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China Autos in a Growth Shift

Wall Street Journal - March 3, 2011

The world's biggest auto market is getting congested.

Lured to China by a powerful trend—rising incomes mean rising demand for autos—auto makers now face a slowdown in growth. The government has phased out tax breaks that encouraged car buying in 2009 and 2010, financing purchases has become more difficult and Beijing has begun to restrict issuance of license plates.

After expanding 36 percent in 2010, passenger vehicle sales grew just 21 percent in January from a year earlier. But the decline may have been steeper than the data suggest: because manufacturers hit their 2010 sales targets early, they might not have counted some December sales until January. For 2011 overall, J.D. Power & Associates is forecasting a much slower growth rate of around 11 percent.

That's not too shabby given the size of China's market, but it means the race is on for manufacturers to find the sections of the market where the scope for expansion is greatest.

Demand is still in the fast lane at the lower-price end, but this is also where competition is most intense. Domestic brands, which currently have a larger share of the budget market, are making significant additions to production capacity. Taken together, BYD, Chery Automobile and Geely Automobile Holdings, which in 2010 accounted for more than 10 percent of a fragmented market, will effectively double production capacity between 2010 and 2015.

But foreign companies like General Motors, Nissan and Honda, in joint ventures with local partners, are trying to muscle in too. Companies that previously focused on the glittering east are venturing inland and down market, developing new brands to attract demand from a rising wave of consumers in China's third- and fourth-tier cities.

A natural result of this contest will be lower prices. BYD has already announced plans for price cuts of up to 19 percent across five of its main models. Chery and Geely have so far declined to follow, but stock investors still fear a price war. Throw higher costs for raw material and labor into the mix, and the consequence is lower profit margins.

After running up sharply, Hong Kong-listed shares of BYD have been declining for a full year, and Geely has dipped 31 percent from a peak in November last year, considerably more than the 7 percent fall for the Hang Seng Composite Index as a whole. China's independent car makers have already started to stall.

But with competition set to intensify, falling stock prices do not mean value has started to emerge.

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