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AlixPartners: China’s auto suppliers most profitable but with challenges ahead

Thanks to the fast recovery of Chinese economy with record production and sales of light vehicles, Chinese auto suppliers nearly doubled their profit margins in 2009, becoming the most profitable of their sector in the world, according to a survey report by the global business advisory firm AlixPartners.

The market survey 2010 China Auto Outlook conducted between January and March this year is based on extensive research of the auto industry in China with in-depth analysis of data gathered from 50 senior executives of both foreign and domestic players in auto supply and OEM circles.  

In the investigation, two-thirds of parts senior executives expressed their concern about the cost increase of raw materials, while over half of them saw increased “cost-down” pressure from OEMs. The majority agreed to take moves to upgrade their technology, which is a high priority requirement of their customers.

Most profitable year in 2009

Despite the global recession in the automotive market in 2009, China experienced strong auto industry growth with production and sales reaching record highs. Chinese OEMs have benefited greatly from the massive demand for cars, and auto parts and components have always been in short supply. The cheap labor forces in China seem to have neutralized to some extent the rising cost of raw materials like steel, copper and rubber. As a result, Chinese parts makers have generally gained profit margins of 8-10 percent, nearly twice the average profitability of global parts suppliers.  

“This profit level in the auto parts industry is about 2 percent higher than the car business profit margin of 6-8 percent in 2009,” said Ivo Naumann, managing director of AlixPartners and head of the firm’s Shanghai office. “China’s auto industry is doing so well today and we expect the market to continue to grow at a healthy rate, an average of 15-20 percent, over the next five years.”

It is widely believed that the profitability of auto suppliers will continue to rise in the future.

The survey says that China’s auto parts industry revenue reached ¥1.14 trillion ($166.91 billion) last year, up 23 percent over 2008. However, Chinese parts exports suffered gravely as well with total revenue of ¥197.2 billion, down 7 percent over the previous year. In fact Chinese parts players have to turn largely to the domestic market for competition.

Meanwhile several major domestic parts suppliers, such as Weichai Power and Wanxiang Group, have emerged as winners, entering the top 100 global suppliers by revenue. According to statistics, Weichai Power is estimated to have achieved net profits of ¥3.1-¥3.7 billion last year, up by 50-100 percent compared with 2008. Wanxiang Group’s revenue reached ¥51.48 billion in 2009, up 13 percent over a year earlier. 

But the efficiency of Chinese enterprises in business operations has been very low, according to the survey. Though they have reduced their cash flow period from 78 days to 70 days, their efficiency is just as half of companies in developed countries like the U.S., EU and Japan. For this they need to improve a lot to accelerate cash flow, which is an important factor in business evaluation.

“The positive profitability momentum is unlikely to be maintained unless parts companies focus more on margin improvement and further tailor their technical know-how to local-market needs,” added Naumann. “Only those that actively manage it will take full advantage of it.”

To him, auto suppliers in China should effectively manage rising cost pressures, upgrade their technology and build their aftermarket capabilities. More significantly, they have to find ways to recruit and retain qualified people in China, a land that has become a very competitive labor market already.

Since the beginning of this year, the rising prices of raw materials have caused much concern among Chinese parts suppliers. The steel price has changed frequently in the first two quarters, and the copper price has rocketed to $8,000 per ton. By now the prices for iron ore have increased by 80 percent.

As tier 2 or tier 3 suppliers, parts makers have to follow these soaring prices on the market. They are weak in combating business risks and will lose more profits once threatened by unexpected price changes. Therefore Chinese parts suppliers are facing greater challenges ahead despite their profitability today.

Mergers and acquisitions to be intensified

With the stimulus package from the government, China’s auto sales rose over 55 percent in 2009. Generally an ordinary family will buy a first car when its income surpasses ¥65,000 a year. Today 16 percent of Chinese families are wealthy enough to buy a car, and there exists huge space of growth before 2013, when wealthy families rise to 27 percent in the country, says the survey.

The auto industry is expected to develop at the rate of 20 percent in the next five years from 2010 to 2015. As domestic demand continues to grow, Chinese OEMs, such as Geely, BYD and SAIC, will be able to gain more market share in the third and fourth tier cities by selling smaller models.

Currently China’s auto industry is the most fragmental among the major world auto markets, says the survey. The top five auto manufacturers in China account for only 50 percent of total sales, while this proportion makes up 65 percent in the United States, 76 percent in Germany and 87 percent in Japan. The low concentration of local OEMs has resulted in very scattered supporting enterprises in the upstream. This calls for accelerating domestic mergers and acquisitions in the country.

A couple of years ago many Chinese OEMs and suppliers wished to expand or upgrade their businesses by purchasing foreign companies. However, such cross-border acquisitions can meet with lots of uncertainties; only a few cases have been successful, notably Geely’s acquisition of Volvo this year. But now more competitive automakers have emerged through mergers and acquisitions at home.

In term of consolidation, a wave of M&A hit domestic parts suppliers last year. In February Weichai Power acquired the French engine maker Moteurs Baudouin at a price of €8 million; and months later Wanxiang Group purchased Global Steering Systems LLC of Connecticut in America and Jingxi Heavy Industries obtained. Also, there were other domestic M&A cases, including the acquisition of Delphi’s braking and suspension business by Jingxi Heavy Industries.

At the same time, however, many Chinese parts suppliers, encouraged by the Chinese government, are seeking chances of business acquisitions in Europe as well as in the United States, according to AlixPartners.

“The huge challenge for the auto-parts sector is technology improvement, which requires recruiting and retaining sufficient qualified people in all areas of the business,” concluded Naumann. “We have witnessed local companies hiring international experts to improve technical know-how, and we expect this trend to increase this year and beyond.”

 

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