Why selling cars in China is worse than making them

If you thought Chinese automakers were in trouble, try the companies that sell their cars.

Investors have piled into auto dealerships’ stocks, pushing some up as much as 90% over the last six months on hopes that one way or another, there will be demand. They’re still up as much as 13% since the beginning of February, when the coronavirus crisisreally took hold amidthe usual slow buying period of the Lunar New Year. All thatwithout a footfall in showrooms in a country that’sgone intolockdown.

With theoutbreak wreaking havoc across the autosupply chain, among others, there has beenhopethat Beijing will throw aroundstimulus to get China Inc. through another rough patch.A cratering car market could lead thegovernment to support yet more purchasing incentives and othermeasures directed at consumers. Already,authorities in Foshan in Guangdong province are giving consumers a 2,000 yuan to 5,000 yuan ($286to $715) subsidyper new car bought. Households could start talking about car ownership as a safer option topublic transport or ride-sharing. After weeks of empty streets, signs that traffic is picking up in bigger cities has many believingsales could get a lift.

Beijing can stuff cash into consumers’ pockets but they can't drag them into showrooms. Potential buyerswon’t gointo dealershipsand wraptheir hands arounda leathery steering wheel and engage with fancy gadgets if they don’t know who was touching them before. Yet as they sit at home, they’rein theory a captive audience for sales pitches leading them to dealers’ WeChat showrooms. One advertisement invites shoppers tocheck out cars in the online exhibition hall and “enjoy the new experience." Online sales could boost demand, the thinking goes.

Investors are perhaps reaching for cheery scenarios.Under the hood, the situation at dealerships isfar worse. Earlier this month, theirassociation pleaded with financial regulators to provide funding support due to“extreme liquidity pressure" as they expect sales to fall off a cliff.In a sign of desperation, one of the weaker but large dealerships for luxury brands like BMW AG andJaguar Land Rover Automotive Plctapped its existing bonds Tuesday for just $13 million at 12% for two years.Dealershave good reason to be worried. Theirbusinessesare inherently working-capital intensive. They’re not turning inventory and sales fast enough to generate cash,andaccounts receivable are stretched. Elevated inventoriescontinue to tick up. Manufacturers can’t pay dealers ontime, and dealershaven’t been able to meet sales targets that determine the rebates theyget. Loan-backed sales could start to bite their auto finance arms as a weakening economy crimps consumerincomes.

As for stimulus measures and online showrooms buoyingsales, hopes are thinning.Ultimately, buyers need to walk into a showroom and sign documents, whether or not they can pay some fees through WeChat or other platforms.Even the likes of Alibaba Group Holdings Ltd.have tried their luck at online car sales, and ithasn’t resulted in much. As Jefferies Financial Group Inc. analystsput it, buying a car involves several interactions between buyersand otherparties, including the dealer, and “the offline interaction requirements make online car sales almost impossible in the medium term."Dealershipearnings are primarily driven by new car sales. All else being equal, an increase of 50 basis points in new car sales margins boosts net profit by more than 10%, according to an analysis by HSBC Holdings Plc. Even if dealersmanage to sell the heaps of cars they’re sitting on, big discountserode margins.

Other profit streams aren’t looking so strong, either. Dealers have come to rely on various fees and after-sales servicing for a big portion of their earnings. More than40% of profits, on average, come from fees they chargefor thingslike financing, registrationand pre-delivery inspection. With competition rising, those won’t hold up. If sales are low, demand for servicing will also stagnate.

Even with a helping hand from Beijing, the picture won’tchange anytime soon. More thanthree-quarters of dealerships will struggle to reopen after the coronavirus shutdown, the industry association said, because they’re subject to cumbersome approval processes to get operations up and running again. A lack of employees because of travel restrictions and a shortage of face masksare also weighing on these companies, it said.

China’s auto dealers are trading at an average 8.5 times their one-year forward earnings. For most of these companies, that’s well above their long-term average of 7.1 times.All this is much better than carmakers themselvesare faring.Investors can keep waiting for demand to pick up. Butmisplaced optimism can take this rally only so far.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.