China’s electric dreams – a nightmare for European automakers?

The following is an extract from our Q4 Active Insights publication.

For motorists everywhere, undergoing the annual MOT can be a nerve-racking experience. At issue are the potential costs involved, the time needed to carry out any repairs or, in extreme cases, the risk that the vehicle will fail its test completely. In their own way, European car manufacturers, particularly in Germany, are facing an altogether different type of MOT in China, the world’s largest automotive market.

This ‘test’ is characterised by three key elements:

• M: A ‘melting’ ICE (internal combustion engine) segment
• O: Overcapacity in the industry
• T: Fierce technological change

Melting ICE

China leads the world in the transition to EVs. August sales of new electric vehicles (NEVs*) accounted for 37%[1] of the country’s new passenger vehicle sales, the highest share among any major vehicle market. While year-to-date NEV sales growth stands at 39%[2], this is in stark contrast to conventional vehicles, which are down by around 4% over the same period[3]. With the Chinese government determined to channel future growth into the NEV segment, we believe this dynamic is unlikely to change anytime soon, posing a potential challenge to Western automakers, which have typically enjoyed a healthy market share within this segment.

Overcapacity

China’s strategic focus on growing the home EV market has encouraged a plethora of new entrants, all attempting to gain market share, with sales struggling to keep pace with capacity expansion. As Mary Barra, CEO of General Motors*, recently stated: “China has 100 vehicle brands vying for sales and a 50% capacity utilisation rate.”

This overcapacity has inevitably led to discounting and a full-blown price war, despite efforts from the Chinese industry body, CAAM[4]. Western automakers, which for so long have enjoyed above-average margins in China, are now having to decide whether to cut prices to preserve competitiveness or hold firm to maintain their profitability.

Technology

European car manufacturers also face the challenge of pivoting to more ‘software defined’ vehicles. Volkswagen*, the biggest Western OEM in China by market share, has had to recalibrate its platform strategy due to software-related platform delays. This has led to VW striking deals this summer with Chinese companies, SAIC* and Xpeng Motors*, to utilise their platforms and co-develop vehicles. Time will tell whether these moves are sufficient to arrest a slide in market share.

Western carmakers: Failing their MOTs?

Our view is that some European players may be at risk of failing their respective MOTs in China, with the market share of Chinese brands in the country up from around 30% in recent years to over 50% as of July 2023[5]. With capacity utilisation still below ideal levels, China’s attention is also increasingly turning overseas, as Chinese brands look to export more to alleviate overcapacity concerns.

The European Commission (EC) estimates that 8%[6] of European EV sales now originate from China, with this share expected to increase to 15% by 2025[7]. As a result, the EC has recently launched an investigation into Chinese subsidies for electric vehicles, with the potential for higher tariffs on imports. Such a move could allow vehicles produced in Europe to become more competitive in the face of Chinese imports, but it risks retaliatory action against European automakers in what, for now, remains a lucrative Chinese market.

Investor implications

Rapid developments in the EV segment are changing the dynamics of automotive production in China. At the same time, Western automakers are facing an increasingly challenging environment here, in what has traditionally been their most profitable region. In the short term, these automakers continue to reap the benefits of pent-up demand in the aftermath of the pandemic and related supply chain issues.

However, in the long run, we believe action is needed today to ensure that both product offerings and cost bases remain competitive. In our view, a failure to successfully address these issues poses downside risk to profit and, over time, potentially to credit ratings.

The above is an extract from our Q4 Active Insights publication.

*For illustrative purposes only. Reference to this and any other security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. Such references do not constitute a recommendation to buy or sell any security.

[1] Source: Bloomberg NEF as at September 2023

[2] Source: Bloomberg NEF as at September 2023

[3] Source: Bloomberg NEF as at September 2023

[4] Source: https://www.reuters.com/business/autos-transportation/chinas-auto-group-retracts-pledge-avoid-abnormal-pricing-2023-07-08/

[5] Source: Bloomberg as at August 2023.

[6] Source: https://www.euractiv.com/section/economy-jobs/news/how-will-the-eus-investigation-into-chinese-electric-vehicle-subsidies-work/

[7] Source: Ibid