Prospective electric vehicle (EV) owners in China are in a quandary: Fuelled by Tesla’s price cuts for its best-selling models from October last year, Chinese automakers have slashed their prices to avoid being undercut, leaving buyers guessing where prices will eventually trough.
The intensifying competition in China’s EV market is less of a happy problem for automakers. Diminished vehicle margins — compounded by softened demand, the expiry of government subsidies and rising battery-related costs — could result in the number of Chinese EV manufacturers shrinking from the current pool of some 200 companies to a concentrated handful in the next few years.
Around two-thirds of China’s existing EV manufacturers were incorporated between 2018 and 2020, when government policies were implemented to buttress the emerging industry. On the consumer side, government subsidies spurred exponential growth within the Chinese EV market, with sales doubling last year to form over a quarter of all cars sold, signalling that China was well and truly embracing new energy in personal transport.
However, the expiry of the subsidy programme in December last year in an already crowded market, coupled with an uncertain macroeconomic environment, is showing that the world’s largest car market does not have a limitless appetite — in the first quarter of 2023, China’s car sales registered a slump of some 13%.
The price war that has erupted in the Chinese EV market in automakers’ attempts to secure their corners of a limited market could leave few survivors with sufficient economies of scale and the requisite financial firepower to remain intact when the dust eventually settles.
Chinese automakers will also be dealt a wild card in the form of established foreign automakers such as Volkswagen, BMW and Nissan, which are preparing to breach the market with new EV models catered for China — where Tesla is currently the only non-local company in the list of top 10 EV makers by sales.
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EVs still a ‘bright spot’ in Asia
Despite this imminent reshuffling — during which some cards are bound to hit the deck — Asia is set to keep its place as the world’s biggest producer of and market for EVs, EV batteries and EV battery materials, says a report from S&P Global Ratings.
“While the immediate focus is on rising leverage and squeezed margins, the opportunities for the region’s miners, battery firms and carmakers are large,” says S&P credit analyst Claire Yuan.
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She explains that Indonesia is home to much of the natural resources needed for the sector, which is bankrolled by highly supportive Chinese policies and remains the provenance of industry-leading technology from South Korea, China and Japan.
She cautions that a batch of Asian firms threatens to eclipse entrenched players, particularly in China, which has a larger EV market than the rest of the world combined. In 2022, the country generated over 60% of global EV sales. “Supportive government policies, a well-established supply chain and widely available charging infrastructure have established China as the clear EV frontrunner,” says Yuan.
Following the removal of government subsidies at the end of last year, she expects the country’s EV sales to rise by 15%–25% between 2023 and 2024, down from its growth of 96% in 2022. Yuan notes that the slower momentum reflects an already high EV penetration rate, which climbed to about 30% from about 5% in 2020.
Across the entire light vehicle industry, Morningstar equities analyst Vincent Sun expects auto sales will stay muted for the rest of 2023 after light vehicle demand in China increased for the second consecutive year in 2022.
“The government’s release of vehicle purchase tax cut in May last year boosted demand for the rest of the year, leading to a large positive swing in the June to September sales volume and a 5% increase for all of 2022,” he explains in a recent webinar.
Given that there is less government stimulus in the market in 2023 compared with previous years, in conjunction with the outlook of “lukewarm consumer sentiment”, Sun expects demand in China for light vehicles to record a decline of 2%–6%, assuming purchase tax incentives are not extended.
However, he believes that the sale of new energy vehicles (NEVs) — a category designated by the Chinese government for all plug-in vehicles — should remain a “bright spot” within the sector, with increasing consumer adoption and improving range keeping growth positive.
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“While the monetary subsidy for NEVs has expired, purchase tax incentives for NEVs are extended this year,” he adds. “We expect demand for NEVs to remain strong with sales increasing by 25%–30% y-o-y.”
Although he expects the profitability of most automakers to remain under pressure in 1Q2023, Sun says that EV makers are set to benefit from declining battery costs. “With the prices of battery raw materials coming down, we think this might translate to some positive impact on the margins starting from the second quarter of 2023, especially for the second half of this year.”
DBS Group Research analyst Rachel Miu adds that the decreasing input cost of battery-related raw materials, which are falling “steeper and faster than expected” year-to-date (YTD), will provide a “breather” for Chinese automakers.
“The good news is prices for battery raw material such as lithium carbonate has plunged by 62% YTD to around RMB205,000 [$39,310] per tonne. The cobalt price has declined 16% YTD and 52% from its recent peak. The improving product cost should relieve the EV makers, and we anticipate the impact to be more meaningful in 2H2023,” says Miu.
Winners and losers
S&P’s Yuan says that the emergence of EVs will prompt dozens of companies in Asia to raise substantial capital — automakers could raise as much as US$28 billion ($37 billion) this year through the issuance of green bonds to pay for the development of EVs, according to Bloomberg Intelligence.
However, she cautions that heavy investment into EVs will push up leverage and strain credit metrics for some of these entities. “New projects will come with significant execution risk. Some firms will thrive, and some will get left behind.”
To understand how this will play out, Yuan is considering likely winners and losers in Asia as the EV industry emerges. “In the broadest strokes, Chinese companies are the frontrunners in the global EV race, Korean firms are catching up, and Japanese entities are trailing,” says Yuan.
She sees BYD and Tesla as the likely remaining leaders in China over the next two years. Their competitiveness stems from “robust cost controls” built on large sales volume and vertical integration.
She notes that Tesla will most easily manage margin strains as the cost leader, even when growth slows. The American automaker’s price cuts in China have also “weighed heavily” on local automakers, as companies with brands within similar price ranges to Tesla’s Models 3 and Y are forced to follow suit. “Loss-making EV start-ups with heavy investment are burning cash quickly amid intensifying competition. This makes industry consolidation likely in the next few years.”
Among top-rated carmakers, Zhejiang Geely and its core subsidiary, Geely Automobile Holdings, are moving fast into EVs. Although the transition has hit their margins and leverage in the past year, S&P’s current base case assumes “improving financials”.
On the other hand, Dongfeng Motor Group’s sales volumes have been dropping faster than its industry peers. Its joint venture (JV) brands have been slow to adopt electrification and continue to lose share to EVs. With the rising EV penetration of its proprietary brands, Yuan says this will keep its ebitda margin under pressure in 2023.
Having greater success with their JVs are Beijing Automotive Group and China FAW Group, which the S&P analyst notes are “accelerating” their EV initiatives with partners Mercedes Benz and Volkswagen, respectively. Still, she believes their EV progress will be “gradual”, which will likely help to protect margins over the next two years.
Meanwhile, Sun of Morningstar likes pure EV maker Nio, which is listed on the exchanges of New York, Hong Kong and Singapore. Sun likes Nio for its premium branding, as well as a steady product pipeline that includes the ES7 sports utility vehicle and the ET5 sedan. Sun rates this stock as four stars, with a fair value estimate of US$15.50.
He forecasts the Morningstar four-star-rated company’s net loss to narrow this year and achieve “breakeven levels” in 2025. “We expect vehicle margins to remain under pressure in the first quarter, but we believe it will stage a sequential recovery in the second half of the year on a better product mix,” he says.
Sun adds that he is also positive about BYD for its diversified model portfolio and strong plug-in hybrid technology. “While we see intensifying pricing pressure in China’s mass and entry-level premium NEV segment, premium brands have held up well in price competition,” he adds.
Similarly, Miu of DBS prefers BYD for its strong product pipeline to support growth, demonstrated by its strong 1QFY23 vehicle sales and solid market position. BYD’s sales growth of 80% in 1QFY2023 put it well ahead of the industry average of 23%, while Tesla was only slightly higher at 26%.
She also likes Minth due to its rising exposure to the EV segment in terms of revenue contribution and new contracts. Minth’s NEV-related revenue posted a CAGR of 90% from FY2018 to FY2022 and accounted for some 27% of total revenue in FY2022, up from 3% in FY2018. Its NEV-related new business intake accounted for around 78% of the total in FY2022, supporting its future growth, says Miu.
The analyst has kept her “buy” rating and target prices of HK$395 ($67) and HK$30 for BYD and Minth, respectively.
