Green subsidy fraud is rampant in China.
To curb heavy pollution, China has spent billions on green-vehicle subsidies—$4.5 billion last year alone—propelling electric and plug-in hybrid auto sales to quadruple in 2015 and soar 60% this year. But Beijing is starting to realize generosity also comes with fraud. The electric-car industry will face a lot of head winds in China next year, especially for market leader BYD, which counts Warren Buffett’s Berkshire Hathaway as one of its backers.
In September, the government fined five auto makers (not BYD) for defrauding it of one billion yuan ($145 million) worth of green-car subsidies. Four auto makers inflated their sales numbers, while one did not make any electric cars.
China plans to tighten the tap next year. The government said last week that while it planned to maintain the “overall 2016-2020 subsidy scheme,” it will raise eligibility requirements, set caps for central and local subsidies, and lower subsidies for electric buses. In addition, subsidies will be settled after vehicle sales are made—with strict auditing procedures—instead of being prepaid.
Subsidy fraud is rampant in China. Morgan Stanley ’s Jack Yeung says more than 90% of hybrid electric vehicles “sold” in Shanghai in the first half of this year never went to a charging station; in other words, they were just sold on paper. Shanghai is one of BYD’s (ticker: 1211.Hong Kong) largest markets, accounting for about 30% of its electric-car sales, and the Shanghai government is already closing its purse strings. In November, sales of the plug-in hybrid sedan Qin dropped 40%, according to local BYD dealers.
BYD HAS SECURED its market leadership position with its flagship hybrid sedan Qin and its hybrid Tang sport-utility vehicle, but the China market is getting crowded. There are now 94 new electric-vehicle models, 50% more than a year ago. State-owned juggernaut SAIC Motor (600104.China) recently launched its own plug-in hybrid SUV eRX5, seen as a close competitor to BYD’s Tang.
Beijing could slash its electric-bus subsidies by as much as 65% next year, seriously denting BYD’s earnings, warns Citi Research’s Paul Gong. While electric buses account for only about 16% of BYD’s total revenue, they’re the company’s most-profitable segment, with about 40% gross profit margin, accounting for over half of BYD’s operating profit. Government subsidies often exceeded half of the buses’ retail price.
Another problem: delayed subsidy payments. Worried about fraud, the government has been slow at making subsidy payments. Citi’s Gong says some subsidies from late 2015 were not collected even as of November 2016. At BYD, the average number of days it takes to collect cash from government subsidies has ballooned to 118 days in 2016, from 86 days in 2014. “The longer it takes, the higher becomes the risk associated with collections,” notes Citi.
Citi says BYD’s “extraordinary high margins” will come down as the government goes from “stimulating” to “reluctant” mode.