The risks concealed behind the veneer of destocking

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With sales of locally‐made Light Vehicles in July growing by 7.4% year‐on‐year (YoY) – slightly in excess of the 7.2% YoY growth achieved in June – China’s Light Vehicle market appears to be on track. Dig a little bit deeper, however, and the numbers reveal a different story.

Having achieved a YoY growth of 12.7% in H1 2014, the Passenger Vehicle market saw sales of locally‐made models increase by a mere 8.4% on a year ago. This lower YoY growth can be traced back to February 2013, when the sales base for YoY comparison was distorted by the change in timing of the Spring Festival, and even further back to December 2012, when the market went through substantial destocking.

More significantly, the selling rate (Seasonally Adjusted Annual Rate) of Passenger Vehicles reached only 17.4 mn units in July, 1.5 mn units lower than in June and nearly 1 mn units below the average in H1 2014. In the same vein, the lower selling rate in July can be traced back by as much as ten months to September 2013.

On the surface, any concerns might be alleviated to some extent by the changes in inventory levels, which contributed in part to the loss of momentum. According to China’s Automotive Dealer Association, dealer inventories went through a destocking process to reach a level of 1.62 months at the end of July from the 1.69 months recorded a month earlier, marking the end of the consecutive increases that began in March. However, any destocking was sufficiently minor that the latest inventory level still stands above the danger point of 1.5 months. If we compare this to the level reached at the same point last year of 1.46 months, there may be greater cause for concern. The jagged numbers seen at some OEMs might also form part of the story as a footnote to the weakening market. Dongfeng Nissan, which topped the list of domestic manufacturers with the highest inventory index of 2.69 months at the end of July, reported a YoY sales drop of 19% in the month. In turn, GAC Honda saw sales fall in July by 15% YoY, and reported an unusual result with total production volume in the first seven months exceeding the sales volume by half, or around 100,000 units.

In essence, any concerns come as a result of the key driving forces behind the sales momentum seen over the last year, a period in which we believe that the peak in the current cycle, in sales growth terms, has already been reached.

Policy‐wise, car registration quotas, which are widely expected to spread to more cities over the next few years, have provided the impetus behind the panic buying seen in China’s big cities. Passenger Vehicle registrations in Nanjing and Shenzhen surged by over 60% YoY in H1 2014, raising concerns not only over how long this growth level can be sustained, but also over how soon it might lead to the introduction of similar registration quotas in both cities. Vehicle sales in China’s major cities may be lifted in the short term, but the spikes are bound to be followed by a contraction in sales volume in the long run.In economic terms, the government’s mini stimulus measures, along with the central bank’s targeted monetary easing policy, helped boost Q2 GDP growth to 7.5% YoY in Q2 from 7.4% in Q1. The positive impact of such measures, however, appears to be waning already. In July, credit growth weakened markedly after a strong gain in June. Growth in fixed asset investment, industrial production, and retail sales all moderated in July. With the supportive measures extending further, GDP growth is expected to be sustained at a similar level to that seen recently, although in some provinces, weaker economic growth has acted as a drag on new vehicle sales.

Bearing these factors in mind, we believe that the sales result in July is a clear reminder of the downside risk to our current baseline forecast. Although we have not revised our forecast down at this point, we may do so in the next round if the August result fails to recover to the level we anticipate.

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