OREANDA-NEWS. November 17, 2015. Fitch Ratings says today that sport utility vehicles (SUVs) will remain the key growth driver for China's passenger vehicle (PV) market, while small-sized and low-emission SUVs in particular may expand their market share further - thanks to strong lower-end consumer demand and the vehicle purchase tax cut effective from October 2015. However, SUV margins may be under pressure due to intensifying competition, and rich margins may start to weaken for automakers with high exposure to SUVs.

Q: What are the Growth Prospects for the SUV Market in China Following Strong Sales over the Last Few Years?

A: Fitch expects the SUV segment to grow further at a robust double-digit rate in 2016, and to continue to outperform China's PV market. Chinese consumers have displayed a growing appetite for SUVs, and there have been intensive product launches by both global and local automakers. However, the rate of growth may start to ease back after a supply-driven boom in 2013-2015.

China's SUV sales volume grew by 48.0% yoy in January-October 2015, while the overall passenger PV market growth slowed to 3.8% from 9.9% in 2014, according to the China Association of Automobile Manufacturers (CAAM).

Fitch believes there is still substantial growth headroom for China's SUV market, as SUVs' penetration remains low compared with other large and geographically diverse countries such as the US, Canada and Russia. SUVs accounted for around 21% of China PV sales volume in 2014 and 29% as of 10M15, compared with over 30% in the US.

Q: What is Behind the Popularity of SUVs in China? How do the SUVs Offered in China Differ from Those in Developed Markets?

A: The rapid expansion of China's SUV market in the last few years has been fuelled by the popularity of urban SUVs. These models are typically developed on sedan platforms, and are smaller, lighter, cheaper and less fuel-consuming than larger-sized off-road SUVs common in developed markets. In particular, compact and small-sized SUVs launched by Chinese indigenous brands have gained substantial traction and have become the fastest-growing SUV segments.

The compact and small-sized SUVs target a typically younger, lower-end customer base that is looking for individual requirements and better cost-performance ratios. These consumers prefer SUVs for their larger space, higher seating position, more attractive designs and more stable performance in various terrains, but this customer base will also be more price-sensitive.

Fitch expects the market shares of smaller, lower-emission SUVs to expand further, because a cut in vehicle purchase tax to 5% from 10% for PVs with engine displacement below 1.6L - effective from October 2015 - will improve the affordability of low-end SUVs, and encourage more Chinese consumers to switch from sedans to SUVs.

The larger space of SUVs caters to the needs of bigger "core families" in China, consisting typically of a couple, their children and four grandparents. Fitch believes demand for larger vehicles like SUVs and MPVs may rise further over the long run if the national application of the new "second-child" policy leads to a larger average family size.

Q: What are the Auto Brands' SUV Strategies? How Would the Competition Landscape Change?

A: Competition will intensify further with the long and crowded SUV pipelines from both indigenous and JV brands. Existing SUV models may strive to maintain market share and new SUV models may have higher failure risks, as consumers now have a wide choice in each product and price category.

Chinese indigenous brands have been allocating more resources to SUVs as they have been losing market share in the sedan market, but most of their SUVs focus on lower-end markets. Some market leaders (eg Great Wall) have moved upward in the product curve by launching higher-specification products, but it may take a long while to improve their brand image and attract higher-end consumers.

The JV mass-market brands, meanwhile, have accelerated the pace of SUV launches in China. Some have added compact and small-sized SUVs to their product lines to compete head-to-head with Chinese local brands, and may offer lower-emission models (with engine size ?1.6L) that are eligible for tax savings.

Luxury brands may attract Chinese consumers with smaller and lower-specification SUVs, and further improve the affordability of their SUVs by increasing the local production ratio. Audi, Cadillac and Maserati, for example, have all announced plans to launch compact SUVs in 2016. They are also likely to launch SUVs with smaller engines and hybrid engines to meet the increasingly stringent environmental requirements in China.

Q: How do the Gross Margins of SUVs Compare with Sedans? Is the Current Gross Margin Sustainable?

A: SUVs have been enjoying wider gross margins than similar-specification sedans in China, thanks to strong consumer demand and a limited selection of models. Some popular JV-brand and Chinese indigenous-brand SUVs have maintained gross margins over 25% and become the key profit drivers for the manufacturers. Fitch believes such wide margins are unsustainable and will diverge across models as competition intensifies. The risks of model failure will also increase, so that some unpopular SUV models could become loss-making due to a lack of economies of scale and low capacity utilisation.

Auto manufacturers with high exposure to SUVs used to enjoy a margin premium, but may face downward margin pressure amid intensifying competition. Some Chinese indigenous brands have streamlined sedans and been relying heavily on SUVs, so that their margins are more vulnerable to potential SUV price wars. Fitch feels that diversified product portfolios, flexible or shared production capacities, and effective cost management, would help to mitigate the margin risks from a more competitive SUV market.