Fitch: China Economy, Stocks Bigger Risk for EU Autos Than Yuan

OREANDA-NEWS. China's slowing economy and the recent sharp falls in its stock market are likely to pose a bigger challenge for European carmakers than a moderately weaker yuan, Fitch Ratings says.

We believe that the sudden yuan devaluation of around 4% on Tuesday and Wednesday will not significantly affect European carmakers' sales and earnings in 2015, although it could reduce cash generation. But the recent fall in share prices on China's stock market and a weakening economy have harmed consumer sentiment and wealth. This contributed to a deceleration in new vehicle sales growth rates in China in the past 12 months, including the recent year-on-year sales declines in June and July.

We expect a small negative effect from any devaluation on dividend payments from China. Most Chinese joint ventures have increased dividends in recent years to account for better earnings and free cash flow. A sharp cut in dividend inflows, reported in European groups' funds from operations, or falling values in dividends repatriated to Europe will reduce European manufacturers' cash generation.

However, for profit and loss generation, manufacturers have largely hedged their open positions and this should lower the impact on their earnings in 2015 and potentially 2016. We expect most of the impact to occur below operating profits as earnings from China are typically reported as associate income.

The increasing share of local production should absorb the negative impact of a lower yuan as it will cut expenses in yuan, which will offset the reduction in revenues. Peugeot has a 100% localisation rate and Volkswagen more than 90%. However, premium manufacturers BMW and Daimler still import nearly half of their sales in China and remain more at risk of a yuan devaluation that boosts the price of imported vehicles. Renault and FCA have no material presence in China.

In the longer-term we believe that the growth potential for carmakers in China is intact, due to the rising middle class and the low equipment rate, and that growth will therefore recover to mid-single digit rates in the medium term. Such growth rates will remain healthy and should be viewed against the high volume base, with the total market now above 20 million units sold annually, more than double 2008 numbers.

European manufacturers have flexibility in their ratings and we had already factored in a decline in growth rates in China into our projections and rating cases. The fundamental structure of the Chinese market is a developing market, with high volatility and unpredictability. The financial profiles of German manufacturers, which are the most at risk of a lower contribution from China, are very strong for their ratings. Therefore, we do not expect the deceleration to have a direct and immediate impact on ratings.

Fitch will publish tomorrow an Automotive Dashboard focused on China.