Base Will Be SAIC's Asian Springboard',
July 5 2013), and plans to establish sales ventures in the Middle East and Latin America in the near future.
This new trading company will be able to leverage the FTZ's preferential trade tariffs and source the most
competitive component prices for the carmaker's global operations.
FTZ Has Potential To Boost Exports
We believe the Shanghai FTZ could go on to boost China's auto parts exports. While exact details on the
economic incentives within the zone still remain sketchy and it is likely that the FTZ's full potential will
take years to materialise, its set up is a step in the right direction. According to CAAM, the gross value of
auto parts exports rose 4.6% y-o-y in H113. If regulators manage to attract more suppliers to set up shop
within the FTZ and take advantage of its preferential tariffs, component exports can be further boosted.
On the other hand, the current picture for Chinese vehicle exports is not as bright. BMI has long held the
view that export oriented auto manufacturing is becoming increasingly uncompetitive in China due to the
rising cost of production. Adding weight to our view is the sharp y-o-y declines in vehicle exports over the
past few months. While some of the contraction can be attributed to cooling demand in some of the regional
markets, Thailand and Indonesia, two prominent regional exporters, have not experienced such drastic falls
in the same period. Therefore, we conclude that other factors such as China's rising manufacturing wages
are to be blamed for lacklustre export volumes.
Can The Shanghai FTZ Arrest This Decline?
China - Vehicle Exports Value In US$Mns And Units (LHS); % Chg y-o-y (RHS)
Source: BMI, Bloomberg
Lastly, while it is still too early to tell, we speculate that it is possible that automakers may be attracted to
export vehicles from the FTZ in the future. For example, General Motors Company (GM) plans to boost
its Chinese vehicle exports by 70.0% in 2013, to 130,000 units, on the back of demand from emerging
markets for low-cost Chinese cars. If the Chinese authorities put together investor friendly incentives - for
example, just requiring a representative office in the FTZ to enjoy its benefits as opposed to an actual
manufacturing plant - and follow up with the provision of world-class port infrastructure within the zone,
more carmakers could follow in GM's footsteps and look to export from China.
Industry Trend Analysis - Rise In Funding Cost Poses Risks To Auto Sector Players
BMI View: Should the recent rise in funding costs due to the Chinese banking sector's woes flare up once
more, small dealerships which already need to grapple with tight cash flows will come under greater
pressure, potentially forcing many of them to shutter. Domestic carmakers which have seen a surge in
accounts receivables would also see a detrimental impact to their balance sheets and should they shelve
expansion plans due to more expensive financing, auto sales would be indirectly hurt.
The recent turbulence in the Chinese banking system saw overnight interbank borrowing rates soaring
beyond 30% (see 'Beijing's Credit Crunch Conundrum', June 20 2013). While rates have fallen since then
as the central bank stepped in to ease the credit crunch in the banking system, they still remain elevated
compared with the more benign environment before the liquidity squeeze. The accompanying chart
highlights the rise in interest rates, showcasing the upward shift of the swap curve from May 1 2013 (before
the banking sector crunch) and July 8 2013.
Moreover, the risk of a further flare-up remains ever-present given the precarious health of the banking
system. In this section, we look at such a scenario and examine the impact to the auto sector supply chain.
Market Re-pricing Yield Curve
China Onshore CNY IRS Curve, %
With 86% of all receivables in the Chinese auto industry funded by bankers' acceptance bills (usually
ranging from 30-180 days), short-term financing costs would inevitably rise should we see another round of
financial markets volatility. Discount bills remain an important lubricant for transactions, allowing
automakers to extend generous payment terms to dealers, and suppliers to extend credit to carmakers.
Dealerships Will Bear The Brunt Of Higher Interest Rates...
Small dealerships have tight cash flows and depend on bankers' acceptance bills to pay carmakers for
inventory purchases. Furthermore, they do not enjoy access to long-term financing and are unable to borrow
funds at attractive low interest rates, a privilege which state-owned enterprises enjoy. This makes this mode
of funding even more vital to them.
The rise in note yields would mean that dealerships which cannot afford the higher interest rates would cut
their inventory levels. This could, in turn, impinge upon potential car sales if the requisite stocks were not
on hand to meet demand.
In the worst case scenario, we see already struggling dealerships being dealt a fatal blow in an
elevated interest rate environment. With inventory costs rising and our view for auto sales to experience
slower growth in H213, smaller dealers will be forced out of business.
...But Surge In Carmakers' Accounts Receivables Is Worrying
We acknowledge that carmakers remain diversified as they supply vehicles to different dealers and have
balance sheets which are generally well-capitalised. Their cash balances are healthy and average long-term
debt/equity ratios are below 15%. However, we have observed a trend of a surge in accounts/note
receivables for many of the private Chinese automakers and this becomes a source of concern with a rise in
financing costs. Since it is not easy to extract data on total vehicle sales made on credit, we find it
reasonable to look at accounts receivables as a percentage of total revenues to get an idea of dependency on
deferred payments among carmakers.
As the accompanying chart shows, the rise in accounts receivables in the past few years for China's largest
SUV maker, Great Wall Motors, is not commensurate with a similar increase in revenues (in millions of
CNY). The percentage of revenues as account receivables at the firm surged from 10.5% in 2006, to 37.2%
in 2012. For Geely, since its takeover of Volvo in 2008, its account receivables have formed a big
percentage of total revenues, with average receivable days hitting 172 in 2012.
Dependency On Receivables Evident
Select Financial Metrics Of Private Chinese Automakers - Great Wall Motors (LHS); Geely (RHS)
While state-run automakers have lower average receivable days which are more in line with global norms
(around 30 days), the rise in yields of short-term discount bills puts every carmaker on the hook for sales
made on credit. With small dealers potentially going bust, a significant share of these account receivables
could go bad, with private carmakers being the most vulnerable. Although firms such as Great Wall have
the cash on their balance sheet to take the necessary write-downs, we caution the negative impact to the
bottom line of carmakers in the coming quarters should this trend continue.
Suppliers May Shorten Duration Of Credit Terms
Meanwhile, should the hike in short-term borrowing costs persist, suppliers to car manufacturers may no
longer find it worthwhile to extend long payment terms, which is currently the case. This would then have
the effect of increasing the working capital requirements of automakers in an already tighter credit
environment.
Higher Yields Will Hurt Investment
Companies have reportedly cancelled bond issuances amid the volatile market. Big auto dealerships rely on
the bond market to fund their investments for new dealerships. While demand for cars remains robust,
should more auto dealerships shelve capital-raising plans, we could see a slowdown in the inland expansion
of automakers. This detrimental impact on the supply side of the industry will then indirectly hurt auto
sales.
Passenger Vehicles
Table: China Autos Sector - Passenger Cars

2010 2011 2012 2013f 2014f 2015f 2016f 2017f
Passenger Car Production (mn units) 13.897 14.485 15.524 17.231 18.610 20.099 21.706 23.226
Passenger Car Sales (mn units) 13.760 14.500 15.500 17.200 18.576 20.062 21.666 23.183
f= BMI forecast. Source: BMI, CAAM, OICA
Sales
According to the CAAM, passenger car sales in September 2013 surged 21.1% y-o-y, to 1,593,500 units.
We upgraded our 2013 sales forecasts for both passenger cars and CVs in September as we are of the view
that the sector will have a strong finish to the full year (see 'Sector Slowdown View Pushed To 2014',
September 13 2013). True enough, September's sales figures validate our timely upgrade.
Comeback Of Japanese Brands Aids Monthly Performance
The strong print in passenger car sales figures is attributable to broad-based strength in the sector. Besides
the continued outperformance of the SUV and MPV segments, which is in line with BMI's long-held view,
the recovery in Japanese automakers' sales also contributed to the surge.
Indeed, anti-Japanese sentiment generated by the Sino-Japanese dispute was at its peak during September
and October 2012, leading to sharp sales declines for Japanese carmakers in those months (see 'Escalating
China-Japan Tensions Spell Trouble', September 18 2012). We warned that the comeback for Japanese
brands would take a while, due to the deep rooted cultural underpinnings of the dispute. True enough,
consumer misgivings towards Japanese brands have started to abate 12 months later, and these carmakers
are now enjoying surging growth rates from a low base (see 'Weakening Yen Possible Trump Card For
Japanese Autos', January 17 2013).
Upside Risk To Passenger Car Sales Forecast
While we believe our 2013 CV sales growth forecast of 5.0%, to 4mn units is well placed, there is definitely
an upside risk to our car sales growth forecast of 11.0%. With the recent stabilisation of the Chinese
economy, consumer sentiment remains strong and continued sales momentum for Japanese automakers as
they look to rebuild sales lost at the tail end of 2012 points to strong growth ahead.
Sector Plays Amid Passenger Car Segment Outperformance
One such domestic automaker we are bullish on is SAIC Motor. SAIC is China's largest auto manufacturer
and its joint ventures with General Motors Company (GM) and Volkswagen, the top two selling foreign
automakers in the market, make its fundamental story very attractive. To elaborate, Volkswagen's sales for
the first nine months of 2013 rose almost 18.0% y-o-y to 2.35mn units, and GM's sales increased 11.0% y-
o-y in the same period to 2.31mn units.
Looking Attractive
SAIC Motor - Share Price, CNY
Industry Trend Analysis - Rebalancing Presents Niche Opportunities In Steel Sector
BMI View: While we remain downbeat on the prospects for the Chinese steel industry in the coming years
due to falling overall demand and overcapacity issues, we see opportunities within the sub-sector as the
country's economy rebalances towards a more consumption driven model. Going forward, we expect
demand for automotive steel products to remain robust on the back of strong vehicle production growth.
A new steel production joint venture (JV) called Zhejiang Nisshin Worthington Precision Specialty Steel
Company Ltd. will be formed between Worthington Industries Inc, Nisshin Steel Company Ltd and
Marubeni-Itochu Steel Inc. The Zhejiang-based factory, which is expected to begin production in Q415,
will produce cold rolled strip steel largely for the automotive industry and will have an annual capacity of
130,000 tonnes. US-based Worthington will own 10% of the JV and its Japanese partners, Nisshin and
Marubeni, will own 55% and 35% respectively.
BMI has long been bullish on the Chinese auto industry and we forecast vehicle sales to grow at an annual
average of 7.7% over the 2013-2017 period, to 28mn units by 2017. Moreover, we have highlighted for
a while that domestic production is increasingly aligned towards satisfying local demand and therefore, we
forecast a similar growth trajectory for vehicle production over the same period. Hence, we believe the
sector remains attractive for additional supplier investment and the creation of this JV plays out our view.
To be sure, our Commodities team has a bearish outlook on the Chinese steel sector and forecasts both
production and consumption growth to weaken over the coming years, as a number of precarious
fundamentals weigh heavily on China's bloated steel industry (see 'Steel: Bloated Sector Running Out Of
Luck', August 12 2013). As the country's economy re-orientates away from a fixed asset investment model
towards one where private consumption forms a larger share, demand for steel is naturally going to wane
given that investment currently makes up about 50% of the country's GDP.
Automotive Steel Presents A Niche Market Opportunity
China - Domestic Steel And Auto Production Growth Rates, %
f= BMI forecast. Source: BMI, WSA, CAAM
That said, we see opportunities within the steel sub-sectors and cold rolled strip steel for the
automotive industry is a case in point. We expect passenger car production to continue enjoying strong
growth in the coming years as sales remain robust on the back of the rising ranks of middle-class consumers
and the sustained inland push by carmakers.
In our opinion, as China's biggest steelmakers such as Baosteel Group are consolidating their operations
due to overcapacity issues, the three JV partners are well placed to exploit the demand within the niche
automotive steel market. Indeed, our Commodities team forecasts demand for flat steel (used in
manufacturing) to be more resilient compared with long steel (used in construction). Given that we forecast
domestic auto production growth to average 7.8% over the 2013-2017 period, and we hold the view that
original equipment manufacturers are increasing their local sourcing of parts and materials for car assembly,
the outlook for the JV remains bright.
Alternative Fuel
According to CAAM, Chinese consumers purchased only 11,375 electric cars (including plug-in hybrids) in
2012, double the number sold in 2011, but still far short of government targets. This was despite the
generous subsidies offered. Furthermore, 1,416 plug-in hybrid vehicles were sold from this total figure. EV
production appears to be in line with sales. Automakers produced 11,241 EVs and 1,311 plug-ins in 2012.
Under the existing subsidy programme introduced in 2010, the central government offers subsidies of up to
CNY60,000 (US$9,550) for an electric car and CNY50,000 (US$7,962) for a plug-in vehicle in Shanghai,
Hangzhou, Hefei, Shenzhen and Changchun.
One of the reasons for such poor electric vehicle (EV) sales is that China shields its domestic EV
manufacturers by giving purchasing subsidies to only domestically manufactured electric cars. This puts
imported models such as the Chevy Volt at a big price disadvantage in the Chinese market and thus
depresses annual EV sales. However, it has been our view that should there be national standards and
increased investment by the government in charging infrastructure, we would see more foreign automakers
willing to set-up EV production plants in China. This would then bring Chinese EV sales more on a par
with US sales.
Kandi Technologies Group subsidiary Zhejiang Kandi Vehicles Co, reached what's regarded as the
largest-ever EV distribution agreement in China with the city of Hangzhou in July 2012. The company
reached a 'definitive sales contract' to sell the 5,000 EVs to the city for about US$31.6mn. This amounts to
roughly US$6,300 a vehicle. However, the low price is due to the fact that the vehicles do not contain
batteries. Batteries will be provided by China Aviation Lithium Battery Co and the electricity will be
supplied for free by local utilities.
BYD Co and Jiangling Automobile Co delivered a total of 23 EVs to 11 Chinese government agencies in
2012. These agencies will use the vehicles for a one year trial and more agencies can be expected to take
part.
We believe this EV testing is another in a series of recent efforts by the Chinese government to show its
seriousness in building up the EV industry, following legislation announced in September (see 'Push For
National Standards Crucial To China's EV Industry', September 20 2013). Should the trials conclude
successfully, they would complement the upcoming proposed standards. More purchases of EVs by the
central government together with greater clarity on the sector's regulations would give automakers greater
confidence to increase their investments in EV development.
Nissan Motor has not given up the firm's vision of leadership in zero emission vehicles and is betting big
on EV sales. The firm intends to make China the cornerstone of its long-term EV strategy. Nissan plans to
introduce an electric car with Chinese partner Dongfeng in 2015 and its joint venture partner Renault aims
to start local production of a battery model around that time.
Hybrid Vehicles' Wasted Potential
China - Sales of EVs, Plug-Ins & Conventional Hybrids, Units
2012 conventional hybrid sales figures are BMI estimates. Source: BMI, CAAM
Auto Financing
In September 2012, Hyundai started providing auto loans in China in a bid to increase sales. Hyundai joins
GM and VW, which both have existing auto financing businesses in China. VW is spending CNY2bn to
expand its lending business this year.
Hyundai's latest foray into the auto financing business is testament to the intense competition facing
automakers in China. While imported luxury brands have been recently competing by cutting prices, this
strategy does not make sense for mid-market brands such as Hyundai and GM, due to the smaller profit
margins on their models. Therefore, these companies are competing for buyers by offering attractive loan
packages. It is also a way for these automakers to differentiate themselves from the ever increasing car
brands available domestically.
BMI views this latest trend with some caution, given the risks. With our forecast of a slowdown in the
economy in the coming quarters, we expect property prices to correct and buyer sentiment to deteriorate.
There would also be an uptick in unemployment which might possibly make loan servicing more difficult.
While it will take many quarters before delinquencies in auto loans start to rise, such a scenario represents a
pertinent risk for automakers such as Hyundai. Furthermore, it is likely that consumers taking on auto loans
from auto financing companies have previously faced difficulties getting loans from banks themselves. This
riskier customer credit profile puts carmakers on the hook should such loans turn sour. With roughly 15% of
new car purchases financed by loans currently, there is significant risk in this market.
Also, we consider lending by automakers to be within China's vast shadow banking system, as part of our
broader definition, given that it is non-bank related lending. Our Asia macroeconomic team has highlighted
the risks facing China's shadow banking system (see 'The Makings Of A Chinese Subprime Crisis', January
23 2013). While automakers involved in the lending business are probably well-capitalised, it would be
prudent for them to consider the potential risks stemming from liquidity possibly drying up in the Chinese
banking sector.
That said, we view the trend of increased access to consumer credit as positive for China's economy in the
long term. While the Chinese have traditionally only used loans to purchase property, there has been a
recent shift among the younger generation who are more willing to take loans to purchase durables such as
cars. With auto companies willing to step in and provide loans, we believe a well functioning consumer
credit market could emerge over the long term.
Furthermore, according to industry reports, Zhongsheng Group Holdings Ltd., a large Chinese auto
dealership group, said consumer financing is fast gaining acceptance in China. While helping to boost the
market, it also encourages younger buyers to buy more expensive cars. Carmakers are increasingly trying to
woo the younger generation to buy cars by coming up with newer and trendier models, so as to find new
areas of growth.
The company said that about one fifth of car buyers use financing at Zhongsheng's 160 dealerships, with the
rest paying cash.
Huang Yi, chairman and co-founder of the dealer group, gave a conservative estimate of financing at the
dealer group, predicting a 30% rise within five years, adding that in 10 years, that should rise to more than
half of new car buyers. The chairman further added that brands that are the most aggressive in offering
financing at its dealerships are Toyota Motor's luxury brand Lexus, and Daimler AG's Mercedes-Benz
brand.
In our opinion, a well functioning consumer credit market would help the Chinese government in its aims to
rebalance the economy from one which is currently investment driven to an economy where consumption
has a bigger share. While the current levels of auto financing are not large, we believe that they are a step in
the right direction to boost consumption in the long term.
Commercial Vehicles
Table: China Autos Sector - Commercial Vehicles

2010 2011 2012 2013f 2014f 2015f 2016f 2017f
Production: Total commercial vehicles (mn units) 4.206 3.770 3.748 3.973 4.171 4.379 4.641 4.920
Production: Light commercial vehicles (mn units) 1.947 1.845 1.833 1.943 2.060 2.183 2.336 2.476
Production: Heavy trucks (mn units) 2.259 1.924 1.915 2.030 2.111 2.196 2.305 2.444

Sales: Total Commercial Vehicle (mn units) 4.300 4.030 3.811 4.002 4.162 4.412 4.632 4.817
f = BMI forecast. Source: BMI, CAAM, OICA
According to the CAAM, commercial vehicle (CV) sales enjoyed healthy growth of 13.3% y-o-y in
September 2013, to 342,300 units. Our 2013 CV sales growth forecast of 5.0%, to 4mn units is well placed.
Although Chinese economic growth is slowing down and rebalancing towards consumption, our freight
growth forecast shows that there still remains long-term potential in the market.
Still Decent Growth In Long Term
China Road Freight And Real GDP Growth
ROAD: Road Freight Tonnes (000) (LHS)
GDP: Real GDP growth, % change y-o-y (RHS)
2
0
1
0
2
0
1
1
2
0
1
2
2
0
1
3
f
2
0
1
4
f
2
0
1
5
f
2
0
1
6
f
2
0
1
7
f
0M
20M
40M
60M
6
8
10
4
12
f = BMI forecast. Source: BMI, National Statistics Agency, National Bureau of Statistics
Road freight still accounts for around 76% of China's total freight transport and Ford said it is looking at
the longer-term strength of the truck market, with its acquisition of Taiyuan Changan Heavy Truck, based
on the country's economic potential and infrastructure developments. Indeed, despite a softening of
infrastructure growth forecast for 2013, BMI's Infrastructure team believes the country's long-term
fundamentals are strong, ensuring it will still be one of the largest infrastructure markets over our forecast
period.
Ford's acquisition will enable the company to have a more diversified approach in its aim to increase its
presence in China, where it currently has a market share of less than 5%. We do still see downside risks to a
segment so closely tied to other sectors, which are dependent on economic growth both in China and export
markets. Also, high levels of local government debt could impede any new stimulus to the infrastructure
sector.
Industry Developments
FAW-GM, the 50-50 joint venture between General Motors Company (GM) and China FAW Group
Corp has started exporting CVs to other countries. According to the firm, a ship carrying 20 Jiefang
pickups left the Shanghai port for Algeria, in early April. Later this year, the CV manufacturer will export
the pickup to Azerbaijan and Uruguay.
While we have highlighted the increasingly uncompetitive nature of China as an export hub, we also
observe a trend of plenty of spare capacity among China's CV manufacturers, due to slowing CV sales
growth, in light of the rebalancing of the economy from an investment-led to one which is more
consumption oriented. Should automakers be able to utilise this spare capacity effectively, we believe it is a
possibility for them to export some CVs to other countries. Therefore, we would not be surprised if more
firms followed FAW-GM's move and exported a small number of vehicles overseas.
Motorcycles
Table: China Autos Sector - Motorcycles

2010 2011 2012 2013f 2014f 2015f 2016f 2017f
Motorcycle Production (mn units) 26.690 27.005 23.630 23.040 23.500 23.970 24.689 25.430
Motorcycle Sales (mn units) 26.590 26.928 23.651 23.059 23.521 23.991 24.711 25.452
f= BMI forecast. Source: BMI, CAAM, OICA
While around 50mn motorcycles are produced globally, China is the world's largest producer of
motorcycles, producing almost half of them. A large part of China's motorcycle production is exported to
other emerging markets such as Africa, Middle East and South America. However, motorcycle exports
suffered in 2012 due to poor global economic conditions, the appreciating CNY and rising production costs.
According to CAAM, China produced 23.63mn bikes in 2012, a fall of 12.5% and a six-year low.
Motorbike sales for the first six months of 2013 came in at 11,453,554 units, down 2.4% year-on-year (y-o-
y). The poor sales performance in H113 has prompted us to downgrade our full-year sales growth forecast
to -2.5%, to 23.1mn units, from 0% previously.
Reasons for poor sales:
End of Subsidies
The Ministry of Finance and six other related departments announced earlier in the year that there will be no
new subsidies on motorbike purchases. China had initially offered a 13% subsidy on motorbike purchases in
2009, in a bid to lift rural residents' living standards and had extended the subsidy for three years when it
expired in January 31 2010. This, in our opinion, will put downward pressure on motorbike sales.
Gasoline-Powered Motorbikes Will Continue To Be Regulated

More than 100 cities in China have banned gasoline-powered motorbikes on elevated highways and
thoroughfares due to safety and pollution issues. We do not expect these regulations to ease, going forward.
These restrictions on gasoline powered motorbikes will continue to make e-bikes attractive. China has an
estimated 120mn 'e-bikes' (electric cycles, scooters and motorcycles) and sales are expected to enjoy strong
growth in the coming years.
Competition From Passenger Cars

With tier-one cities adopting curbs for passenger cars and their markets becoming increasingly saturated,
car manufacturers are turning to the rural markets for growth. Give that rural consumers form a large part of
the motorcycle market, this increased competition from passenger cars will reduce the market share of
motorcycles. Therefore, we expect growth in passenger car sales to outperform motorcycle sales in the
coming years.
We forecast motorbike sales to grow at an annual average of 1.5% over the 2013-2017 period, to hit 25.5mn
units by 2017.
Company Developments
Japan's Denso has formed a joint venture with a Chinese motorcycle component producer as it wants to
'increase our competitiveness in that market through this integration', according to the senior executive
director of Denso's Powertrain Control Systems group, Masahiko Miyaki. Although motorcycle 2012
sales are down from 2011, the market's size is still a draw.
Besides production, the Chinese motorcycle market is the biggest market for two-wheelers in the world and
is still big enough in volume terms to attract interest. Denso is also interested in the new energy
developments in the sector and will be preparing the new JV to supply these areas.
Under the terms of the deal, Denso's Chinese motorcycle component base, Chongqing Denso, has joined
with domestic manufacturer Kunshan Gongcheng Electric Equipment Co. The new JV,
Gongcheng Denso (Chongqing), will be based at the former Chongqing Denso site, with Kunshan
Gongcheng providing a second plant.
While the JV will continue with the production of ignition systems for engines with carburettors, it will also
branch out into ignition systems for electrically controlled fuel-injected engines. The company expects this
to be a growth area as the country's emission standards are stepped up. Indeed, Beijing has reportedly been
drafting a new set of emission standards, Beijing V, which will be comparable to the Euro V standard.
Moving with trends in the world's biggest market will be vital to the growth of Denso's Asian operations.
Based on the company's latest FY2013 (April-March) Q2 results, it projects annual sales of JPY3.4trn (US
$34.7bn) for FY2013. Furthermore, although Japan forms the majority of sales from Denso's YTD FY2013
Q2 results, the company is looking to increase the share of its Asia & Oceania sales and make it the largest
segment in terms of geographical sales by FY2016. Indeed, another feature of its strategy is to achieve
'outstanding' cost competiveness on the way to its ultimate target of global sales of JPY4.0trn (US$40.8bn)
by FY2016.
Suppliers
A growing after-sales market in China, as well as the auto sector's upbeat prospects seen in the strong sales
momentum in the first nine months of 2013, continues to draw strong investment from suppliers.
Industry Developments
Still Attractive Growth Rates To Attract Greater Investment In Sector
China - Domestic Auto Production, Units (LHS); % Chg y-o-y (RHS)
f = BMI forecast. Source: BMI, CAAM
While we expect future vehicle production growth rates to be slower compared with historical growth rates,
we still expect the sector to continue attracting investment from both new, as well as existing players. The
large size of the Chinese car market makes it attractive to small, nimble firms, which aim to grab market
share from incumbents, as well as industry leaders such as Continental, which need to continue investing to
maintain their technological and market dominance.
Furthermore, as the Chinese car market begins to mature, we expect both OEMs and suppliers to upgrade
their offerings, to cater to a more sophisticated and discerning consumer. Indeed, the electronic parking
brake component, which Continental plans to manufacture, is considered to be a value-added offering in a
car. BMI believes that as consumer incomes increase, automakers will increasingly look to offer more
advanced features in cars, spanning safety, aesthetics, energy efficiency, and infotainment devices.
Macroeconomic Forecasts
Economic Analysis
BMI View: While the outlook for China's traditional economic growth drivers such as heavy industry and
real estate construction remains cloudy, the outlook facing the more consumer-focussed industries is
relatively strong over the medium term. Overall, though, as the traditional sectors remain the dominant
drivers of the economy, we remain below consensus in our real GDP growth outlook, and caution that the
inevitable bursting of the ongoing credit bubble could also serve to undermine the profitability of the
consumer-focussed industries. We are revising up our forecast for 2013 to 7.6% from 7.5% previously,
while maintaining our downbeat forecast for 2014 of 6.7%.
The bullish and the bearish case regarding China's economic growth outlook both have merit. As regular
readers will know, we have been in the bearish camp over recent years, arguing that the excessive credit-
fuelled nature of the economic expansion would result in a painful hard landing. This remains our central
case. Despite the recent pick-up, economic activity remains meagre on the whole, at a time when credit
growth is still rising almost 20% annually from an already-high base. It is difficult to dismiss the
importance that the largest recorded credit boom will have on economic growth once it finally ends, as all
credit booms do. That said, in an emerging economy in excess of US$8.0trn, there are clearly areas of
strong growth and opportunity.
Stabilisation Not A New Upswing
China - Average Of Official And HSBC PMI Indices
Source: BMI, HSBC, China Federation of Logistics and Purchasing
Old Versus New China
Commentators are increasingly talking of an 'old China' and a 'new China', with the old China referring to
the low value-added infrastructure investment that has characterised the past few years of growth, and the
new China referring to the high value-added consumer and services driven growth that is hoped will take
over. The contrast is very neatly illustrated in the following chart. On the left hand side you have the
Shanghai Industrials Index, made up of the conglomerates that have dominated China's resource allocation
over recent years, which has been in a structural bear market. On the right hand side you have the ChiNext,
an index made up of high-growth tech-heavy companies, which has been in a soaring bull market.
Two Contrasting Outlooks
Shanghai Industrials Index Vs ChiNext Composite Index
Source: BMI
'New China' Is Booming
Within China's new economy there are a number of industry sectors witnessing rapid growth. E-commerce
is an area which is hitting the headlines of late, with the likes of Alibaba's TMall, JD.com, and Tencent
leading a market that has risen exponentially in recent years, and accounts for over CNY150bn (US$24.5bn)
according to some estimates. Our pharmaceuticals team continues to see double-digit growth in both
healthcare and pharmaceutical spending over the coming years. China's IT and semiconductor industries
also continue to grow at a blistering pace. These industries are likely to continue outperforming, and gaining
in relative strength as China's economy transforms.
Shanghai Free Trade Zone A Positive Sign
The construction of the Shanghai Free Trade Zone will help to further propel the free-market driven sectors
of China's economy, and is a sign of the potential that new China holds. As part of its push towards eventual
liberalisation of the Chinese yuan, Beijing has officially opened the country's first free trade zone in
Shanghai. Full details have yet to be announced but the free trade zone, spanning 29 square metres, will see
the central government loosen regulations across 19 industries, from banking to shipping and even culture,
while also piloting reforms in several financial products and permitting a freely convertible yuan.
Strong Yuan Supporting Domestic Consumption
The People's Bank of China's decision to appreciate the yuan is no doubt providing a boon to the domestic
consumer market even as it reduced external competitiveness. The yuan has appreciated significantly in real
effective terms this year, lowering input costs and increasing disposable incomes for Chinese consumers.
'Old China' Still The Dominant Force
Regarding the idea that the new China can take over the growth reins, there are two significant obstacles.
Firstly, the old China remains the dominant driver of the overall economy. Indeed, the recovery in economic
activity over recent months, as seen by the rise in the purchasing managers' indices back above 50, has been
largely down to the boost in construction activity rather than the boom in the service/consumer sectors.
Indeed, following on from the strong property sales figures seen in H113, construction activity has begun to
pick up, perhaps with the help of the renewed push to roll out affordable housing. The real estate sector
remains the major driving force in the Chinese economy, and it is fuelled by easy credit, which, despite
slowing, is growing far in excess of nominal GDP.
Bubble Still Growing
China - Total Social Financing Stock, % chg y-o-y
Source: BMI, PBoC
This brings us to the second obstacle. New China has certainly benefitted from the surge in credit growth
and the appreciation of property prices. During credit and asset bubbles, resources are typically drawn
towards high order areas such as real estate development, but as peoples' perceived wealth increases, so too
does consumer spending. While impossible to calculate, we believe that the abundance of cheap credit and
the appreciation of home prices has played an important part in driving sectors of the economy that at first
do not appear to be credit sensitive. It is only once we see credit growth begin to turn down, as it inevitably
will over the coming years, that the negative consequences will emerge. Regarding our real GDP growth
forecasts, we are revising up our forecast for 2013 to 7.6% from 7.5% previously, while maintaining our
downbeat forecast for 2014 of 6.7%.
Table: China - Economic Activity

2008

2009

2010

2011

2012

2013f

2014f

2015f

2016f

2017f

Nominal GDP,
CNYbn
1
31,490

34,632

40,293

46,547

51,469

56,922

62,505

68,089

73,995

80,432

Nominal GDP,
US$bn
1
4,531

5,069

5,953

7,200

8,159

9,152

10,147

10,938

11,840

12,869

Real GDP
growth, %
change y-o-y
1
9.6

9.2

10.3

9.1

7.7

7.6

6.7

6.0

5.8

5.8

GDP per capita,
US$
1
3,374

3,752

4,377

5,262

5,925

6,605

7,280

7,804

8,403

9,090

Population, mn
2
1,342.7

1,351.2

1,359.8

1,368.4 e 1,377.1 e 1,385.6

1,393.8

1,401.6

1,408.9

1,415.8

Industrial
production
index, % y-o-y,
ave
1
12.9

11.1

14.4

10.8

7.8 e 8.2

8.5

8.0

8.0

8.0

Unemployment,
% of labour
force, eop
3
4.2

4.3

4.1

4.1

4.9 e 5.0

5.0

5.0

5.0

5.0

Notes:
e
BMI estimates.
f
BMI forecasts. Sources:
1
National Bureau of Statistics, BMI;
2
World Bank/UN/BMI;
3
National
Bureau of Statistics.
Industry Risk Reward Ratings
Company Monitor
BMI View: Mazda's push into SEA chimes with the firm's strategy to increase the share of its sales from
emerging markets and is well supported by the carmaker's dealership networks in the region. However, we
believe the automaker needs to accelerate its production diversification away from Japan and consider
building a new facility in ASEAN, which would enable it to be closer to its target markets and reduce the
impact of a fluctuating Japanese yen on its financial performance.
Mazda Motor recently announced that its vehicles will soon be sold in all 10 Association of South East
Asian Nations (ASEAN) countries. The firm opened its first dealership in Phnom Penh in August 2013 and
plans to officially open a dealership in Myanmar in H114. These moves are in line with the carmaker's
strategic shift towards emerging markets under its Structural Reform Plan.
Growth Is In ASEAN
BMI maintains a bullish long-term outlook on the ASEAN region and we believe the various emerging
economies in the bloc hold some of the most attractive growth prospects for the automaker. Mazda's forays
into early emerging markets such as Cambodia and Myanmar are not unilateral, as we have seen other
carmakers also entering these markets recently for their long-term potential (see 'Porsche Dips Its Toes Into
Cambodia Luxury Market', February 22 and 'Ford Not Immune To Myanmar Auto Market Charms', March
18).
Indeed, when looking at the carmaker's overall sales make-up, sales from 'other markets' have been
increasing their share. This category, which includes the firm's Asian car markets, has seen its share of total
global sales rise from 22.0% in FY2010/11 (April-March) to 24.5% in FY2012/13. Delving deeper, we see
that the firm's ASEAN sales (excludes Myanmar and Cambodia for now) have seen the strongest growth in
FY2012/13, rising some 53.0% to hit 101,000 units.
ASEAN Makes Up A Bigger Share
Mazda - Annual (Years ended March 31) Sales Units, 000s
Source: BMI, Company Report
Japan Reliance Needs To Be Reduced
One positive is that the automaker already has well-placed distribution channels in the ASEAN region. At
the end of FY2012/13, the firm had 507 dealerships in the Asia and Oceania region. These distribution
networks will come in handy as the firm looks to increase its sales volumes in the region.
However, we believe the firm needs to accelerate its diversification away from Japan. Mazda has been
trying to reduce its reliance on Japanese exports for some time, so as to reduce the impact of a fluctuating
Japanese yen on its financial performance. While, it has made some efforts on that front by investing in new
plants in Mexico and Thailand, progress remains slow as the accompanying chart illustrates.
Diversification Efforts Still Slow
Mazda - Global Production (Years ending March 31), 000s
Additional SEA Production Could Be The Key
Given the company's bigger focus on South East Asia (SEA) going forward, we believe the firm needs to
increase its manufacturing investments in the region. While a few Mazda models are built in the firm's Thai,
Malaysian and Vietnamese production facilities, there is still some dependency on completely knocked
down kits exported from Japan, which are then assembled in local ASEAN markets.
We have a long-held view on the attractiveness of producing in certain South East Asian countries such as
Indonesia and Thailand. Some automakers even use these two countries as export bases to the rest of SEA.
Automakers manufacturing in these countries reap many advantages compared with Japan, which suffers
from high production costs and a rigid labour market. Therefore, we believe Mazda needs to consider
opening a new plant in SEA and/or increase investments in its existing facilities if it intends to sustainably
grow the share of its ASEAN sales.
Share Price Highlights Exchange Rate Worry
The high concentration risk, which Mazda faces, can be best seen in the run-up of its share price since the
yen began weakening in late 2012. The firm's shares have risen an eye-popping 187% since September
2012 as the weakness in the yen boosts export earnings and increases the value of repatriated profits.
Benefit Of Weaker Yen Largely Reaped
Mazda Share Price (JPY)
However, the carmaker's huge reliance on Japan is a double-edged sword and its share price could fall
sharply if the yen began to strengthen once more. While Mazda posted a net income of JPY11.48 (US$0.12)
per share in FY2012/13, it had been running losses in the years prior due to the strong yen. Therefore, we
believe the firm needs to accelerate its diversification strategy to avoid the risk of ending back in the red
should the weakness in the yen begin to reverse.
Company Profile
Company Monitor
BMI View: Mazda's push into SEA chimes with the firm's strategy to increase the share of its sales from
emerging markets and is well supported by the carmaker's dealership networks in the region. However, we
believe the automaker needs to accelerate its production diversification away from Japan and consider
building a new facility in ASEAN, which would enable it to be closer to its target markets and reduce the
impact of a fluctuating Japanese yen on its financial performance.
Mazda Motor recently announced that its vehicles will soon be sold in all 10 Association of South East
Asian Nations (ASEAN) countries. The firm opened its first dealership in Phnom Penh in August 2013 and
plans to officially open a dealership in Myanmar in H114. These moves are in line with the carmaker's
strategic shift towards emerging markets under its Structural Reform Plan.
Growth Is In ASEAN
BMI maintains a bullish long-term outlook on the ASEAN region and we believe the various emerging
economies in the bloc hold some of the most attractive growth prospects for the automaker. Mazda's forays
into early emerging markets such as Cambodia and Myanmar are not unilateral, as we have seen other
carmakers also entering these markets recently for their long-term potential (see 'Porsche Dips Its Toes Into
Cambodia Luxury Market', February 22 and 'Ford Not Immune To Myanmar Auto Market Charms', March
18).
Indeed, when looking at the carmaker's overall sales make-up, sales from 'other markets' have been
increasing their share. This category, which includes the firm's Asian car markets, has seen its share of total
global sales rise from 22.0% in FY2010/11 (April-March) to 24.5% in FY2012/13. Delving deeper, we see
that the firm's ASEAN sales (excludes Myanmar and Cambodia for now) have seen the strongest growth in
FY2012/13, rising some 53.0% to hit 101,000 units.
ASEAN Makes Up A Bigger Share
Mazda - Annual (Years ended March 31) Sales Units, 000s
Japan Reliance Needs To Be Reduced
One positive is that the automaker already has well-placed distribution channels in the ASEAN region. At
the end of FY2012/13, the firm had 507 dealerships in the Asia and Oceania region. These distribution
networks will come in handy as the firm looks to increase its sales volumes in the region.
However, we believe the firm needs to accelerate its diversification away from Japan. Mazda has been
trying to reduce its reliance on Japanese exports for some time, so as to reduce the impact of a fluctuating
Japanese yen on its financial performance. While, it has made some efforts on that front by investing in new
plants in Mexico and Thailand, progress remains slow as the accompanying chart illustrates.
Diversification Efforts Still Slow
Mazda - Global Production (Years ending March 31), 000s
Additional SEA Production Could Be The Key
Given the company's bigger focus on South East Asia (SEA) going forward, we believe the firm needs to
increase its manufacturing investments in the region. While a few Mazda models are built in the firm's Thai,
Malaysian and Vietnamese production facilities, there is still some dependency on completely knocked
down kits exported from Japan, which are then assembled in local ASEAN markets.
We have a long-held view on the attractiveness of producing in certain South East Asian countries such as
Indonesia and Thailand. Some automakers even use these two countries as export bases to the rest of SEA.
Automakers manufacturing in these countries reap many advantages compared with Japan, which suffers
from high production costs and a rigid labour market. Therefore, we believe Mazda needs to consider
opening a new plant in SEA and/or increase investments in its existing facilities if it intends to sustainably
grow the share of its ASEAN sales.
Share Price Highlights Exchange Rate Worry
The high concentration risk, which Mazda faces, can be best seen in the run-up of its share price since the
yen began weakening in late 2012. The firm's shares have risen an eye-popping 187% since September
2012 as the weakness in the yen boosts export earnings and increases the value of repatriated profits.
Benefit Of Weaker Yen Largely Reaped
Mazda Share Price (JPY)
However, the carmaker's huge reliance on Japan is a double-edged sword and its share price could fall
sharply if the yen began to strengthen once more. While Mazda posted a net income of JPY11.48 (US$0.12)
per share in FY2012/13, it had been running losses in the years prior due to the strong yen. Therefore, we
believe the firm needs to accelerate its diversification strategy to avoid the risk of ending back in the red
should the weakness in the yen begin to reverse.
Shanghai GM
SWOT Analysis

Strengths

GM is the sales leader in China among the foreign automakers.
Able to export vehicles from China to other emerging markets.

Weaknesses

A significant presence in the CV segment could undermine the parent company's
performance due to the underperformance of the CV segment vis-a-vis the passenger
car segment.
Opportunities

Plenty of untapped potential in lower tier cities.
Focus on emission standards could boost demand for company's eco-friendly

vehicles.
The upcoming local Cadillac plant will allow the firm to compete better in a market
which holds plenty of long-term potential.
Threats

Strong competition from Volkswagen AG, which is a close number two.
A hard landing in the Chinese economy would also hurt auto sales.
Company Overview
Shanghai General Motors Company Ltd also known as Shanghai GM, is a JV between
GM of the USA and Chinese automaker, SAIC Motor.
GM and its JVs sold 277,647 units in September 2013, an increase of 14.0% year-on-
year (y-o-y). For the first nine months of 2013, GM's total sales were 2.31mn vehicles, a
rise of 11.0% y-o-y.
China is a bright spot for GM amid a slowdown in the rest of Asia for the carmaker. GM
and its China JVs earned US$400mn pretax income for Q313 versus a US$100mn loss
for the rest of Asia. GM's overall Q313 pretax profit for Asia was down 61% y-o-y, to
US$299mn.
Strategy
Earlier in 2013, GM announced that it has won approval to build a new Cadillac plant in
Shanghai. The firm will invest at least CNY8bn (US$1.3bn) and local production will
allow it to circumvent China's 25% import tariff. Construction of the factory will begin in
June 2013 and annual capacity will be 150,000 units. We see this as a strong
commitment by the firm towards the domestic luxury market. Despite the current
headwinds faced by the premium segment, GM shares BMI's view on the attractive
long-term potential of the premium market.
Shanghai GM is also planning to boost the annual production capacity of its Shenyang
Beisheng facility. The company aims to increase its capacity to 300,000 units by 2014,
compared with the current capacity of 200,000 units, through an investment of nearly
US$1bn. The expansion has been attributed to increasing demand for the Chevrolet
Cruze sedan and the Buick GL8 minivan.
Furthermore, GM and its JVs are investing US$1bn to build their third plant in
Southwest China, Chongqing, which will have a production capacity of 400,000 units,
by 2015. BMI has been highlighting the potential of inland lower-tier cities for sometime
already, due to their relatively untapped nature.
Over the long term, GM intends to spend US$11bn to build four new plants to boost its
annual capacity in China to 5mn vehicles.
GM and SAIC have also announced plans to jointly produce electric cars in China to
fulfil the government's demand for low-emission vehicles. Pan Asia Technical
Automotive Centre (PATAC), an existing JV between GM and SAIC, will design the EVs
and produce components. The development of EVs is an important part of GM's five-
year strategy for China, according to the head of international operations at GM, Tim
Lee.
To support the ongoing development of products for China and the world, GM's PATAC
JV opened a climate wind tunnel in Shanghai, and GM China and its partner SAIC
joined Shanghai GM and PATAC in opening the Guangde Proving Ground in Anhui
province. The GM China Advanced Technical Center recorded milestones in lightweight
materials and EV battery development during its first full year of operation, while
opening its second phase in November.
Shanghai GM exported 61,636 Chevrolet New Sail subcompacts in 2012, up 98%. The
car is GM's best-selling China compact, with 2012 sales of 218,090 units, a 31%
increase.
GM continued to expand the dealership networks of all of its brands, with a focus on
China's tier three and tier four cities. While the firm ended 2012 with about 3,800
dealerships nationwide, it is adding 400 dealers in 2013, to bring the total count to
4,200 dealerships by year-end. The company wants to make it easier for customers to
buy and service their vehicles.
New Models
GM and its JVs are adding 17 new and upgraded models in China in 2013. They include
the Chevrolet Cruze hatchback, the new Wuling Sunshine, two new Jiefang light-duty
trucks and the Insignia Sports Tourer, Zafira Tourer and Astra GTC from Opel.
Volkswagen
SWOT Analysis

Strengths

Strong brands with a global recognition.
Among the top two foreign automakers in China in terms of total group sales units.
Weaknesses

Strong expansion drive in production capacity could backfire if demand in China fails
to catch up.
China being VW Group's biggest market makes in vulnerable to a slowdown in the

Chinese economy.
Opportunities

Plenty of potential in lower tier cities.
Focus on emission standards could boost demand for country's eco-friendly vehicles.
Threats

Strong competition from GM, who is locked with VW in the battle for China's largest
automaker by sales.
A hard landing in the Chinese economy would also hurt auto sales.
Company Overview
Volkswagen (VW) is represented in China through the JVs Shanghai VW (with
SAIC Motor) and FAW-VW (with FAW Motor).
In September 2013, VW and its related brands sold 230,000 vehicles, bringing sales for
the first nine months of the year to 1.8mn units, up 18% y-o-y.
Luxury sales continue to bolster the automaker as its premium brand subsidiary, Audi,
reported a 28% y-o-y rise in sales in September, to 45,530 units.
Strategy
VW plans to increase its auto production capacity in China by 60% through 2018,
where its 2012 profits grew by almost 50%. According to CEO Martin Winterkorn, VW is
building an additional 10 plants in the coming years, with seven of them based in China.
This would raise VW's capacity in China to 4mn vehicles by 2018, from the current
2.5mn. This chimes with the firm's strategy to become the world's largest automaker by
this time.
The automaker's joint ventures (JVs), Shanghai VW and FAW-VW, which are not
consolidated, will spend another CNY79bn (US$12.7bn) in the same period.
The increase in Chinese investment is in line with its global strategy, which includes an
increase in overall investment to EUR62.4bn (US$83.9bn).
New Products
VW has announced plans to produce electric vehicles (EVs) with Chinese partners from
2013. It has already developed prototypes with its two JV partners, SAIC and FAW.
VW plans to have 10,000 EVs on Chinese roads by 2018, but there are still concerns
about government policy. According to VW, it is 'not clear what the rules will be around
the electric car', which supports BMI's view that strong industry policy is needed to
develop hubs of any description. Subsidies are still in the pilot stages, and the need for
foreign companies to share their technology with local partners still appears to be an
unwritten rule.
According to recent news by development chief, Ulrich Hackenberg, in January 2013,
VW may build its first low-cost car in China. The company wants to enter this vehicle
segment to compete with Renault's Dacia and Nissan's Datsun. Volkswagen is looking
at a price range of US$6,700 to US$13,500 for the car. The car could also be exported
to fast-growing markets such as Brazil, Russia, India and China.
Ford Motor
SWOT Analysis

Strengths

Long-term vision for the market.
Improving financial position in the US, bodes well for the company's subsidiaries
around the world as additional capital can be deployed to growing markets.
Weaknesses

Late entrant to the Chinese market.
Sales are much lower than industry leaders.

Opportunities

Potential for volume sales in lower-tier cities.
CV segment sales have a lot of potential to grow.

Threats

Ford will need to differentiate itself from other brands to maintain and grow its market
share.
Company Overview
Ford's August 2013 sales rose 46.0% y-o-y, to 71,183 units. For the first eight months
of 2013, Ford and its JV sales totalled 551,738 units, an increase of 50.0% year-on-year
(y-o-y). Ford increased its market share to 4.3% and intends raise it to 6% by 2015.
Ford's passenger car JV Changan Ford Automobile (CAF) continues to deliver a strong
performance.
Ford's CV JV in China, Jiangling Motors Corp, saw its profits rise 12.0% y-o-y, to US
$157mn for H113. The gain in profit was attributed to higher sales, a good product mix
and effective cost controls. For H113, Jiangling Motors sold 110,230 CVs, pickups and
SUVs, a gain of 7.0% y-o-y.
Strategy
As Ford races to catch up with GM, which sells about four times as many vehicles in
China, it is aggressively ramping up its investments. The firm is spending US$4.9bn to
expand in China with five plants under construction and new models lined-up. The
firm's Chinese affiliate, Jiangling Motors Corp, will acquire domestic heavy truck
manufacturer Taiyuan Changan Heavy Truck for an undisclosed sum, opening up the
long-term growth opportunities of the heavy commercial vehicle segment to the US
carmaker and rounding out its China business.
Ford said it is looking to the longer term strength of the truck market, based on the
country's economic potential and infrastructure developments. Indeed, despite a
softening of infrastructure growth forecast for 2012 and 2013, BMI's Infrastructure team
believes the country's long-term fundamentals are strong, ensuring it will still be one of
the largest infrastructure markets over our forecast period.
The deal, which is subject to government approval, will also enable Ford to have a more
diversified approach to its aim of increasing its presence in China, where it currently has
a market share of less than 5%. Ford Motor China's chairman and CEO, Dave Schoch,
said the deal 'represents a great opportunity to continue to expand the breadth of our
business in China across vehicle segments'.
New Products
Ford plans to produce electric cars in China with its partner, Chang'An Automobile
Group, but has not announced a deadline by which it may start producing electric cars
in China, with rivals, such as Daimler and GM, announcing plans to produce such
vehicles in China. The government aims to have 1mn electric cars on the road by 2015.
Ford's CEO, Alan Mulally, commented that 'a roll-out of electric vehicles depends
largely on infrastructure and advances in battery technology' but added that 'as we
move to more electrification, you're going to see more hybrids, plug-in hybrids and all-
electric cars'.
The company intends to introduce 15 new models to the Chinese market by 2015,
double production capacity and its dealership network. Its stand at the show
showcased four new vehicles - The EcoSport, Kuga, Edge and Explorer CUV and
convenience features such as the Mandarin-enabled SYNC system in the new, Chinese-
built Focus.
In January 2013, Ford launched its first locally produced SUV, the Ford Kuga. It is fitted
with a 1.6-litre or 2.0-litre variant of Ford's EcoBoost engine, and retails for CNY193,800
(US$31,129) to CNY275,800 (US$44,300). SUV and MPV sales continue to bolster the
passenger car segment, in line with BMI's view that the Chinese market will witness
a premiumisation trend. SUV sales jumped 33% y-o-y in March 2013, to 235,000 units
and MPV sales surged 160%, to 117,000 units.
Daimler
SWOT Analysis

Strengths

Premium luxury brand name.
China is the world's largest consumer of the high-end S class model.
Automaker has announced large capex plans over the next few years to catch up with
rivals in the luxury segment.
Weaknesses

Poor performance relative to rivals in the luxury car market.
Opportunities

Outperformance and resilience of the luxury car segment should allow company to re-
group and grab market share, especially as turnaround strategy seems to be bearing
fruit.
Growing prosperity together with economic rebalancing provides ample room for
growth.
Threats

Another economic slowdown could affect sales in the luxury segment.
Company Overview
Beijing-Benz is a restructuring of the former DaimlerChrysler and Beijing Automotive
Industry JV, Beijing Jeep.
For the first nine months of 2013, Mercedes-Benz sold 155,906 vehicles, up about
8.0% y-o-y.
Strategy
While currently lagging BMW and Audi, Daimler plans to spend EUR2.0bn (US$2.65bn)
in China over the 2013-2015 period to increase sales of Mercedes-Benz cars by a third
to over 300,000 units annually. With sales of 208,000 cars in 2012, such a bold target
will see the country becoming the carmaker's largest market by 2015 (assuming sales in
the US and Germany remain constant).
China's Share Poised To Grow
2012 Sales Of Mercedes Cars In Selected Markets, Units
Commitment To The Market At A Challenging Time
Through this planned investment, Daimler is reiterating its strong commitment to the premium market. At present,
BMI sees the Chinese luxury car market experiencing a near-term slowdown as it navigates challenges such as a pricing
probe and austerity measures aimed at curbing extravagance (see 'Pricing Probe And Mini-Stimulus Could Impact Sector',
August 16 2013). However, we believe Daimler is looking to the future as it expects these headwinds to pass and growth
rates in the segment to recover.
Mercedes Addresses Product Woes
To be sure, this bold strategic move is backed up by investment in new models. While China is already the largest market
for the high-end S class sedan, the firm does not intend to rely solely on this model's sales for its success. Mercedes will
launch 20 new or upgraded car models over the next two years, which we believe will aid the carmaker in wooing new
premium car buyers, who fall into different sub-segment categories such as entry and mid-level luxury.
The firm's investment into new models is also timely given that Mercedes has been lagging its German luxury rivals, Audi
and BMW. Although Mercedes achieved record 2012 sales in China, its sales growth rate of 4% paled in comparison to
Audi's 32% (407,738 unit sales) and BMW's 41% (313,638 unit sales).
Mercedes Clearly The Laggard
China - 2012 Domestic Car Sales Of Selected Automakers, Units (LHS); Sales Growth, % (RHS)
Source: BMI, Company Reports
We have highlighted the dearth of new models as one of the key factors which had impeded the firm's performance in
recent times. To be sure, Daimler has taken steps to address the other issues responsible for its poor performance;
including a management team shake-up and the merging of two separate distribution networks, which had handled
imported vehicles and locally produced vehicles separately, causing confusion among dealers.
Indeed, the firm's turnaround strategy is already beginning to bear fruit with domestic sales growing at a rapid year-on-
year (y-o-y) clip in the past few months. Sales grew 7% y-o-y in May, 16% y-o-y in June and 31% y-o-y in July.
Additionally, the arrival of a slew of revamped models in the next two years will go a long way in supporting this
turnaround.
Localisation Will Provide Cost Savings
As part of its 2020 initiative, the firm intends to expand manufacturing capacity and sales networks in countries where car
density is still relatively low. The firm intends to raise the proportion of locally produced models from 50% to 70% of its
Chinese sales by 2015. Mercedes intends to increase its localisation by using its Beijing factory which it operates with its
joint venture partner, Beijing Automotive Group.
Similar to Audi, which currently produces nine out of 10 cars it sells in China, and more recently GM, which has decided
to build a Cadillac factory in Shanghai (see 'GM Marks Its Space With Cadillac Plant', May 8), Mercedes will enjoy
greater cost savings from increased localisation as it avoids costly import tariffs and will thus be able to price its offerings
more competitively.
New Products
Daimler's JV with BYD Auto, Shenzhen BYD Daimler New Technology (BDNT), unveiled
its first concept car at the April 2012 Beijing auto show. The partnership also unveiled
its brand and logo at the event before commencing mass production of a fully electric
mid-sized vehicle in 2013. BDNT benefits from the use of BYD's battery technology and
Daimler's expertise in EV design and safety.
BDNT unveiled its new Denza electric car at the Beijing auto show in April 2013 and will
go into production later in 2013.
Regional Overview
BMI View: As 2013 comes to a close, we expect Chinese auto sales to end on a high. Indian vehicle sales
will continue to struggle and we believe that a real recovery would only take place in Q114 at the earliest.
While the Indonesian auto sector has shown resilience in the face of recent fuel price increases, in line with
our view, we believe there is weakness ahead in 2014 due to a deteriorating macroeconomic backdrop and
the persisting drag of higher interest rates.
In this quarterly regional round-up, we examine the trends in Asia and specifically focus on the Chinese,
Indian, Indonesian and Japanese auto markets. These countries are chosen due to the large size of their auto
sectors, as well as their importance to automakers, suppliers and other players in the industry.
Table: Vehicle Sales Sep 2013 (Cbus)

Last
Month
Monthly
Sales % chg y-o-y YTD Sales
% chg y-o-
y
BMI End-2013
Sales
BMI Full-year Growth
Forecast (2013, % chg
y-o-y)
China Sep 1,935,800 19.7 15,882,449 12.7 21,201,432 9.8
India Sep 267,711 -9.3 1,525,526 -7.6 3,315,257 -4.6
Japan Sep 522,760 17.0 4,073,268 -4.8 5,491,824 2.3
Indonesia Sep 115,921 13.5 907,996 11.2 1,194,347 7.0
* India's YTD sales figures refer to its FY2013/14 (April-March) figures and its full-year BMI forecast refers to FY2013/14.
Source: BMI, Individual Trade Associations
China: Market To End 2013 On A High
According to the China Association of Automobile Manufacturers (CAAM), passenger car sales in
September 2013 surged 21.1% year-on-year (y-o-y), to 1,593,500 units. Commercial vehicle (CV) sales too
enjoyed healthy growth of 13.3% y-o-y, to 342,300 units, bringing overall auto sales to 1,935,800 units, an
increase of 19.7% y-o-y.
With the stabilisation of the Chinese economy in Q313, consumer sentiment remains strong, while
continued sales momentum for Japanese automakers looking to rebuild sales lost at the tail end of 2012
points to strong growth for the rest of 2013.
Passenger Car Sales To Bring A Strong 2013
China - Domestic Auto Sales, Units (LHS); % Chg y-o-y (RHS)
Source: BMI, CAAM
As a result, our sector slowdown view has been pushed back to 2014. As the current stimulus driven
economic growth gives way in 2014, vehicle demand will undoubtedly take a hit. However, we are of the
view that passenger car sales will still hold up reasonably well despite slowing economic growth. Although
a slower pace of growth will hurt consumer sentiment, the painful but necessary rebalancing of the economy
towards private consumption will act as a countervailing force. As such, we remain convinced that
passenger car sales will continue outperforming CV sales in the coming years, and see SAIC Motor, a
carmaker with joint ventures with two of the largest foreign carmakers in China, as a good way to play the
country's rebalancing story.
India: No Real Recovery In Sight Until Q114
Although the sharp declines in passenger vehicle sales (includes passenger car, utility vehicle and van
sales), which we saw in early 2013, have been staunched in Q313 due to base effects, we highlight that the
sector still faces challenges for the rest of 2013. According to the Society of Indian Automobile
Manufacturers (SIAM), auto sales in September 2013 fell 9.8% y-o-y, to 267,711 units. While passenger car
sales did manage to eke out a small 0.7% y-o-y gain, to 156,018 units, they were partially helped by low
base effects from 2012 due to the lingering effects of Maruti Suzuki's plant shutdown.
Real Recovery Earliest Only In Q114
India - Passenger Car & Passenger Vehicle Sales, Units (LHS); % Chg y-o-y (RHS)
Source: BMI, SIAM
We acknowledge that car sales could see some respite in Q413 due to the excellent monsoon, which has
boosted rural incomes, and the festive season. However, we remain convinced that fundamental demand
remains weak. Indeed, we believe that a real recovery will only take place in Q114 at the earliest. The
recent 25 basis point hike in the benchmark repo rate by the Reserve Bank of India (RBI) on September 20
will likely continue to deter buyers from making a purchase due to higher borrowing costs. However, our
Country Risk team believes that India's ongoing external balancing will pave the way for the RBI to begin
easing in early 2014, which would then see consumer sentiment getting a boost (see 'External Adjustment
To Pave Way For Rate Cuts In 2014', October 10).
CV Sales Go From Bad To Worse
The CV segment, with its rapidly deteriorating fundamentals, remains the weakest link in the Indian auto
sector. The accompanying chart illustrates the severity of the declines experienced by the segment in recent
months. After suffering a precipitous 23.1% y-o-y drop in August, sales contracted further in September,
down some 27.0% y-o-y, to 51,680 units.
Where Is The Bottom?
India - CV Sales, Units (LHS); % Chg y-o-y (RHS)
Source: BMI, SIAM
Headwinds in the CV segment are unlikely to abate anytime soon. The high debt levels of infrastructure
firms have pushed corporates in that sector into deleveraging mode. As infrastructure companies sell assets
to pare down debt, it is only logical that their defensive stance will translate into a significant decline in
demand for CVs.
Indonesia: Weathering Fuel Price Hikes Well, But Weakness Ahead
In line with our view that the recent cut in fuel subsidies is not going to cause the Indonesian auto sector to
go into a tailspin, vehicle sales continued growing even after fuel prices were raised in June 2013 (see 'Fuel
Price Hikes: Initial Thoughts', July 1). With 9M13 sales up 11.2% y-o-y, to 907,996 units, our cautiously
optimistic outlook was certainly validated.
Weakness Ahead
Indonesia - Domestic Auto Sales, Units (LHS); % Chg y-o-y (RHS)
Source: BMI, Gaikindo
Sales Will Face Drag From Higher Interest Rates In 2014
Going forward, however, we note that it will be difficult for the sector to continue posting record sales in
the coming months due to a deteriorating macroeconomic backdrop and the persistent drag of higher interest
rates.
The CV segment, which is already facing challenges from a rise in loan servicing costs, will also have to
contend with a slowdown in demand from interest rate sensitive sectors such as construction and
infrastructure. Indeed, our Infrastructure team recently downgraded its 2014 growth forecast for the
construction sector as it expects higher financing costs to weigh on the sector.
Furthermore, with three-quarters of auto sales utilising some sort of financing, consumers too will begin to
feel the pinch from persistent higher interest rates and we forecast slower growth in the passenger car
segment in 2014.
Japan: Sales Tax Increase Will Benefit Sales Until Q114
The rising consumer optimism in Japan is evident, with auto sales in September 2013 registering their first
y-o-y gain since April 2013. According to Honda Motor's senior managing officer, Sho Minekawa,
customers have slowly been returning to showrooms. We believe this positive sales momentum will
continue for the rest of 2013 as Abenomics (a set of aggressive fiscal and monetary stimulus policies
introduced by Prime Minister Shinzo Abe) finally begin to loosen consumer purse strings.
Consumer Sentiment Turning Positive
Japan - Domestic Auto Sales, Units (LHS); Chg y-o-y (RHS)
Source: BMI, Japan Automobile Manufacturers Association (JAMA)
Another development, which would also provide a boost to car sales in the short term, is the recent decision
by Abe to raise the consumption tax from 5% to 8% in April 2014. We now expect to see buyers front-
loading their auto sales purchases for the rest of 2013 and Q114.
Besides the lift in consumer sentiment, the outlook among firms has also become more favourable. The
Bank of Japan Tankan survey in September 2013 shows confidence among large Japanese manufacturers
rising to the highest it has been since 2007. Furthermore, Abe has pledged a JPY5trn (US$51bn) stimulus
programme to help firms mitigate the effects of the impending sales tax hike. One of the ideas being mooted
is a corporate tax cut, which we believe will be beneficial in accelerating firms' capital expenditure plans.
This could then increase hiring and wages, further boosting consumption.
After the initial boost to car sales in Q114, it is likely that sales will give way for the rest of 2014. However,
we believe it is still early to predict the consumer fallout from the hike in the consumption tax and we are
waiting for more economic data.
Global Industry Overview
BMI View: The global auto supplier and equipment index has outperformed the global auto
manufacturers' index since the global financial crisis. We believe possible reasons for this include the
greater flexibility of EU suppliers, the rise in the average age of US cars and trade protectionism. Two
future developments which may cause a reversal in fortunes in favour of original equipment manufacturers
are a pick up in the European auto market and the forming of the ASEAN Economic Community (AEC) in
2015.
We recently highlighted original equipment manufacturer (OEM)'s greater bargaining power versus auto
suppliers (see 'Illegal Cartels Highlight Low Supplier Power', October 1 2013). However, this does not
always translate into automakers' share prices outperforming. Indeed, when we chart the performance of the
Bloomberg World Auto Manufacturers Index and Bloomberg World Auto Parts And Equipment Index over
the past 10 years, it is clear that both suppliers and automakers have their own periods of outperformance.
While suppliers' margins on the parts they sell are usually lower than the margins which OEMs enjoy on
their cars, there are other dynamics at play that determine the actual financial results of firms and ultimately
their share price performance. The accompanying chart illustrates the outperformance of suppliers versus
carmakers since the global financial crisis in 2008-2009. Below, we explain this phenomenon and give our
thoughts on changing industry trends, which may cause a reversal.
Suppliers Outperforming Since Global Financial Crisis
BW Auto Manufacturers And Parts And Equipment Indices (top) And Spread (bottom)
NB Indices are rebased to 100 from August 2003; * BW = Bloomberg World. Source: BMI, Bloomberg
EU Suppliers More Nimble Than Carmakers
Vehicle sales in the EU have been contracting since 2008 and sales declines in some markets intensified
when the eurozone crisis hit the region in 2010. This has led to heavy losses for European carmakers in the
past few years. Further compounding their problems is their inability to shed large proportions of their
workforce, or expediently close underperforming factories, due to political pressure on some national
carmakers to retain workers.
European suppliers, on the other hand, are less in the political limelight due to their smaller size, and they
have therefore been able to rationalise their European operations faster. This has allowed them to be more
nimble and re-orientate their businesses to find new growth opportunities in emerging markets in Asia,
Eastern Europe and Latin America, which are increasingly making up a bigger share of their sales (see
'Suppliers Continue To Shift Strategic Focus', June 24 2013).
Therefore, it is no surprise that the share prices of European suppliers have recovered much faster and more
strongly than their carmaker counterparts since the global financial crisis.
Ageing US Fleet Makes Market Attractive For Suppliers
The American consumer has deleveraged significantly since the financial crisis. However, the bumpy
economic recovery has resulted in consumers holding on to their set of wheels longer and has also given
rise to strong used car sales. Therefore, while new vehicle sales have been growing at a strong clip since
2009, the average age of the US vehicle fleet has climbed to an all-time high of 11.4 years.
In such an environment, suppliers would naturally perform better, as they are able to sell parts to OEMs for
the production of new cars as well as sell replacement parts directly to the end consumers. As the vehicles
on the road get older, it is reasonable to assume that spending on replacement parts has to rise to keep them
in a roadworthy condition.
Trade Protectionism Puts Vehicle Imports At A Disadvantage
In recent years, trade protectionism, especially in emerging markets, has been on the rise. Many of these
countries have nascent auto industries, and in order to encourage automakers to produce domestically, they
usually impose high tariffs on auto imports. While both auto parts and vehicle imports are taxed, parts are
usually taxed at a lower rate. We believe this may be because governments realise that the lack of
localisation in their domestic auto industries requires local manufacturers to import components from
overseas. A case in point is Vietnam, where the import tariff on completely built unit (CBU) imports from
ASEAN will be 50% in 2014, but for car parts only 15-25%.
The upshot of this, in our opinion, is that suppliers will find it easier to export their parts to early emerging/
frontier markets than automakers, whose exports may be priced out due to exorbitant tariffs.
Can Suppliers Continue Outperforming?
While there may definitely be other reasons for suppliers' share prices outperforming manufacturers in the
past few years, the important question is whether this trend will endure. We believe it is hard to tell at this
point. However, we highlight two future developments that may cause a reversal in fortunes.
Pick Up In The European Vehicle Market

Although BMI maintains a bearish outlook on the European vehicle market, we expect the region to recover
in coming years. As sales in individual car markets begin to slow their rate of contraction and eventually
return to growth on the back of pent-up demand, European carmakers' could begin to outperform suppliers.
Upcoming 2015 AEC Could Tilt The Scales In OEMs' Favour

The formation of the AEC in 2015 will bring down trade tariffs in South East Asia and by 2018 most, if not
all, countries in South East Asia will cut their import tariffs to zero. This development may end up being a
game changer for automakers as they concentrate their production in one or two hubs in the region and
export their CBUs tariff-free to the rest of the AEC.
Demographic Forecast
Demographic Outlook
Demographic analysis is a key pillar of BMI's macroeconomic and industry forecasting model. Not only is
the total population of a country a key variable in consumer demand, but an understanding of the
demographic profile is key to understanding issues ranging from future population trends to productivity
growth and government spending requirements.
The accompanying charts detail China's population pyramid for 2013, the change in the structure of the
population between 2013 and 2050 and the total population between 1990 and 2050, as well as life
expectancy. The tables show key datapoints from all of these charts, in addition to important metrics
including the dependency ratio and the urban/rural split.
Population Pyramid
2013 (LHS) and 2013 v. 2050 (RHS)
Source: World Bank, UN, BMI
Population Indicators
Population, mn (LHS) and Life Expectancy, yrs (RHS)
Table: China's Population By Age Group, 1990-2020 ('000)

1990 1995 2000 2005 2010 2013e 2015f 2020f
Total 1,165,429 1,237,531 1,280,429 1,318,177 1,359,821 1,385,567 1,401,587 1,432,868
0-4 years 136,835 109,708 83,372 78,477 85,579 90,093 91,238 85,100
5-9 years 107,721 135,717 109,039 83,055 78,235 81,896 85,291 90,977
10-14 years 96,909 107,330 135,323 108,796 82,893 77,751 78,081 85,144
15-19 years 121,984 96,503 106,947 134,744 108,370 90,831 82,605 77,816
20-24 years 125,159 121,206 95,922 106,031 133,874 121,873 107,827 82,148
25-29 years 106,503 124,204 120,354 94,936 105,154 125,700 133,207 107,277
30-34 years 85,142 105,623 123,273 119,245 94,141 95,930 104,616 132,633
35-39 years 87,137 84,321 104,710 122,171 118,329 101,899 93,629 104,113
40-44 years 62,786 86,049 83,351 103,575 121,040 122,367 117,516 93,030
45-49 years 48,341 61,658 84,621 82,107 102,225 114,541 119,760 116,389
50-54 years 44,963 47,035 60,121 82,883 80,577 90,914 100,504 117,919
55-59 years 41,190 43,061 45,175 58,208 80,467 78,874 78,300 97,885
60-64 years 33,438 38,355 40,257 42,815 55,392 69,850 76,555 74,743
65-69 years 25,668 29,739 34,278 36,714 39,275 44,691 50,809 70,576
70-74 years 19,719 21,155 24,614 29,195 31,532 32,357 33,870 44,164
China's Population By Age Group, 1990-2020 ('000) - Continued

1990 1995 2000 2005 2010 2013e 2015f 2020f
75-79 years 12,265 14,437 15,589 18,961 22,758 24,054 24,610 26,734
80-84 years 6,428 7,477 8,838 10,212 12,614 14,079 14,910 16,372
85-89 years 2,572 3,037 3,551 4,720 5,568 5,931 6,253 7,542
90-94 years 588 811 956 1,188 1,619 1,704 1,742 2,005
95-99 years 76 97 130 132 170 220 250 278
100+ years 4 7 8 9 10 11 13 20
f = BMI forecast. Source: World Bank, UN, BMI
Table: China's Population By Age Group, 1990-2020 (% of total)

1990 1995 2000 2005 2010 2013e 2015f 2020f
0-4 years 11.74 8.87 6.51 5.95 6.29 6.50 6.51 5.94
5-9 years 9.24 10.97 8.52 6.30 5.75 5.91 6.09 6.35
10-14 years 8.32 8.67 10.57 8.25 6.10 5.61 5.57 5.94
15-19 years 10.47 7.80 8.35 10.22 7.97 6.56 5.89 5.43
20-24 years 10.74 9.79 7.49 8.04 9.84 8.80 7.69 5.73
25-29 years 9.14 10.04 9.40 7.20 7.73 9.07 9.50 7.49
30-34 years 7.31 8.54 9.63 9.05 6.92 6.92 7.46 9.26
35-39 years 7.48 6.81 8.18 9.27 8.70 7.35 6.68 7.27
40-44 years 5.39 6.95 6.51 7.86 8.90 8.83 8.38 6.49
45-49 years 4.15 4.98 6.61 6.23 7.52 8.27 8.54 8.12
50-54 years 3.86 3.80 4.70 6.29 5.93 6.56 7.17 8.23
55-59 years 3.53 3.48 3.53 4.42 5.92 5.69 5.59 6.83
60-64 years 2.87 3.10 3.14 3.25 4.07 5.04 5.46 5.22
65-69 years 2.20 2.40 2.68 2.79 2.89 3.23 3.63 4.93
70-74 years 1.69 1.71 1.92 2.21 2.32 2.34 2.42 3.08
75-79 years 1.05 1.17 1.22 1.44 1.67 1.74 1.76 1.87
80-84 years 0.55 0.60 0.69 0.77 0.93 1.02 1.06 1.14
85-89 years 0.22 0.25 0.28 0.36 0.41 0.43 0.45 0.53
90-94 years 0.05 0.07 0.07 0.09 0.12 0.12 0.12 0.14
95-99 years 0.01 0.01 0.01 0.01 0.01 0.02 0.02 0.02
100+ years 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
f = BMI forecast. Source: World Bank, UN, BMI
Table: China's Key Population Ratios, 1990-2020

1990 1995 2000 2005 2010 2013e 2015f 2020f
Dependent ratio, % of total
working age 54.0 53.2 48.1 39.2 36.0 36.8 38.2 42.7
Dependent population, total,
'000 408,785 429,516 415,699 371,460 360,252 372,787 387,067 428,914
Active population, % of total 64.9 65.3 67.5 71.8 73.5 73.1 72.4 70.1
Active population, total, '000 756,644 808,016 864,730 946,717 999,569 1,012,779 1,014,520 1,003,954
Youth population, % of total
working age 45.1 43.7 37.9 28.6 24.7 24.7 25.1 26.0
Youth population, total, '000 341,465 352,755 327,734 270,328 246,707 249,740 254,610 261,221
Pensionable popn, % of total
working age 8.9 9.5 10.2 10.7 11.4 12.1 13.1 16.7
Pensionable popn, total, '000 67,320 76,761 87,965 101,132 113,545 123,048 132,457 167,692
f = BMI forecast; 1 0>15 plus 65+, as % of total working age population; 2 0>15 plus 65+; 3 15-64, as % of total
population; 4 15-64; 5 0>15, % of total working age population; 6 0>15; 7 65+, % of total working age population; 8 65+.
Table: China's Rural And Urban Population, 1990-2020

1990 1995 2000 2005 2010 2013e 2015f 2020f
Urban popn. % of total 26.4 31.0 35.9 42.5 49.2 53.1 55.6 61.0
Rural popn. % of total 73.6 69.0 64.1 57.5 50.8 46.9 44.4 39.0
Urban popn, total, '000 308,163 383,152 459,379 560,515 669,386 735,049 779,282 873,849
Rural popn, total, '000 857,266 854,379 821,049 757,662 690,436 650,518 622,304 559,019
Sources: World Bank, UN, BMI
Methodology
Industry Forecasts
BMI industry forecasts are generated using the best-practice techniques of time-series modelling and
causal/econometric modelling. The precise form of model we use varies from industry to industry, in each
case being determined, as per standard practice, by the prevailing features of the industry data being
examined.
Common to our analysis of every industry is the use of vector autoregressions. Vector autoregressions allow
us to forecast a variable using more than the variable's own history as explanatory information. For
example, when forecasting oil prices, we can include information about oil consumption, supply and
capacity.
When forecasting for some of our industry sub-component variables, however, using a variable's own
history is often the most desirable method of analysis. Such single-variable analysis is called univariate
modelling. We use the most common and versatile form of univariate models: the autoregressive moving
average model (ARMA).
In some cases ARMA techniques are inappropriate because there is insufficient historic data or data quality
is poor. In such cases we use either traditional decomposition methods or smoothing methods as a basis for
analysis and forecasting.
BMI mainly uses OLS estimators and in order to avoid relying on subjective views and encourage the use
of objective views, BMI uses a 'general-to-specific' method. We mainly use a linear model, but simple non-
linear models, such as the log-linear model, are used when necessary. During periods of 'industry shock', for
example when poor weather conditions impede agricultural output, dummy variables are used to determine
the level of impact.
Effective forecasting depends on appropriately selected regression models. We select the best model
according to various different criteria and tests, including but not exclusive to:
R
2
tests explanatory power; adjusted R
2
takes degree of freedom into account.
Testing the directional movement and magnitude of coefficients.
Hypothesis testing to ensure coefficients are significant (normally t-test and/or P-value).
All results are assessed to alleviate issues related to auto-correlation and multi-collinearity.
BMI uses the selected best model to perform forecasting.
Human intervention plays a necessary and desirable role in all of our industry forecasting. Experience,
expertise and knowledge of industry data and trends ensure that analysts spot structural breaks, anomalous
data, turning points and seasonal features where a purely mechanical forecasting process would not.
Sector-Specific Methodology
A number of principal criteria drive our extrapolations and forecasts for each autos variable.
Production And Sales

At a general level, we approach our forecasting from both a micro and a macro perspective, assessing the
expansion plans of relevant multinationals/indigenous firms, while also taking account of the prevailing
economic outlook. In this latter respect, our projections for macro variables such as industrial output,
private consumption, government investment, monetary policy and GDP growth play a key role.
Figures for production are derived from a generic source (thereby ensuring maximum comparability
between country data-sets), and include all vehicles with four wheels or more. For sales, we rely on data
from government agencies and national automobile associations. Unless otherwise stated, sales numbers
include domestically produced and imported vehicles, but not exports. The sector's contribution to GDP is
projected by taking the US dollar production value as a proportion of nominal GDP, using our own
macroeconomic and demographic forecasts.
Auto Imports And Exports

These variables are mainly calculated at the micro level, using individual company reports. Changes in
government policy, particularly with regard to tariffs and quotas, also have a significant bearing.
Sources
Aside from government departments and official company reports, we rely on the International
Organization of Motor Vehicle Manufacturers (OICA), other established think tanks, institutes, and
international and national news agencies.
Risk/Reward Ratings Methodology
BMI's Risk/Reward Ratings (RRR) provide a comparative regional ranking system evaluating the ease of
doing business and the industry-specific opportunities and limitations for potential investors in a given
market. The RRR system divides into two distinct areas.
Rewards
Evaluation of sector's size and growth potential in each state, and also broader industry/state characteristics
that may inhibit its development. This is further broken down into two sub categories:
Industry Rewards (this is an industry-specific category taking into account current industry size and
growth forecasts, the openness of market to new entrants and foreign investors, to provide an overall
score for potential returns for investors).
Country Rewards (this is a country-specific category, and the score factors in favourable political and
economic conditions for the industry).
Risks
Evaluation of industry-specific dangers and those emanating from a state's political/economic profile that
call into question the likelihood of anticipated returns being realised over the assessed time period. This is
further broken down into two sub categories:
Industry Risks (this is an industry-specific category whose score covers potential operational risks to
investors, regulatory issues inhibiting the industry, and the relative maturity of a market).
Country Risks (this is a country -pecific category in which political and economic instability,
unfavourable legislation and a poor overall business environment are evaluated to provide an overall
score).
We take a weighted average, combining industry and country risks, or industry and country rewards. These
two results provide an overall Risk/Reward Rating, which is used to create our regional ranking system for
the risks and rewards of involvement in the autos industry in a particular country.
For each category and sub-category, each state is scored out of 100 (100 being the best), with the overall
Risk/Reward Rating a weighted average of the total score. As most of the countries and territories evaluated
are considered by BMI to be 'emerging markets', our rating is revised on a quarterly basis. This ensures that
the rating draws on the latest information and data across our broad range of sources, and the expertise of
our analysts.
In constructing these ratings, the indicators in the table below have been used. Almost all indicators are
objectively based. Given the number of indicators/datasets used, it would be inappropriate to give all sub-
components equal weight. The weighting given is described in the table.
Table: Automotive Risk/Reward Ratings Indicators And Weighting Of Indicators
Indicator Weighting, %
Rewards 70, of which
Industry Rewards 65, of which
Vehicle ownership, % of population 10
Total vehicle stock, mn 10
Total production 10
Production growth, five-year forecast average 10
Total vehicle sales 10
Sales growth, five-year forecast average 10
Country Rewards 35, of which
Urban/rural split 10
Rigidity of employment 10
Labour costs 10
GDP per capita, US$ 10
Risks 30, of which
Industry Risks 50, of which
Regulatory environment 10
Competitive landscape 10
Country Risks 50, of which
Corruption 10
Bureaucracy 10
Market orientation - openness 10
Legal framework 10
Long-term monetary risks 10
Long-term external risks 10
Long-term financial risks 10
Long-term policy continuity 10
Source: BMI
Reproduced with permission of the copyright owner. Further reproduction prohibited without
permission.

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Q1 2014

Provincial governments often fail to enforce central government directives.

The country's dependency on investment to boost growth has made it vulnerable to a

Chinese corporate governance is weak and non-transparent by Western standards.

Gasoline-Powered Motorbikes Will Continue To Be Regulated

Competition From Passenger Cars

Able to export vehicles from China to other emerging markets.

Focus on emission standards could boost demand for company's eco-friendly

China being VW Group's biggest market makes in vulnerable to a slowdown in the

Sales are much lower than industry leaders.

CV segment sales have a lot of potential to grow.

China is the world's largest consumer of the high-end S class model.

Pick Up In The European Vehicle Market

Upcoming 2015 AEC Could Tilt The Scales In OEMs' Favour

Testing the directional movement and magnitude of coefficients.

Production And Sales

Auto Imports And Exports

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