Structure and Markets

How big a slowdown in China's Heavy Truck Market?

Chinese heavy truck market watchers have been growing progressively gloomier over the past few months, after some initial optimism in 2014 that the erratic recovery evident in 2013 could continue. Recent market data and company announcements help us interpret the nature of the current turning point.

Preliminary data shows October heavy duty sales of no more than 50,000 units, a stark 17% below the same month of 2013, and capping the 15% decline already witnessed in September. This implies that Chinese heavy truck sales, up 20% in 1Q14 and still up 5% in 1H14 are now only just ahead of 2013 on a 10 month ytd basis. This has rung a few alarm bells amongst industry watchers. If we are to judge the truck market solely by percent changes year-on-year, it is likely that there is worse to come – we expect 20%-plus declines in November and December. Recall that standard industry data is factory sales to dealers, and anecdotal evidence of high inventories alongside economic stats showing that small and medium enterprises in China are under particular pressure in the de-celerating economy, suggest little relief.

But how bad is this really? Certainly enough to ensure the market will fall materially below the 774,000 units of 2013, unless we see truly concerted off-loading of inventory from factory to dealers in November and December to clear CN 3 only product,. Such an inventory clear-out became much less likely following a CCTV programme exposing manipulation of emissions documentation. That TV shame convinced the industry that their actions were being carefully scrutinised by officials, and that there would be zero tolerance for registration of CN 3 standard vehicles after January 1st.

Source: CAAM and TIR analytics

A look at seasonally adjusted running rates for the market also provides a different interpretation of recent market performance. Adjusting for normal seasonality suggests that 2014’s market, far from being erratic, has actually been running remarkably steadily throughout the year, in a range consistent with annual sales between 710-750,000. So far as our graphic shows there is little retreat from this running rate. It is the previous 2 years where volatility is most apparent. This was most conspicuous at the end of 2013 when pre-buy effects associated with the expected move to CN 4 caused the market to shoot up to a peak running rate of 1.1m units, back in territory only previously reached during the famous ‘RMB 4 trn boom’ period. With the comparatives from end-2013 so strong, it is inevitable that end 2014 will see some of the biggest year on year market contraction.

2015 Market auspices not positive

If there is no improvement in economic conditions, there is little reason to hope for any short-term relief in heavy truck sales volumes. Inventories remain too high, and with all trucks needing to achieve CN 4 from January prices are RMB20,000 per vehicle higher in that majority of the country where the standard is applicable for the first time. Many users will also regard the additional operating expense and rather slowly improving availability of Adblue a further disincentive. Sales settling at a lower level than recent run-rates would suggest risk of a further large year-over-year contraction in January 2015’s market, but much more modest contraction for the balance of the year.

Changing mood on China Outlook evident in Truck Makers’ 3rd Quarter Reports

The changing mood of market participants has also been evident in global manufacturers’ 3Q14 reports of end-October and early November 2014. In many of these reports, China is just part of a complex overall picture where market geography is critical to current business trends. For the moment North American orders are still booming, while Japan and India are modestly positive. But big negatives are being reported in Latin America where there is a scramble to reduce manned capacity, while Europe suffers from a Euro 6 hangover and softening economy. Russia and China are perhaps the most recent markets to move into negative territory.

Reports do show managements scaling back expectations for China, acknowledging uncertainty, but not yet prepared to concede that trends have turned unremittingly negative. For many non-domestic participants in China’s truck market, too, volume contraction is a setback which may still be neatly offset by gains associated with the upgrading of product and more content opportunity.

Cummins is by far the most active Western company in China medium/heavy truck, with an annual running rate (LTM) of around $1.5bn direct revenue and $2.8bn of joint venture sales. It saw third-quarter revenues in China, including joint ventures up 16% year-over-year, despite industry sales for heavy and medium duty trucks in China declining 10% for the third quarter. Much of this growth however was powered by a near-doubling of shipments of its ISF (3l & 4l capacity) for lighter trucks with partner Foton. The new ISG heavy duty engine (with 10 & 12l capacities) is just starting, also in the Foton JV: CEO Tom Linebarger comments that so far they have been very measured regarding launch volumes, but they see this engine (fitted to the Auman GTL alongside engines from Weichai and Daimler) as contributing to the outlook story in 2015 (at 2Q14 management had indicated they could be up to 80/day by September). The switch to CN 4 has also helped Cummins’ emission equipment sales, as echoed by several other suppliers: Cummins comments that CN4 compliant trucks represented 40% of the total industry production in the third quarter and should exceed 50% in the fourth quarter. Navistar similarly looked forward to positive developments first from the 3l and 5l light truck engines now produced at a new JV plant with JAC in Hefei, and the 7l due to start next year. Cummins has gradually attenuated its earlier optimism on the China truck outlook, and told analysts ‘there's a lot of uncertainty still… the truck market has been kind of fits and starts. Although we knew second (half) was going to be worse than first, there was more up and down than we expected and we just don't know what to expect next year in that regard’.

Volvo is still largely a spectator in the China heavy duty industry pending substantive activity in its JV with Dongfeng, but has a major share of China construction equipment markets through its VCE division, which owns 70% of SDLG Lingong. It noted further deceleration in heavy construction markets (a 30% drop in both deliveries and new orders in 3Q14). We have previously noted construction equipment market trends are strongly directionally aligned with those of Heavy Trucks, if perhaps even more volatile, and to some extent a leading indicator.

China truck did not achieve much prominence in Daimler’s quarterly soundtrack, as Daimler Truck asserted its global leadership by reporting 3Q14 revenue of €8.5bn and a 6.9% truck segment operating income margin - powered by NAFTA and cost reduction. It also referenced uncertainty in the China market related to the ‘repeated postponement’ of CN 4 regulations, and its new expectation that demand would end the year ‘slightly’ down on 2013. As a footnote, it also revealed its JV BFDA (Beijing Foton Daimler Automotive Co) unit sales down 25% (to 18,050) in 3Q14 after surging 13% in 1H14.

Domestic owned truck engine and equipment producers either do not report material 3Q numbers, or where they do (as with supplier of 39% of heavy duty truck engines, and owner of Shaanxi Trucks and equipment companies) provide no commentary. A 77% surge in revenues at Weichai Power in 3Q14 is related to first time consolidation of its controlling minority in forklift truck maker Kion.