Global Auto Industry Driving through China Headwinds


The Chinese auto market is the largest in the world. As such it has a significant effect on both US and European original equipment manufacturers' (OEM), profitability. In fact, profitability in China was one of the points highlighted in the recent credit rating downgrade of Ford Motor Co (Ford). Weakness in China autos also has knock-on effects to global auto suppliers, as well as chemical, technology, metals and diversified industrial companies. Therefore, understanding China's auto market, the reasons for the recent weakness and potential catalysts toward market stabilization is important.

Four reasons behind recent decline in auto sales Year-to-date Chinese passenger vehicle sales are down 12% year-over-year (Exhibit 1). Certainly the market has been negatively impacted by a slower macro Chinese economy and trade issues. More importantly, we highlight four reasons cited for the weakness specific to vehicles:

  1. Shadow Banking: Government regulation has significantly shrunk these lending sources. At its peak, over 3,500 peer-to-peer (P2P) platforms existed, but declined to roughly 1,000 in 2018 with an expectation to decline to less than 500 in 2019.1 Auto financing in China is still nascent so the curb on shadow banking financing sources had a direct influence on sales.
  2. Rising Housing Costs: In August 2019, average Chinese home prices grew 9.3% year-over-year.2 Surges in home prices and increasing outstanding mortgage loans has negatively impacted household discretionary income. The People's Bank of China, PBoC, has found that a 100 basis point increase in household debt results in a 30 basis point decline in retail sales growth (auto is around 30% of China retail sales).
  3. Decreases in Government Subsidies: In March 2019, the Chinese Ministry of Finance announced the reduction of subsidies on electric vehicles (EV). The subsidy reduction applies to both battery EV (BEV) and plug-in hybrid (PHEV). Starting in June of this year, subsidies were cut by 45-60% for ranges greater than 250km and eliminated for all ranges below that range. The indication is that the government will remove all subsidies in 2020 which will likely further negatively impact EV sales in the near-term.
  4. Acceleration of China 6: China 6 emissions standards were initially slated to go into effect in July 2020 (China 6a with a stricter China 6b in July 2023). However, a number of key cities and provinces (representing two-thirds of the market) announced the acceleration of China 6b adoption to July 2019. The timing resulted in high levels of non-compliant inventory as well as timing delays of new purchases. Compliant production still does not account for 75% of total production, particularly as local OEMs continue to struggle to adapt.3

Exhibit 1: Changes in Chinese passenger car sales year-over-year

Source: AAM, China Association of Automobile Manufacturers. As of August 18, 2019.

Auto sector stimulus has been ineffective

Initial expectations were for year-over-year growth in auto sales in 2019. Current estimates are for a decline of 7%.4 So what happened? In the face of the headwinds noted above, the impact of government initiatives has been minimal. The National Development and Reform Commission's (NDRC) initial plan to ease specific regulations was largely ineffective. Further, the government's cut on VAT tax in April didn't result in material lasting increases in volume. Recent initiatives to increase the issuance of license plates are expected to also have a limited impact.

Despite the importance of the auto industry to the economy as a whole, the market had expected stronger government support to drive demand. With over 80 Chinese OEMs and over 500 electric vehicle (EV) startups5, the Chinese government likely does not want to support unprofitable entities through subsidies. A number of local/regional Chinese OEMs are operating at less than 50% plant capacity utilization which is unsustainable without support from government subsidies.6 However, these local/regional OEMs are important provincial employers so they are supported by local and regional authorities. But without the financial and technical resources to invest in new models and regulatory standards, sales volumes and realized pricing will continue to suffer.

Potential areas of stabilization for China market

While consolidation could take time to play out, we highlight five points that can drive Chinese auto demand going forward:

Premium continues to grow: The premium segment of the market (11-12%) has continued to grow year-over-year despite the declines in the overall market.7 Additionally, similar to the US, SUVs are increasing as a percentage of total vehicles.

New and refreshed vehicle models: The Chinese market has demonstrated demand for new vehicles and technologies. Ford highlighted this fact in explaining much of the sales weakness it has seen in China over the past 18 months.

Vehicle replacement: Chinese vehicle replacement cycle is five to six years compared to US/Europe at nine to ten years.8 The replacement cycle was likely delayed by the change to China 6 standards so any normalization could be positive.

Vehicle penetration: At 155 vehicles per 1000 people, Chinese vehicle penetration rates are still well below the US (857 per 1000) and Europe. Despite license plate restriction in the more populated provinces, upside exists in a number of provinces where penetration rates that are at or below 100 per 1000 people.9

EV targets: Government targets for EV penetration are still aggressive, including 2 million EV sales by 2020. Additionally, China is targeting >20% of all vehicle sales to be EVs by 2025. Chinese and foreign OEMs plan to meet these targets by greatly increasing the number of new EVs to the market. GM, for instance, intends to introduce 20 new-energy models by 2023.

Foreign OEMs exposure to China

Amongst North American OEMs, Ford and General Motors (GM) have consolidated operations as well as joint ventures in China. In 2018, Ford EBIT in China was a loss of $1.5billion, a decline of $1.7 billion year-over-year, as China market share declined to 3%. With a market share of 13% last year, GM generated $2.0 billion of equity income from its China joint ventures. The big three European OEMs: BMW, Daimler, VW, are even more heavily exposed with China deliveries as a percentage of total representing 26%, 28% and 38%, respectively. As mentioned above, premium vehicles continue to perform well as evidenced by continued growth at BMW in China units. On the other hand, Jaguar Land Rover (JLR) realized year-over-year unit declines of 34% in China in fiscal 2019.

The difference between GM and Ford, BMW and JLR highlights the importance of product and quality to overcome the headwinds in the market. While the China auto market continues to be weak overall, certain OEMs have continued to perform well due to new product introductions. We believe as the market stabilizes, the stronger OEMs must have the right product for the market and a healthy dealer network.

1Wang, Orange. Bray, Chad. "China's P2P lending market could be decimated this year amid Beijing crackdown." South China Morning Post. 15 April 2019. 
2CEIC. China House Prices Growth. 
3Barclays Capital Inc. Special Report Research. "China--the temperamental dragon." 23 July 2019.
4Morgan Stanley Research. Global Auto Monitor. 27 September 2019.
5Fair Observer. "China's Electric Vehicle Market: A Storm of Competition is Coming." 12 May 2019 
6Gasgoo China Automotive News. "Data Talk: China's PV capacity utilization rate may shrink to 46% in 2019." 8 August 2019. 
7BMW Group. Investor Presentation. September 2019.
8Barclays Capital Inc. Special Report Research. "China--the temperamental dragon." 23 July 2019.
9Perkowski, Jack. "Will 2018 be an Inflection Point for China's Auto Sales?" Forbes. 27 November 2018.


Past performance is not indicative of future results. This material is to be used for institutional investors and not for any other purpose. This communication is being provided for informational purposes in connection with the marketing and advertising of products and services. This material contains current opinions of the manager and such opinions are subject to change without notice. Aegon AM US is under no obligation, expressed or implied, to update the material contained herein. This material contains general information only on investment matters; it should not be considered a comprehensive statement on any matter and should not be relied upon as such. If there is any conflict between the enclosed information and Aegon AM US' ADV, the Form ADV controls. The information contained does not take into account any investor's investment objectives, particular needs, or financial situation. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to you. The value of any investment may fluctuate. Investors should consult their investment professional prior to making an investment decision. Aegon AM is not undertaking to provide impartial investment advice or give advice in a fiduciary capacity for purposes of any applicable federal or state law or regulation. By receiving this communication, you agree with the intended purpose described above.
The information presented is for illustrative purposes only.

Results for certain charts and graphs are included for illustrative purposes only and should not be relied upon to assist or inform the making of any investment decisions.

Specific sectors mentioned do not represent all sectors in which Aegon AM US seeks investments. It should not be assumed that investments of securities in these sectors were or will be profitable.

This document contains "forward-looking statements" which are based on the firm's beliefs, as well as on a number of assumptions concerning future events, based on information currently available, and are subject to change without notice. These statements involve certain risks, uncertainties and assumptions which are difficult to predict. Consequently, such statements cannot be guarantees of future performance and actual outcomes and returns may differ materially from statements set forth herein. In addition, this material contains information regarding market outlook, rates of return, market indicators and other statistical information that is not intended and should not be considered an indication of the results of any Aegon AM US-managed portfolio.

Aegon Asset Management US is a US-based SEC registered investment adviser and is also registered as a Commodity Trading Advisor (CTA) with the Commodity Futures Trading Commission (CFTC) and is a member of the National Futures Association (NFA). Aegon Asset Management US is part of Aegon Asset Management, the global investment management brand of the Aegon Group.

Recipient shall not distribute, publish, sell, license or otherwise create derivative works using any of the content of this report without the prior written consent of Aegon USA Investment Management, LLC, 6300 C Street SW, Cedar Rapids, IA 52499. ©2019 Aegon Asset Management US. Ad Trax: 2749320.2 Exp Date: 9/30/2020

Jonathan Guantt

About Jonathan Guantt

Jonathan Gauntt is a senior credit research analyst responsible for global credit analysis of investment grade and high yield securities within his coverage universe.