Volkswagen’s China Stronghold Is Under Threat

Volkswagen AG (OTCMKTS:VLKAY) leads the Chinese automotive market with around 15% volume share. However, it is facing stiff competition from not only other foreign makers in the country, but also domestic manufacturers who have grabbed a large chunk of the growth recently on high demand for budget vehicles. Does this mean that Volkswagen might keep losing ground in its single largest market?

Maybe. And here’s why:

— China’s economy has slowed down from the high growth levels seen in previous years, mainly due to industry overcapacity, slowdown in infrastructure, and the real estate sectors. Although the estimated GDP growth for the country of 7% this year is still solid, the slowdown has caught up to the automotive sector as well, which is expected to grow by 6-8%, slower than previous years’ levels.

We have a $52 price estimate for Volkswagen AG, which is above the current market price.

See Our Complete Analysis For Volkswagen AG

— Apart from a slight volume slowdown, there has been a shift in consumer preference from the well-known higher priced foreign-made vehicles to budget SUVs and sedans. This has cost Volkswagen, whose volume sales fell 1.1% year-over-year through May in China, while the overall market for passenger vehicles grew 6.4%. This comes after a solid 12.5% volume growth for the group in 2014 in the country, which forms over one-third of net volume sales for the group.

— Volkswagen is losing out to the domestic manufacturers in China, who have gained ground in the last few months on higher demand for budget SUVs. Through May, Chinese-branded passenger vehicles increased their market share to 42.1%, 3.9 percentage points more than 2014 levels. This was on a 17.3% year-over-year rise in vehicle sales for local manufacturers, which included a whopping 101.5% rise in sales of their SUVs, which formed one-third of net volume sales for these manufacturers. ^[1] As opposed to selling four of the six highest-selling sedans in China last year, Volkswagen had only the Tiguan in the top ten best-selling SUVs in the country.

— Apart from local competitors, Volkswagen is also losing ground to its foreign counterparts such as the American GM and Ford. GM is the second largest automaker in China, but has narrowed its gap with Volkswagen this year, growing volumes by 5.1% year-over-year, to 1.47 million vehicles through May (Volkswagen sold 1.49 million units). Although GM’s volumes slipped 4% in the country last month, the company has cut model prices on 40 models by as much as 53,900 yuan (~$8,700), and is launching more products in the high-growth SUV, MPV, and premium segments, including the Baojun 560, Buick Envision, Buick Verano, and Chevrolet Malibu sedans. Growth for GM could come at the expense of Volkswagen in China.

— Volkswagen hasn’t been prompt in responding to the changing customer preferences in China. The group’s Chief Executive, Martin Winterkorn, has said that the group is lining up a family of budget cars in the country that will include an SUV and a hatchback in 2018, and the cars will be priced between €8,000-€11,000 ($9,000-$12,300). ^[2] Earlier in 2013, Volkswagen planned to launch the budget family for emerging markets by 2016. Not only has the time of launch been delayed, but the price range for the concept models is also higher than the previous target of €6,000-€8,000, making them more expensive for the entry-level segment.

— Volkswagen luxury car brand Audi’s stronghold in China has also somewhat weakened this year. The brand is the largest-selling premium vehicle brand in the country, but its volume growth has lagged both its compatriots BMW and Mercedes-Benz this year, as seen from the table. For reference, Audi volumes rose 17.7% year-over-year in the country in 2014. The current reticence to buy in the luxury segment has impacted Audi and other luxury automakers in China recently, and this is expected to weigh on Volkswagen, as Audi forms ~16% of the group’s net volume sold in the country.

Volkswagen’s China joint ventures Shanghai Volkswagen and FAW-Volkswagen are planning to invest €22 billion ($25 billion) in the country between 2015-2019 for the purpose of product development and extending production capacity to over 5 million vehicles by 2019, up from 3.5 million vehicles in 2014. Building more vehicles locally is crucial for Volkswagen at a time when operating at lower price points has played into the hands of domestic automakers in China, and other players are also cutting model prices. The delayed launch of the budget lineup could be detrimental to Volkswagen’s near-term prospects in the country.

The group is going through a transition of sorts, and is now reportedly planning to split its twelve brands into four holding companies, citing the highly centralized management structure as one of the obstacles in the way of the profitability targets. In addition, Mr. Winterkorn wants to give more autonomy to Volkswagen, Audi, and Porsche, and also different regional units, including the China unit, which could allow the company to concentrate more on its strategy in the country, and come out with products more in tune with the current demand trends.

See the links below for more information and analysis:

• Volkswagen’s split could be good news
• Volkswagen: turnaround in the U.S. fortunes?
• Mercedes-Benz is catching up with competition in China
• Who will gain most from the large SUV/Crossover demand in the U.S.?
• Trefis analysis: Volkswagen China and Affiliates Vehicles Sold
• Trefis analysis: Volkswagen Passenger Cars, SEAT, LCVs Revenues
• Trefis analysis: Volkswagen Audi Revenues

View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research

1. The market share of Chinese brand passenger cars kept growth [↩]
2. Volkswagen finds itself in a budget car bind, wsj.com [↩]