China is at the center of the conversation on the global auto sector. As the world's major producer of electric vehicles (EVs),the country is increasingly ensnared in trade tensions that could alter the global production landscape. S&P Global Ratings believes trade policy and rising protectionism is an overhang for the sector.

China-related questions dominated at our latest webcast on the Asia-Pacific auto sector, held May 29, 2024. Investors also asked us about consumer appetite and preferences across the global auto markets. In addition, we discussed outlooks for sales and margins, electrification trends, and the diverse strategies undertaken by producers in this fast-changing market, among other issues.

Those interested in a replay of the event, can register at the link provided at the bottom of this report. Highlights from the discussion follow.

Frequently Asked Questions

Are auto price wars revving up? And with China EV in particular, can producers reach the scale needed to improve margins? Will the industry consolidate?

We expect price competition to stay ferocious in China over the next 12 months or so, due to declining sales of internal combustion engine (ICE) vehicles and a crowded electric vehicle (EV) market.   In the EV space, producers are striving to scale up to take market share and to improve margins. This strategy is complicated by the large number of players and products--some 50 producers are currently offering 90 brands and over 400 models (see "China EV Startups Struggling To Stay Afloat," published on RatingsDirect on May 28, 2024). Most EV producers will likely continue making a loss for the next two years, in our view, due to their small volume, high operating costs, and price competition.

Nonetheless, meaningful industry consolidation is unlikely in the next 12-24 months, in our view. This is because large-scale traditional original equipment manufacturers (OEMs) are still moving into EV, and the resilience of their gasoline vehicles will help to partially mitigate the profit and cashflow pressure and delay the consolidation progress.

In Europe and the U.S., the pricing party is ending.  After two years of very favorable pricing for auto OEMs, supply and demand is normalizing. Nonetheless, we don't expect price wars in these markets because production is tamer. Nor do we think Chinese EVs will seek to spark a price war in Europe; that would trigger protectionism, which might interfere with their diversification strategy. Their products do have cost advantages in the market, however.

Will Europe increase tariffs on Chinese EVs as aggressively as the U.S. has? How painful, or not, would that be for EV producers?

Europe will likely adopt a more refined solution than the U.S to counter against what some officials have described as an unfair cost advantages. China's integrated supply chain gives producers cost advantages. The introduction of high tariffs could hurt the economic interests of some European players that also export from China to Europe.

If trade restrictions did reach prohibitive levels, that could be negative for Chinese producers including SAIC Motors, BYD and Zhejiang Geely, which are among the top Chinese EV exporters to Europe. Not only do sales to Europe provide additional volume growth for these producers, but at higher margins relative to those they are now getting in the domestic market.

To hedge against the risk of higher duties, some Chinese automakers are accelerating the localization of production in Europe. Apart from looking for production sites, companies are also setting up commercial agreements with independent local dealers.

Why is the electrification trend slowing in the U.S. and Europe? Will it continue to ebb?

In our view, a lack of affordable EV models is a key factor for the current slowing trend. While we believe consumers are ready for the shift, at least in Europe, the cost of ownership of EVs remains an issue. EVs in these two markets are generally 20%-30% pricier than equivalent ICE models. Smaller production volume for EVs and a less-developed supply chains in their local markets keep production costs high.

We believe electrification will be an irreversible long-term trend, and it has already attracted billions of dollars of investment globally, thus leaving little room to the development of alternative decarbonizing technologies for the auto industry. Despite bumpy market conditions, we believe that EV penetration remains on the rise globally supported by declining battery costs.

Will falling battery costs repair margin and cash flow pain for the EV players in China?

The decline in battery costs can help to moderate the profitability and cash flow pressure of EV makers in China.

The price of lithium ion battery cells dropped roughly 40% year-over-year in the first four months of the year, and batteries contribute to about 30%-50% of the total cost of EVs.

Accordingly, EV production costs in general can theoretically reduce 10%-20% year on year in the first four months of 2024. That said, it could take three to six months for automakers to digest old battery inventory and fully reflect the cost benefit.

For OEMs with sizable EV sales volumes, we think profitability and free cash flow could gradually improve over the next two years. However, the ongoing price war will add uncertainty to the magnitude of improvement. For those just starting to roll out EV models, profitability and cash flow will likely face meaningful pressure over the next two years.

Will Japanese producers' offerings be resilient given the continued electrification globally? How are Korean auto makers prepared for the ongoing EV transition?

We think the demand for hybrid-electric vehicles will remain strong over the next one to two years. Hybrid models have risen in popularity in the U.S. and Europe, likely because they are more affordable than EVs. They also offer high fuel efficiency without driving range anxiety.

Major Japanese automakers will benefit the most. Toyota Motor Corp. and Honda Motor Co. Ltd. have dominated the hybrid-car market, partly because they developed and produced this product earlier than global peers. Nissan Motor Co. Ltd. will likely benefit much less because of its limited presence in North America and China.

Despite likely solid hybrid demand in coming years, Japanese automakers could fall behind if they fail to catch up with rivals in the EV market. We expect increasing downward pressure on their creditworthiness over the next three to five years as the EV market expands.

For Korean auto OEMs, Hyundai Motor Co. and Kia Corp. stand out among global peers for having solid products across both EV and hybrids. EV accounts for a mid- to high single-digit percentage of HMC-Kia's wholesale fleet, and hybrids for an early teen percentage. With the recent slowdown in EV market growth, the wholesale-volume contribution from hybrids increased quite rapidly. Their drivetrain variety gives the company the flexibility and agility to respond to customer demand shifts.

How do automakers view Southeast Asia as a manufacturing hub and consumption play?

In terms of manufacturing, these countries have advantages including rich mineral resources and low labor costs. Moreover, some of these countries don't want to export their raw resources, but rather develop the entire value chain from raw material extraction and refining to the production of EV batteries and EVs locally.

For example, Indonesia produced about 53% of the world's nickel in 2023, up from about 34% in 2019. But it bans export of nickel ore, which creates an incentive for some automakers seeking long-term resource security to make onshore investments. Major companies including Japan's Mitsubishi Motors Corp., Korea's Hyundai Motors LG Energy Solution Ltd., and China's SAIC Motor Corp. have announced investment in Indonesia.

Policymakers in both Thailand and Indonesia aim to turn their countries into EV production and export bases. Chinese automakers including BYD and Great Wall plan to start local production in the region, in part to get access to local demand.

In our view, Japanese automakers see Southeast Asia as a good production and export hub for other regions like the Middle East and Australia. The region will remain an important manufacturing base for Japanese producers since they have established local supply chains and efficient vehicle production lines there.

In terms of consumption, Southeast Asia is a relatively small market globally.  And in recent years, overall demand in some of the region's countries has been sluggish due to rising interest rates and stricter credit conditions for auto loans. We do nonetheless expect sales will grow by a mid- to high single digit per annum over the next five years.

In terms of EV, demand is rising, mainly in Thailand and Indonesia.  This is mostly driven by affordable EV models supplied by Chinese automakers, as well as local government purchase subsidies and tax credits. However, at this point, we believe that the EV market will increase gradually. This is mainly due to lack of charging infrastructure and lack of government regulation on vehicle emission reduction. Moreover, Japanese automakers, which have a dominant position in the market, are not yet very active in EV production and sales.

To register for a replay of the webcast, click on this link: https://event.on24.com/wcc/r/4594613/DD79E7B0ED71FF2931978AFBFFA62898?partnerref=PostEventComm.

Writing: Cathy Holcombe

Digital design: Evy Cheung

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