Three Factors Which Will Determine GM’s Fate In Its Biggest Market
When General Motors (NYSE:GM) announced results for the third quarter of fiscal 2015 recently, it announced record profits in North America and record unit sales in China, driven by a 171% increase in sales of SUVs. ((GM 10-Q SEC Filing, GM Investor Relations)) However, it also sounded a note of caution regarding future expectations from the Chinese car market: while previously, China could reliably be expected to post double-digit growth in unit sales year after year, GM said that it expects car sales to grow in low single digits for the rest of the decade. More precisely, GM said that it expects car sales to grow at a rate of 3% to 5% for the 2015-2020 period. [1]
The Detroit-based auto maker is one of the few American companies that has been able to crack the Chinese market. It has been locked in a neck-to-neck fight with Volkswagen for the lead position among international car makers in China. Although most of its profits come from North America, China is where most of the growth in profits is expected to come from. According to the World Bank, car penetration rates in China stood at only 69 vehicle per 1,000 inhabitants in 2011, compared to 786 in the U.S. [2] Given such a low rate of penetration, there is a lot of scope for growth. First-time buyers can form the base target market for compact cars and hatchbacks, while second-time buyers form the target for sales of SUVs and sedans. As the economy matures, car buyers upgrade to more expensive vehicles and drive up profitability. But the Chinese market has been struck by a triple whammy of slowing GDP growth, a currency devaluation and a stock market crash this year. Consumer spending has fallen. Auto sales have dropped on a year-over-year basis. GM’s unit sales in the region have dropped in 5 of the last six months.
In response, car makers are having to offer generous incentives to buyers to persuade them to purchase new cars. [3] In a landscape, where cars get cheaper each month, while also getting better in terms of technology, car buyers tend to be patient and hold off buying new cars. In addition to discounts, car makers and dealers are offering other incentives such as subsidized insurance, zero down payments and zero-interest financing, further putting pressure on profits. In this environment, it is normal for there to be much uncertainty regarding GM’s future prospects in the region. Below, we outline three factors which will determine GM’s fortunes in China going forward.
1) Volkswagen’s Loss Can Be GM’s Gain: In 2013, German auto maker Volkswagen overtook GM as the highest selling foreign car maker in China. China is General Motors’ largest market by volume and accounts for almost 50% of the company’s valuation according to our estimates. With the recent diesel emissions scandal, Volkswagen is facing management changes, legal penalties, pending criminal investigations and a loss of reputation. There is a possibility that, with loss of consumer trust in Volkswagen, buyers may now move back to General Motors, allowing it to regain its number one position in China.
2) State Subsidies: The China State Council recently announced a stimulus package for the auto market. [4] The package starts this month and will extend through the end of 2016. Under the plan, the vehicle purchase tax on all cars with engines 1.6 liters or smaller will fall from 10% to 5%. According to an estimate by Credit Suisse, this should pass on around $1,500 to the consumer. [5] Around 80% of the passenger vehicles and light vans sold by GM will qualify for this package. So, this package can boost GM’s sales.
3) Adapting Model Lineup: While the two factors above could help GM in the near term, the company will have to adjust its strategy to continue to do well in the longer term. For this purpose, it will have to adjust its model lineup so that it is well represented in the segments that can offer high growth going forward. Although the overall car market growth rate is expected to fall from double digits to 3% to 5%, the luxury, MPV and SUV segments should all continue to do well. The three segments together are expected to double the market’s growth through the 2020 period. Accordingly, GM plans to introduce 26 new or refreshed vehicles in these three segments. If these vehicles fare well, GM should not only be the leading international car seller in the region but also a high profit generator.
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Notes:- General Motors (GM) Mary Teresa Barra on Q3 2015 Results – Earnings Call Transcript, Seeking Alpha, October 2015 [↩]
- China Has More Space Than U.S. for Adding Car Ownership, Bloomberg, January 2015 [↩]
- Chinese Spurn Unprecedented Car Discounts Amid Slowdown, Bloomberg, August 2015 [↩]
- Chinese Automakers Surge After Government Cuts Purchase Tax, Bloomberg, September 2015 [↩]
- General Motors: China to the Rescue!, Barrons, September 2015 [↩]