Authors: Raymond Tsang, Bruno Zhao, Ralf Kalmbach, Helen liu

At a Glance

> Priority actions for carmakers include systematically improving operational efficiency, redefining pricing strategy and mastering online sales.

When SARS hit China in 2003, the epidemic failed to dent the booming automobile industry. Carmakers pushed ahead, building new factories to take advantage of the ongoing transformation occurring within China's economy. The outbreak even ended up spurring demand for cars among some Chinese commuters who didn't want to risk infection by taking public transit. Overall, nearly 2 million cars were sold in 2003, up three-quarters from 2002.

It's too early to predict how or when the coronavirus outbreak of 2020 will resolve itself in China, but it's probably safe to say that the automobile industry won't be powering on as spectacularly as it did almost two decades ago. For starters, COVID-19 has spread more widely than SARS, doing so against a backdrop of economic growth that has already slowed. In addition, years of strong sales growth means that the automobile market is much more mature than it was around the time of SARS; in 2018, there were 183 cars in use per 1,000 adults in China, up from just 9 cars in 2003. The Chinese market has become a major source of sales for the auto industry globally (see Figure 1).

Figure 1: For some global carmakers, China had been expected to account for about one-third of their sales volume in 2020

Demand shocks outweigh supply challenges

The auto industry has certainly faced a short-term supply shock in China. Nearly 7% of China's light vehicle production is in Wuhan, the city in which COVID-19 was first identified. Parts suppliers and original equipment manufacturers (OEMs) in China typically had to suspend work for 10 to 20 days in late January and February as the Lunar New Year holidays were extended in a bid to control the outbreak. The return to work hasn't been straightforward either. Productivity has been hampered by shortages of protective supplies, logistical shortcomings and other factors. Indeed, some OEMs have shifted production to making protective masks.

In spite of this disruption, we think that demand, not supply, will be the chief obstacle to the auto industry in China over the coming weeks and months. If there is no resurgence of the pandemic, production capacity should be back to normal within the first quarter of 2020. Moreover, inventory already within the sales network ought to be enough to cover 30 to 45 days of regular sales.

As sales have declined to a level that is anything but regular, undersupply is unlikely to be an issue. Restrictions imposed during the early stages of the outbreak have already forced consumers to delay car purchases, as shown by the 80% year-over-year sales volume drop in February. That catastrophic month represents a lot of missing revenue. We examined in detail three automotive OEMs with a strong Chinese presence and calculated that their lost revenue in February alone would be about $12 billion to $15 billion; much of this impact—about $10 billion to $12 billion—would cascade down to become lost revenue for their suppliers. The liquidity impact on some suppliers could be significant given the limited room they have to cut fixed costs, and it is likely to take time to ease fully. For instance, the profit hit for suppliers to the three OEMs we analyzed could be about $3 billion in February.

We think sales volumes will shrink over 2020 as a whole; the big question is by how much. In the second and third quarters, pent-up demand will probably support sales, but not in a uniform fashion. Given that wealthier consumers are less likely to have been affected by purchasing power restrictions, the mid- to high-end segment of the market will likely stabilize first. As had happened after SARS, some of these consumers are likely to be buying a car for the first time to avoid public transit and its perceived health risks. Demand for less expensive vehicles is likely to rebound more slowly, though, as lower-paid workers will have been hit harder by unpaid wages, pay freezes and other purchasing power negatives.

In our first (and mildest) scenario for 2020 China car sales, we assume a swift local conclusion to the pandemic in the first quarter and limited impact on purchasing power. This would be possible if authorities were to take timely and effective action to control the virus and then relax restrictions as quickly as possible without jeopardizing public safety. If that were to occur, 2020 passenger vehicle sales might only dip 5% below our preoutbreak expectations.

Our second scenario is more pessimistic, projecting a 10% decline in 2020 sales and a heavy impact on both suppliers and OEMs. It assumes that the pandemic in China continues into the second quarter, requiring the authorities to extend moderate restrictions and causing a moderate hit to purchasing power.

Figure 2: China's car sales could decline by more than 20% in 2020 because of COVID-19

Figure 3: Premium carmakers could see earnings before interest and taxes fall by 20% to 40% in 2020

Over the medium to long term, we think three factors will support demand.

> The easing real estate market means that households will face less pressure to pour all their wealth into property.

Helen Liu
Partner based in Bain's Shanghai office

The authors would like to thank Daisy Lu, Lesley Li and and Ingo Stein for their contributions to this brief.

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