China’s economic growth may be slowing, but automobile sales in the country are continuing to surge, shooting up by more than 21 percent in the first quarter, traditionally one of the strongest sales periods. They’re expected to grow by another 15 percent to 18 percent in the second quarter of this year.

Already the largest automobile market in the world, the country now accounts for nearly a quarter of total annual vehicle production globally.

As urbanization continues apace in China, automobiles are quickly becoming the favored mode of transportations for those who can afford them. Growing distances traveled make bicycles impractical and mass transportation is increasingly crowded and uncomfortable.

Given the sheer size of the Chinese market and continued demand growth, most major global automotive manufacturers operate in some capacity in China. Thanks to the government’s encouragement of the industry and domestic-oriented tastes, Chinese automotive manufacturers are reaping the greatest rewards in the growing Chinese market. Sales of domestically made cars are growing faster than total sales and domestic car manufacturers now control more than a third of the Chinese market.

Home Field Advantage

In the early 1990s, Great Wall Motor Company (Hong Kong: 2333) entered the automotive market producing pickup trucks. Since the late 1990s, its Wingle model has become the top seller in China, with a 33 percent market share.

Then in the early 2000s, sport utility vehicles (SUV) became popular in China. Sales were dominated primarily by foreign auto makers operating joint ventures with local companies, but Great Wall has long taken a rather nationalist view of the Chinese auto market. Its chairman, Jianjun Wei, recently said, “One of the responsibilities of Chinese automakers is to vie for market share from foreign car manufacturers. We must challenge them and fight for market share.”

To that end, Great Wall introduced its entry-priced Safe model of SUV in 2002, followed by its higher priced, more luxury oriented Haval in 2005. After several years of aggressive marketing and continued improvements through research and development, the Haval has been the top-ranked domestic SUV for the past three years and holds a 14 percent market share.

The company finally entered the passenger car market in 2007 with the launch of its Great Wall model. Largely thanks to its late entry, annual sales of the Great Wall are currently averaging about 200,000 units, ranking near the bottom of the passenger vehicle market in terms of market share (see bar chart below).



Despite its still small presence in the passenger segment, Great Wall’s vehicle sales shot up by 28 percent year-over-year to hit 620,000 units in 2012. That far surpasses the 4.3 percent overall growth in the market last year. Revenue was also up 43.4 percent from 2011, hitting CNY43.2 billion, while net profit rose by 65.7 percent to CNY5.7 billion.

What has really set Great Wall Motor apart from other Chinese auto manufacturers is its focus on just a handful of core models in its three operating segments. As other Chinese manufacturers have historically run large, multi-brand strategies which essentially end up cannibalizing themselves and eating into profits, Great Wall’s laser-like focus has allowed it to control costs and maximize profits.

Between 2009 and 2012, gross margin has risen from 20.2 percent to 26.9 percent, while profit margin before interest and tax has more than doubled from 7.1 percent to 15.9 percent. Over that same period, expenses have fallen from about 5 percent to just less than 4 percent last year. Inventory turnover has also increased significantly along with sales volume, falling from 43 days in 2009 to 31 days in 2012.

While Great Wall Motor Company’s past performance is impressive, the question is whether or not it can continue on that trajectory, as China’s economy slows. We argue that it can, for three main reasons.

The first is largely political. While foreign luxury brands will always have a place in the market—the Chinese are just as keen on status as any other consumers—growing nationalist sentiment has been pressuring sales of foreign vehicles in the mid and lower price points.

Simmering tensions with South Korea and Japan have put a severe dent in their Chinese sales, as the average Chinese consumer opts for domestic models.

Great Wall also enjoys an advantage in that most of its components, especially its engines and transmissions, are made either by its own subsidiaries or other Chinese manufacturers through preference contracts. As a result, it hasn’t suffered from shortages of critical components which occasionally impact its competitors, especially foreign manufacturers which often import many of their components. It also allows Great Wall to keep a tight lid on its costs, a major reason its expenses have been declining in recent years.

Finally, Great Wall has also done an excellent job of catering to consumers at a variety of price points. From its CNY70,000 passenger sedan to its recently introduced CNY200,000 Haval H8 SUV, it captures both the middle class buyer of family vehicles to more luxury-oriented affluent consumers.

The company invests heavily in research and development, recently committing itself to the goal of selling more SUVs than Jeep within the next few years. To that end, the company is building a huge new research center and increasing its research staff by 40 percent to a total of 10,000 engineers. While that will be a tough goal to achieve given Great Wall’s limited presence in Europe and the US, the ambition alone is extremely encouraging and will be beneficial to sales even if the company falls short.

Great Wall also has a strong presence in other emerging markets, with exports typically accounting for about a fifth of sales and growing by about 12 percent annually. Russia is its top export destination and Iraq is its fastest growing market. High volumes of vehicles are also sent to Australia and sub-Saharan Africa.

Prevailing domestic preference, strong innovation and growing exports make Great Wall Motor Company a buy up to HKD47.

Gas Revolution

All of those vehicles on the road, especially SUVs, are creating huge fuel demand in China. But rather than focus on diesel and gasoline, we’ll shift gears a bit and consider vehicles fueled by natural gas.

There’s been a lot of talk about shifting to compressed natural gas or liquefied natural gas to fuel the automobile fleet in the US, thanks to the glut of natural gas on the market. However, the Chinese have actually made much more significant progress in that arena.

More than a decade ago, the Chinese government set itself the goal of having at least 10 percent of all vehicles using clean energy fuels, primarily natural gas. The country also wants 40 percent to 50 percent of taxis and buses running off natural gas.

As of 2010, the latest year for which complete statistics are available, more than 80 first- and second-tier cities had natural gas refueling stations. Under China’s current Five Year Plan, an additional 1,000 natural gas refueling stations are slated for construction to keep the country’s growing fleet of natural gas vehicles running, with about 150,000 new ones hitting Chinese roads each year.

ENN Energy Holdings (Hong Kong: 2688) is China’s largest clean energy group and one of the leading operators of natural gas refueling stations in the country. Last year, its 330 refueling stations accounted for about 13 percent of its RMB18 billion in revenue, a 42 percent increase in contribution, with most of the remainder coming from sales of piped gas and connections.

ENN has ambitious plans to build another 200 Chinese refueling stations over the next few years. One of the most interesting aspects of ENN is its intention to help America advance its own system of natural gas refueling stations.

While media attention surrounding the deal has been subdued, ENN partnered with Utah-based CH4 energy to roll out 50 natural gas filling stations across the US this year, more than doubling the number currently in existence. Operating under Blu LNG, 5 stations are already in operation and the ultimate goal is to have about 500 stations up and running within the next several years.

ENN has also formed a deal with Westport Innovations (NSDQ: WPRT) to help speed the adoption of natural gas engines in the US.

Fueling China’s natural gas filling station boom and helping spur America’s, ENN Energy Holdings is a buy under HKD52.