Fitch Ratings (Fitch) today pointed out that in the first half of 2006, the Chinese auto industry's profits and profit margins have all increased substantially, reversing the downward trend in profit margins since 2004. Although still facing many challenges, it is expected that this growth will be maintained during 2006 and will have a positive impact on the credit status of China's automakers.
In the recently released interim report of China’s listed auto companies, what investors are most concerned about is the substantial increase in the overall industry’s profit margin. The increase in profits exceeds the increase in sales revenue, and thus the profit rate is higher than that in the same period of last year. According to the data from the China Association of Automobile Manufacturers, in the first half of 2006, the auto industry’s sales revenue and profit before tax increased by 30.6% and 59.6%, respectively, compared with the same period of last year. The pre-tax profit rate increased to 5.0%, while in the first half of 2005, 4.1%. China Dongfeng Motor Group Co., Ltd. (Rated by 'BBB', with its stable outlook) announced that its net profit in the first half of the year increased from RMB 660 million in the same period last year to RMB 1.1 billion, an increase of 69%. Chongqing Changan Automobile Co., Ltd.’s interim profit increased by 48% year-on-year. Tianjin FAW Xiali Automobile Co., Ltd., the economic car manufacturer of China FAW Group, the largest automobile company in China, has more than tripled its net profit in the first half of this year.
Fitch believes that the increase in profitability is mainly driven by the growth of up to 27% of car sales in the first half of this year, while the demand for the first family car from Chinese consumers with increasing purchasing power has boosted the sales volume. The strong market demand eased the pressure on car prices and kept the car prices relatively stable. According to the data from the National Development and Reform Commission's Price Monitoring Center, the overall vehicle price fell by 2.4% year-on-year to the end of June. At the same time, in terms of costs, the decline in steel prices will help reduce raw material costs. In addition, the appreciation of the renminbi and the increase in local procurement have also contributed to the reduction of costs. In the first half of 2006, Chinese automakers released more new models. As new models generally enjoy higher profit margins than older models, the increase in the proportion of new models also enables automakers to achieve higher profit margins.
Fitch believes that the substantial increase in cash flow from operating activities due to increased profits will help to provide capital for capital expenditures. Capital expenditures, in turn, are a major expense for these rapidly growing auto companies, resulting in a significant increase in profitability. It will improve the credit level of Chinese auto companies. The use of funds generated by the company itself, rather than financing the company's growth through debt, will reduce the deterioration of the company's balance sheet. The increase in profitability also improved the auto company’s debt coverage and liquidity.
Since the aforementioned favorable factors are not expected to change significantly in the second half of 2006, Fitch believes this trend will continue throughout the year. Although overcapacity in the auto industry will still exert pressure on the price of the car, Fitch notes that the inventory level of the auto industry is still healthy and acceptable, and that many auto companies have exceeded their sales plans in the first half of the year to a great extent. There was a risk of a fierce price war like the second half of 2004. Fitch expects that the capacity utilization rate of passenger cars will increase from about 70% at the beginning of this year to 78-80% at the end of 2006.
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