Short-Term Tax Worries Frighten Investors, Momentarily
Rich Chinese More Likely Than Westerners To Splurge On Cars
Darker Scenarios Include Runaway Inflation, Political Unrest
China has provided a massive boost in profits for the German luxury car manufacturers, with most forecasts firmly predicting that the good times will continue to roll and maybe even accelerate far into the future.
But December saw the first inkling that there may be the occasional roadblock on the road to the sunlit uplands.
Firstly, stock markets were roiled by news China had decided not to extend its version of cash-for-clunkers incentives, and planned to introduce some new consumption taxes. Then came news that inflation was threatening what has been the country’s smooth, powerful and relentless economic growth.
The incentive change entailed the reinstatement of a purchase tax on cars under 1.6 litres which had been cut from 10 per cent to five per cent a year ago, raised to 7-1/2 per cent during 2010, and will return to 10 per cent in 2011.
When stock markets realized that this measure wouldn’t impact any high margin Audis, BMWs, Mercedes and Porsche vehicles, calm returned after share prices had plunged by up to seven per cent. China also announced new rules for fuel economy on cars under 1.6 litres, while the government introduced a City Construction Tax and an Education Surcharge which will have a minor impact on BMW, Audi and Mercedes Benz.
According to Bank America Merrill Lynch, VW will take a minor hit from the removal of incentives but benefit from new fuel economy rules.
“BMW, Audi and Mercedes Benz do not sell 1.6 litre engines and as such there’s no impact on our (profit) forecasts,” said Merrill Lynch analyst Fraser Hill.
The impact on BMW, VW’s Audi and Mercedes from the construction and education taxes will amount to less than 0.5 per cent of earnings in 2011, Merrill Lynch said.
Nomura International also believed the impact from the ending of incentives was a non-story.
“The incentive was supposed to end in 2011, the only unknown was and remains the precise date,” said Nomura analyst Alexis Albert.
Albert pointed out that VW cars of less than 1.6 litres are less than 20 per cent of total sales in China. China sales are likely to be 25 per cent of VW’s global sales in 2010, with net income from China 30 per cent of its total.
Perhaps a more worrying development was news inflation in China soared to 5.1 per cent in November, much higher than expected and compared with 4.4 per cent in October, according to the Financial Times.
“(This) was well above the government’s three per cent inflation target and will increase pressure on the authorities to raise interest rates and further rein in the huge monetary stimulus of the past two years,” the FT said. The FT said China’s monetary policy will shift to “prudent” from “appropriately loose”.
Max Warburton, in a new study of China’s luxury goods potential for Bernstein Research, points to the fantastic potential that remains in the country for manufacturers like BMW, Mercedes and Audi, tried to get a handle on just how sustainable is this boom.
His short answer is “very” sustainable, not least because of China’s propensity to buy more luxury cars per person than anywhere else.
“Chinese are “over-consuming” the highest end premium cars at present – 206 super-premium cars purchased annually per 1,000 millionaires versus 78 for the United States and 120 for the United Kingdom. This arguably excess consumption and rapid recent acceleration clearly creates near-term risks. Pricing and mix must surely decline. But further volume growth looks almost inevitable in the medium term – we model demand growth based on wealth creation to 2020, which suggests premium sales in China could climb above 200 per cent from current levels to 1.4 million units a year,” Warburton said.
Warburton points out that the German premium car makers probably now make more than 50 per cent of their profits in China.
He quoted forecasts predicting the number of Chinese millionaires will almost double by 2015, and the number of Chinese with incomes over $100,000 will climb by 94 per cent to 3.5 million by then. BMWs and Mercedes are seen as superior brands to Ferrari and Porsche. Warburton said as volume increases, more cars will have to be built in China which will mean lower margins, but they will still be huge by European and U.S. ones, brought down by CO2 rules.
“China could help BMW and Mercedes maintain margins at an historical average of six per cent plus, despite mix pressures in the E.U. and the U.S. But in a bull case, China could sustain margins at recent levels, or, with a U.S./European recovery, help to power margins into consistent double-digit territory,” Warburton said.
Looking to closer horizons, Deutsche Bank said China sales growth overall should “slow” to 11 per cent in 2011, while small and luxury car sub-segments could probably outperform, and long-term auto sales growth should be sustainable.
Warburton talks about reasonable predictions and the more over-the-top “bull” case” but doesn’t mention any possible darker sides. The recent inflation figures, published after the Bernstein report, suggest that if not controlled the whole growth scenario might quickly come to an end. And there is the more difficult political question; will China’s middle classes be happy to continue to outsource their political aspirations to the communist government? Will the material benefits outweigh any moves to seek a more liberal system of government, with all the turmoil that would bring?
Neil Winton – December 15, 2010