VOLKSWAGEN´S OTHER PROBLEM IS MADE IN CHINA / THE WALL STREET JOURNAL

Volkswagen’s Other Problem Is Made in China

Volkswagen’s regulatory problems are compounded by a downturn in its biggest market

By Abheek Bhattacharya 

 A Shanghai Volkswagen dealership branch in Beijing, August 2015. Falling sales in the world’s largest auto market will likely add to Volkswagen’s woes. Photo: European Pressphoto Agency


Volkswagen VLKAY -7.67 % ’s emissions scandal would be bad news in any given year. But shareholders have it worse now because they no longer have the consolation of runaway growth in the car maker’s biggest market—China.

At least the allegation that Volkswagen cheated on U.S. emissions tests of its diesel-powered cars isn’t likely to directly spread to China. The company barely sells any diesel cars there. And its two joint ventures in China, both with state-run firms, can probably bear the costs of the potential hit to the brand.

Rather, what Volkswagen is finding hard to bear is China’s slowdown. The company sold 3.9% fewer cars in China during the first half of 2015 than a year ago, probably the first time that number has declined in a decade.

 As China’s largest car seller, Volkswagen can’t buck the broader downturn. It also doesn’t help itself by offering few sport-utility vehicles models, the only Chinese car segment still reliably growing. Volkswagen’s market share dipped to 18.1% between January and August from 18.9% in 2014, according to data from LMC Automotive.

The bigger worry is profits. Chinese demand for cars during the good years was so much higher than supply that Volkswagen used to sell its ubiquitous Passat sedan at a price that was 15% higher than in the U.S., after adjusting for taxes. Its Audi NSU -3.77 % brand’s Q7 SUV commanded more than a 50% premium in China to the U.S., Sanford C. Bernstein’s Max Warburton calculated in a 2014 report.

No wonder China contributed 65% of Volkswagen’s net profit in 2014. It accounted for 50% at BMW, BMW -3.28 % says Mr. Warburton.

Such supernormal prices had to fall as car makers ramped up supply—too much, it turns out.

This April, Volkswagen JVs announced price cuts or offered buyers extra incentives. The operating margin at its Chinese JVs dropped to around 14% in the June quarter from 19% a year before.

These margins have further room to fall, and not just because of poor sales. Dealer discounts were rising even after the sticker-price cuts or incentives in April, according to Macquarie data, suggesting more is needed. And Volkswagen is still expanding supply, having inaugurated a new factory in southern China in May.

The operating margin at the China JVs sometimes clocked below 5% last decade, according to Morgan Stanley. That should give investors at least a rough sense of how low profits could go.

It’s bad enough that Volkswagen is now the auto industry’s poster child for malfeasance. What will hurt, too, is that Volkswagen is also the poster child of how China single-handedly boosted earnings at global auto makers—and perhaps for how China can now drive those earnings down.