Despite record profits in 2011, General Motors (NYS: GM) is still a work in progress. For investors, the company's strengths -- a low fixed-cost base in the U.S., improving products, and low debt -- have been somewhat overshadowed by its remaining challenges, including its money-losing mess of an operation in Europe and its distressingly large pension liabilities.
But there's no doubt that one of GM's shining success stories has been in China. Over the last decade, the General overcame incredible obstacles to become, through its joint ventures, the largest-selling automaker in the world's biggest auto market.
That's a good story. And it's a story that could get even better, thanks to -- of all things -- the Chinese government.
A big presence in a challenging, but huge, market
To put it mildly, China isn't the easiest place for a global automaker to do business, thanks in large part to its government. Byzantine bureaucracies, rules that heavily favor domestic Chinese companies (starting with the local joint-venture partners required for foreign firms), and slippery intellectual-property protections abound. The obstacles are huge, and the leaps required for an outside firm to actually make money in the Middle Kingdom are daunting.
But GM has managed to transcend all of these obstacles, riding an alliance with local giant SAIC to market-topping success and, increasingly, prominence as an export power as well. GM, via its joint ventures, actually sells more vehicles in China than it does in the U.S. Its profits from its Chinese operations are dwarfed by the money it makes here, but it's still making real money in the region -- between $300 million and $500 million every quarter, roughly.
GM's profits in China are constrained by two big factors. First, it obviously splits earnings with its joint venture partners. That's not likely to change. But the second factor, intense and constantly increasing competitive pressure, could ease up a little bit, thanks to new government rules.
A clampdown on factory-building
The Chinese government has recently been concerned about overcapacity -- put simply, having more car factories than their domestic market can profitably support. There are more than 70 automakers with some sort of presence in China, some of which didn't sell a single vehicle in 2011. More to the point, the market share of the domestic automakers has been falling, while the global giants have gained ground in what has recently been a stagnant market.
That has raised some eyebrows. For the last seven years, foreign automakers were given preferential treatment, as they built new factories. China actively courted investments by the global automakers. Meanwhile, domestic Chinese automakers -- both long-established ones like SAIC and more recent entrants like BYD Auto (OTC: BYDDF.PK), the troubled carmaker backed by Berkshire Hathaway -- had been ramping up their own production in order to meet sharply rising demand.
That demand has tapered off recently, however, particularly at the low end of the market serviced primarily by the domestic Chinese carmakers -- hence the government's change in policy. The incentives it was offering to the global automakers will only apply to factory construction projects that were approved by the government before the end of January. New projects won't receive favorable treatment, and the government may be less likely to approve them at all.
A boon for GM, a bane for others
The doors, in other words, may be closing for foreign automakers. That obviously benefits GM, which will thrive if the market-share status quo is perpetuated -- as will Volkswagen, which trails GM by only a tiny margin. Ford (NYS: F) should also do well; while the Blue Oval has ambitious expansion plans in China, it's likely that its planned projects were far enough along to proceed without trouble.
It's the late arrivals that may have trouble. Tata Motors (NYS: TTM) has been hoping to establish its Jaguar and Land Rover brands in China and is known to have been in talks with local player Chery Automobile about a joint venture -- a venture that may now have trouble getting approval to proceed. And Fuji Heavy Industries, the Japanese parent of Subaru, has run into regulatory obstacles in its attempts to establish a Chinese foothold, in part because of Toyota's (NYS: TM) ownership stake in the firm. Chrysler and French giant Renault are other major names that still lack a manufacturing presence in China and may now be shut out.
For the moment, this looks like a clear win for GM and the other global automakers with an established presence in China. But here's the concern: If the new rules simply preserve the status quo -- a market dominated by global brands rather than Chinese ones -- more changes may be in store. And it's a safe bet that those won't favor GM or the other global giants. GM (and Ford) shareholders should consider keeping a careful eye on this story in coming months.
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At the time this article was published Fool contributor John Rosevear owns shares of Ford and General Motors. You can follow his auto-related musings on Twitter, where he goes by @jrosevear. The Motley Fool owns shares of Ford and Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Ford, Berkshire Hathaway, and General Motors. Motley Fool newsletter services have recommended creating a synthetic long position in Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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