Where Does Subaru Stand in China?

Subaru's limited presence in China compared to other Japanese automakers has proved to be a mixed blessing. The automotive division of Fuji Heavy Industries (FUJHY 2.08%) has avoided some of the extreme repercussions and sales losses that have hit Toyota (TM -2.57%) and Honda (HMC -2.06%) hard.

Photo credit: Subaru of China.

But does it really help investors if Subaru maintains its cautious stance in China? More importantly, can investors ever hope to see Subaru reap rewards from the huge opportunity in China?

Shattered sales

To understand Subaru's dynamics in China, investors need to realize the present dilemma of all Japanese auto makers in the country. China and Japan are fighting over their respective claims on a group of uninhabited islands in the East China Sea. Widespread violent protests and boycotts of Japanese goods broke out in China in August last year, when the city of Tokyo resolved to purchase these islands from their private Japanese owners.

Japanese automakers suffered a sharp decline in sales, losing billions of dollars' worth of business. According to a Wall Street Journal report, based on data provided by auto research firm WAYS, Japanese automakers' share of the Chinese market fell from 20.9% in August 2012 to 9.1% in October 2012.

Toyota was gunning for sales of 1 million cars in China  in 2012, but could sell only 840,500 cars . Honda's sales slipped to below 2010 levels.

Subaru also felt a heavy impact; its sales plunged from 57,198 units to 43,459 . But while Subaru's fall was the steepest in percentage terms, it suffered the least slippage in actual lost sales units. Subaru is the only Japanese automaker that does not own a plant on Chinese soil, and it sells only around 50,000 cars in the country. Thus, its overall sales barely budged, and it did not have to cut production. It merely transferred China's quota of cars to other markets like North America, where its cars were highly in demand.

Annual Sales in China

Source: Company financial reports. All sales are for calendar years.

Since then, the situation has improved. Japanese automakers regained a market share of 18.8% by July this year, but the crisis is not yet resolved. Japanese automakers are still facing resistance in fast growing coastal and northeastern markets like Shandong, Zhejiang, and Jiangsu. These provinces were occupied by Japan during the Second World War, and anti-Japanese sentiments still run high here.

Lucky escape

In 2011, Subaru had planned to build a manufacturing plant in China, with annual capacity of 150,000 units . Back then, the company was chasing a sales target of 180,000 cars by 2016 . But the Chinese authorities rejected Subaru's petition to form a joint venture with China's Chery Automobile last year, and the company had to cut its China sales target to 100,000.

At that time, this was a big setback; later, it gave investors cause to rejoice. Subaru would have struggled to build a plant amid anti-Japan sentiments, and there was no chance that it could grow sales by almost four times from the 2012 levels within four short years. More importantly, if the company built the plant but failed to fully utilize its capacity, it could have suffered big losses -- too big for a company of its size.

So, investors can now take heart that Subaru's 2013 sales target in China is a modest but achievable 57,500 , miles away from its erstwhile targets  but a 32% improvement from last year.

Task ahead

No global automaker can afford to ignore China. Though the country books 20 million vehicle sales annually, China still has one of the lowest vehicle ownership rates in the world. Out of every 1,000 Chinese people, only 85 own a car . If we extrapolate the opportunity for China's 1-billion-plus population, the market potential becomes mind-boggling.

Both Toyota and Honda are going for the kill to regain their lost ground in China. Toyota has recently launched the refreshed RAV4, and will introduce the remodelled Vios and Yaris small cars in the fourth quarter. Honda will launch 12 new models here by 2015 , of which five will be exclusively for China.

Subaru management also wants to grow its Chinese business despite the recent challenges. Its Chinese subsidiary, SOC, has formed a joint venture with the country's leading auto dealer group, Pangda Automobile , to consolidate the entire marketing efforts. Earlier, the individual regional agencies carried out this job in a localized manner.

The new joint venture will change many of the company's old practices . Previously, Subaru did not have defined sales targets for monthly, seasonal, or annual sales for all dealerships; SOC will now put these in place. Buyers will start getting purchase incentives, and dealers will get a 50% subsidy for advertisement, investment, and exhibition. The joint venture's operations started on Oct. 1 and investors should keep an eye on the monthly sales numbers to see how the plans are coming through.

I also think that it is inevitable that Subaru will eventually invest in a Chinese facility. How else can it compete with other automakers if it is forever saddled with 25% import taxes? 

Bottom-line

Subaru got lucky in China. Now it needs to get back in the game. The joint venture with Pangda will help the company in meeting its near and mid-term targets. There is a very good chance that the aggressive marketing efforts will push up sales. This can be the first step toward more ambitious future strategies in the country. Subaru is already on a great run in the U.S, so any positive developments in China could be additional catalysts for its stock.