Tuesday, 14 September 2010

Micro Level Trends – Chinese Truck Sector – Continued Domestic, Asian & RoW Concentration, with little Export Will to the West

Recent news stories quoting expert consultant opinion, has highlighted the invisible force Chinese truck manufacturers yield in their home territories and neighbouring Asia. An Undoubted fact. But that opinion has also indicated that Chinese truck producers will invariably expand into the US and Europe – sooner rather than later.

This 'line' has become almost prevalent thinking since the automotive under estimation of the Japanese in the 1970s and latterly S.Koreans in the 1990s. But the car and truck worlds imbue very different political, economic, purchaser and user characteristics; and so easy parallels cannot be drawn, especially so today when the growth and export potential no longer lies in the west, which itself already domestically has over-ripe and presently under-utilised demand and capacity, to say nothing of the endemic regulatory and associated technical barriers.

However, whilst it is not envisaged that Chinese branded trucks will enter western markets any time soon, Africa, Russia, CIS states, the Middle East and parts of South America are the undoubted preferred destinations given broader national economic interests of China and its similar levels of lower technological need with RoW markets: allowing DIY servicing and running repair. Thus as seen with much of its broad apparent strategy – at the managerial cost of some European companies in previous flailed JV talks - the ideal has been to fit modern looking bodies to last generation mechanicals at affordable pricing thus offering what on paper appears a compelling proposition to target markets.

However, the fact that European truck manufactures have a comparably large labour content (versus the car) indicates that western manufacturers will be using their Chinese JVs to reduce the cost of their own purchase and assembly costs, possibly use these centres as structural and 'first-fix' assemblers – before shipping chassis units to their homelands – and using such performance benchmarks as indicators for their own domestic assembly targets.

Thus, whilst the Chinese branded truck export attack is hardly imminent, it is worth while viewing a basic 'outline' picture of the Chinese truck sector, and its accordant strategic future, as would be viewed by both domestic and international investors.

The truck and logistics industries are of course viewed as secondary investment indicators – beyond the metric norms - reflecting enthusiastic, flat or dour demand levels of an economy en mass, both at national and global levels. To this extent, the Chinese truck sector depicts the dynamics of the day, and by virtue, presents itself as a prime component of a much broader global macro picture.

Of course, the Chinese truck manufacturers have over the last 20 years experienced an ever upward growth trend as homeland consumers, services and industry underwent radical change under the auspices of quasi-communism, quasi-capitalism; a very 'alternative' mixed market economy sat on the world stage, which in turn required greater macro-policy comprehension and manouvre, and where the micro-policy of industrial manufacture was given increasing free market reign.

This is well understood by all, yet today China's economic world position has grown to that of a disputably 2nd or 3rd economic pillar, behind the US (and Europe), now nudging ahead of Japan. Yet more presciently, as the wealth gap narrowed under the dynamic of the 'Chinese miracle' its competitive advantage narrowed also, more so since the fiscal and economic stalling in the West under necessary fiscal deleveraging. Rising general inflation, the increased cost of capital (in the 'open' capital markets) and the spiraling wage component of input costs created the need for business model modification.

In reaction, following the basics of regional economic theory, mass manufacturers in lower-value businesses found it necessary to either move eastwards into the Chinese interior, aided by local and national government grants, or over the border to low-cost neighbours; with which bi-lateral trade has been of increasing importance.

Along with aspects of divisional re-locational has been parallel structural re-orientation of those industries which demanded ongoing cost-savings at fixed and variable levels, thus demanding improved logistics and haulage methods, containerisation growing in popularity, this partly enabled by the expansive railway network, but more so driven by the rapid rise of the domestic truck industry which offers ever better tailor-made and fuel-efficient products; itself a prime example participant of the aforementioned 'industrial shift'.

As a result of explosive demand over the last 15 years and the resulting reduced margins of hyper-competition, the face of the truck industry has changed immensely, primarily in terms of output and product offering. But it has also had a major ripple effect on national infrastructure along with popularization of the private car. A ripple which was always destined to created a literal traffic wave and ultimately a grid-lock 'flood'. This illustrated by Beijing's infamous 9-day August traffic jam on the Beijing-Tibet Expressway between Beijing and Jining. This near seizure created by a spike in HGV traffic compounded by on-going road-repair.

Ironically this rapid transit slow-down also reflects the policy-thinking of PRC party seniors and acts as a metaphor for the country at large, including ramifications for the truck sector. Having recognised the all too real changed conditions of the global economy, macro policy focus was re-aligned to inwardly charge the domestic economy with re-circulated wealth, instead of relying upon fading export demand.

That state of play has in effect been in motion since Q308, exemplified by the massive $586bn liquidity injection in 2008/9, orchestrated by the National Development and Reform Commission, and largely apportioned between public infrastructure build on road, rail, airport and irrigation, with the rebuild of Sichuan since the devastating earthquake, consisting primarily of official low-cost housing replacing slum quarters.

Read between the lines of snippets from previous policy speeches, recent central bank remarks and initiatives to cool a possible housing bubble, and it is clear that the PRC is itself undergoing a slowing of sorts to both combat internal cost-base rises and their effect on what officials see as the super-charging of the Renminbi valuation vis a vis foreign currency baskets.

Thus it seems a subtly played-out yet 'across the board' re-orientation is taking place, one in which the implicit party line is that only China can be counted upon to maintain its own growth path. And that will require the discomfort of change, both visible on the ground, and invisibly behind the scenes of industrial restructuring. Thus without the foreign-trade impetus as was so readily seen on its Balance of Trade account, China is seemingly set to become a more inward looking, or at least regionally aligned, country. This the case for all the 'soft pressure' that the US and Europe seeks to apply toward unilateral, bi-lateral and global interests.

A large consideration of the 'Chinese miracle' has of course been due to the ability of indigenous industry to scale-up capacity and so lower costs for a consumer hungry population. But perhaps of equal importance has been the expectational boost delivered to consumers through the catalysts of joint-ventures with western firms. Most notable are VW and GM, joined by a host of other manufacturers seeking their Chinese foothold, but less high-profile has been the JV arrangement in the truck sector. Here the largest – typically ex-state -producers have enjoyed foreign relationships that have helped transform their product ranges and operational methods.

A summary of truck sector players follows:

Top 8 heavy truck makers
- Sinotruck, - FAW, - Shaanxi Auto , - Foton , - Beiben, - SAIC Iveco Hongyan (SIH) , - JAC Auto, - Dongfeng,
Top 10 Medium Truck makers
- Dongfeng, - Chengdu Wangpai, - FAW, - Shaanx Auto, - Sichuan Nanjun Auto Co, - Foton, - Qingling Motors , - Hubei Tri-ing SPV Co, - Chengdu Xindadi Auto Co, - JAC Auto

Top 9 Light Truck makers
- Foton, - Dongfeng, - JAC Auto, - Shandong Kama Auto, - FAW, - Great Wall , - Tangjun Ouling Auto, - Shaanxi Auto , - Sichuan Nanjin Auto.

The span of company types, their geographies and product line-ups is intentionally broad, choosing a 3 examples to illustrate the innate strategic diversity between entities that have been born from political orchestration, set within the competitive arena, yet the fortunes of which are still largely directed PRC policy wishes that must balance free-marketeering and the Chinese social good.
Represented are:

1.Politically Driven - The complexity of what is essentially a devolved but still pseudo state-like operation such as CNHTC operating purely in heavy-truck from 'national-asset' origins.
2.Technically Driven - The seeming 'technical synergy & competence' operation of JMC Auto spanning technically inter-related SUV / light-van / medium truck segments, also exploiting foreign best practice via close-coupled foreign partner (not mentioned above but still a listed entity).
3.Marketing Driven - The broad aspirations of JAC Auto offering a full spectrum of vehicles from cars to small, medium and large trucks, seemingly emulating the Mercedes Benz idiom and business model; played-out across diverse international boundaries.

China National Heavy-Duty Truck Group Co Ltd –
Based in the 'truck producing cradle' of Jinan City, Shandong Province, formed from JAW (1935) and offered the first true heavy truck (8 tonne) via HUANGHE brand in 1963. CNHTC presently holds a plethora of sub-company and brands representing parts suppliers, full-assemblers / retailers and special vehicle developers and re-fitters; these split between the primary Jinan and Shandong areas. Moreover, its R&D centre still sits in government hands, whilst its investment interests also include other asset areas such as real estate, property management, import – export, finance, 'vouching'. It holds a Hong Kong registered company since 2004 (titled CNHTC-HKC) to ease foreign trade transactions (via CNHTC-SDIEC : the import - export company) )and capital markets access; and holds an A-stock listed representation entity titled SINOTRUK.
It essentially operates in a matrix-type structure with all sub-holding companies simultaneously 'operationally fed' by a suite of 'back-office' divisions spanning: Strategy, Enterprise, Finance, Budget Planning, Marketing, Technical Development, Quality, HR. Beyond this 2D structure, the 3rd pillar relates to a separate Sales, Import-Export, Finance, Real Estate and the government owned R&D section. This operational structure undoubtedly reflects its historic government roots, but undoubtedly also raises questions of transparency for foreign investors regards the flow of funds between not only different 'front-office' sister divisions, but also directly and indirectly between 'front-office' and 'back-office'.
On the issue of JVs, CNHTC has previously enacted an agreement with Steyr Truck of Austria which appears successful by observation of shared aesthetic and specific systems, but the deal with Volvo Truck of Sweden flailed in 2007, the Volvo aesthetic seemingly appropriated for the HOWO range In early 2009 Germany's MAN bought 25% of SINOTRUK shares listed in HK, this viewed by investment-auto-motives as both a pure remote investment play with the additional positive of greater negotiational leverage relative to additional synergy seeking between SINOTRUK and MAN after the recent Electrical Systems Harness project.
Today CNHTC brands & products presently span HOWO, STEYR-KING, STEYR, HUANGHE Prince, HUNAGHE Commander.

Jiangling Motors Co – (aka JMC Auto).
Based in Jiangxi Province, as with other similar inter-regional peers, it was essentially created in the mid 1980s thanks to the commercial exploitation agreements formed at the time between Japan and China. JMC has maintained a simple business model that sought to fully exploit 'off-the-shelf' Isuzu platforms via long-life use, profitability attained from resultant early capital investment amortisation, aswell as crucially exploiting its ability as a maximiser of technological synergies between close-coupled product lines..
However, as with peers, all 3 product lines - the Boadian pick-up, the BaoWei SUV and Qingka medium truck – to this day show their historic origins given their 'as-set' engineering hardpoints. Even if, as in the case of the Qingka medium truck, the offshoot variant(s) have been developed to visually replicate respected truck lines from the likes of Toyota's Hino and Mitsubishi's Fuso.
The original re-badged vehicles have been given periodic latter-day minimal investment, providing for updated re-bodies and greater levels of lower-cost locally procured parts, whilst balance sheet reserves were used to create a vertically integrated in-house supply/value-chain for high-value completely dressed engine sets, front axles and primary castings (ie engine blocks, cylinder heads, connecting-rods, manifolds, pump housings and other castings). Produced and sold under JMC Parts Ltd, presumably also service the broad Chinese client-base with similar Isuzu beginnings, aswell as servicing after-market needs across primarily China and Africa (which has absorbed much of the Japanese 4x4 and truck grey market).
Hence the strategy has been to a) drive relative differentiation intended to maintain pricing levels, b) simultaneously reduce the input-cost base, and c) create a further income stream / cost-centre.
By 1993 demonstrable profitability led the company to list A-class stock on the Shenzhen Exchange, followed by the offering of B-class stock via ADRs, available to foreign investors; something taken-up by America's Ford Motor Co.
That relationship allowed the establishment of JMC-Ford, in which the Chinese company produces two generations of Ford's Transit van: the '2006' created from older Mk4 & 5 series models and new generation '2010' van based on the European (2006) Mk7 series van. This essentially provides a much needed additional income stream, aswell as providing JMC's own brands with potential to access Ford's 'past-generation' technology base.
This is crucial if JMC is to maintain itself as a credible player in the eyes of both consumers and investors, the choice of Ford obvious given its parallel product lines and breadth of product range from large pick-ups to city-cars, which JMC could 'piggy-back' to broaden its own range.

Jianghuia Automobile Co - (aka JAC Auto)
Established in 1964 with its singular medium size truck plant – heavily dependent on manual labour, updated in the 1970s with semi-automation with the 131 model, and latterly in the 1980s with Japanese influenced 1061 using Korean sourced automated welding jigs. The product line grew in 2000s to include a new heavy truck demanding Japanese sourced heavy press tooling, a new van-derived MPV and new 'SRV' (SUV), both effectively sourced externally even if touted as developed 'in-house', though now touting R&D centres in Japan and Italy aswell as China. {NB though exactly how well equipped with staff, hardware and software is less well known].
Today JMC offers 7 passenger car models (inc MPV & SRV) but mainly centred around small and compact cars [the first completely cChinese producer to win a JD Power quality award in 2009]. It also offers 1 four-door pick-up (styled after GM's Silverado), 1 light truck, 2 medium sized trucks (various bodies), 1 heavy-duty tractor unit (ie Semi-unit), 5 bus chassis (varying dimensions), an SVO section that tailors MPV / SRV / Sedan for emergency services use, and provides contract manufacture of its European developed 2.0L, 2.4L & 2.7L engines.
The exponential broadening of its product range from into various passenger vehicle segments from 2000 onwards demonstrates the opportunism of the firm, targeting high growth trends at home and with the ambition of simultaneously building its truck and car 'empire' in targeted fringe cost-conscious export countries. Thus, with apparent worldwide ambitions JAC has grown a low-key but broad foot-print, entering fringe areas, offering presence in Central America, the lesser territories of South America, Russia and Ukraine, strategic nations of Africa, the Near Middle East, Afghanistan, Bangladesh, Sri Lanka, Vietnam, Malaysia and the Philippines.
What may be contentious is the brand moniker of a 5 pointed star, which together with styling cues on various cars and a similarly named car range heavily reference Mercedes-Benz. In this manner JAC's modus operandi is similar to other 'copy-cat' companies that wish to exploit the power of consumer cognitive association, expecting a positive rub-off effect. China's increasing political/diplomatic ties with such a coterie of such countries, also intimate that Daimler's ability to legally protect the apparent infringement may be questionable.

This trio of separate examples demonstrates just 3 of the many business platforms that China (ie the PRC Communist Party) have created within the Truck Sector. Each represented a core pillar of capability:

1. The might of the state and its ability to marry little changed organisational structures to the exploitation of Hong Kong as a commercial hub
2. The ability to exploit early phase, foreign derived, homogeneous mechanical platforms to, in turn, create a revenue stream which allows for supply-chain integration and supplementary income streams.
3. The ability to rapidly re-orientate a single product-line domestic business into an enterprise modeled on (arguably) 'the best vehicle company in the world', serving to blossom the vehicle range into new segments and new worldwide territories; ostensibly based upon Chinese economic promise.

However, beyond the detail and grand ambitions of the various enterprises themselves, PRC seniors have well recognised the fact that in the short and medium terms, that the west is not the holy grail it was once considered. With Navistar, Daimler, Renault, Volvo, Scania, MAN, VW, Iveco and others fighting for the much constrained capacity demand in the US, Canada, Western Europe and CEE, although the 'corporate cash-constrained' circumstances might seem like a good entry-point, the real world barriers of comprising of everything between cosy fleet-supplier relationships to buoyant manufacturer cash positions to effectively 'value-fight' the Chinese in the short-term to maintain market-share indicates that any Triad region market ambitions will have to wait.

But the Chinese undoubtedly recognise this, and also well recognise the bounty on the domestic and Asian door-step to be harvested, itself acting as the value-generator throughout the region.

Thus whilst CNHTC, JMC, JAC and the many others may well be technologically inferior to the West, may well have only a spattering of truly capable executives, may well be inefficiently organised and may well be operationally hamstrung by PRC diktat, the real-world environment of their business reality – as depicted by their balance sheets and P&L - looks strong indeed.

Since its earliest days in advisory, investment-auto-motives has been stating that Western truck-makers should equally look to the East for developing relatively low-tech, high style model lines suited to RoW markets, aligned to price-sensitive purchase and running-cost expectations and the ability to endure rough-ride road conditions.

[NB the MAN – Sinotruk JV adopted this rational for a RoW HGV as of last month, promising a new sub-brand marque].

Today the likes of MAN's Lion, Daimler's Star and Renault's Diamond finds themselves in a tough global business. They don't roar so loud, or shine so bright. Instead the rational pull for the professional investor looks to be exemplified by the likes of JMC*, as Ford well recognises with its 30% holding and the various domestic and international fund names on the shareholder register.

[NB JAC may well present its H1,2010 results in an amateurish form, simply as a poorly aligned word document, but the numbers of the unaudited accounts appear to tell a happy tale].

In today's re-orientated global business context, the West offers the stability-base of the renowned heavyweight truck corporates which although battered and bruised have undergone necessary re-structuring. From the nominal retail perspective in the triad regions they still own the share of mind, but increasingly it is China which offers investment traction, and the pillar of a compelling investment growth story.

Though investment-auto-motives states advisedly: that pillar must be made increasingly of transparent, (regulatory) strengthened glass, instead of the historic (politically) impermeable stone.

During this week's World Economic Forum in Tianjin, the PRC Premier Wen Jiabao has promised that progress will be made regards the internal consideration of foreign investment - both at capital inflow and corporate activity levels. Whilst no doubt well intentioned, in reality this statement sits at odds to the Chinese impetus for self regard - as also seen in the rumblings of the US Congress regards the Chinese trade relationship.

Ultimately both nations must demonstrate their support for truly free trade to re-balance the global economy, probably via a few high-profile deals and bills, even if the reality of the everyday minutia that makes-up much of trade flow is encumbered by subtle levels of self-interest. In this regard, the truck sector deserves on-going attention.