HONG KONG (S&P Global Ratings) Nov. 4, 2020--S&P Global Ratings today said that China's new energy vehicle (NEV) industry is set for more dynamic development in the next decade. Competition will intensify and test automakers' competence following significant central government subsidy cuts in the past two years. This would force car manufacturers to launch more attractive products that could foster and increase demand, leading to better quality growth for the industry over the long run.

The Chinese government now aims to have NEVs accounting for 20% of total auto sales by 2025, a more realistic goal compared with the 25% target set in the draft plan announced last year, considering the decline in sales since 2019. This implies a compounded average growth rate of 30%-40% during 2021-2025, based on the current penetration rate of less than 5% and our assumption of low single-digit growth in total auto sales during the period. The details were unveiled in the New Energy Vehicles Industry Development Plan 2021-2035, which was published by the State Council on Nov. 2.

In our view, the government's ambitious growth plan is supported by strengthening battery technology, wider product offerings, novel purchase modes, and growing infrastructure support for NEVs. Given ongoing improvement in battery performance, original equipment manufacturers (OEMs) are able to produce NEVs with driving range of 500 kilometers (km) to 700km per charge, which can meet consumers' daily commute needs. Innovation in purchase options, such as battery rental or swap plans (buying an NEV without the battery), lowers the initial purchase cost significantly and makes NEVs more affordable. In addition, the government plans to provide fiscal funding support to build public battery charging stations. These factors, together with OEMs' own expansion in battery charging and swapping stations, will gradually make NEVs more convenient to use.

The positive industry development is increasing end consumer acceptance for NEVs. This is reflected in the rapid market share gain by Tesla Inc. in China. Tesla has been among the top two NEV sellers since March this year, five months after it commenced production in China. In the first nine months of the year, sales increased by over 110% at NIO Inc., versus the overall NEV sales drop of 16% in the domestic market. Car deliveries at Xpeng Inc. also rose by over 60% in the first 10 months of the year. These companies are the two leading startup NEV makers that mainly target individual consumers.

Meanwhile, we continue to see healthy demand from business customers. This is based on the government's requirement of having NEVs make up at least 80% of the newly added or replaced buses, taxis, and logistics vehicles (that are for public use) in major provinces and cities from 2021.

With the market entering a new stage post subsidy cuts, we see increasing industry competition. Tesla's good brand image, volume ramp-up, and adoption of lower-cost batteries allowed it to cut prices several times in 2020 for its signature model 3, further sharpening its competitive edge. This, in our opinion, will likely support the company in continuing to gain market share in the next six to 12 months. On the other hand, proprietary brands (excluding startup brands) have been losing share due to weaker product design and functionality.

We anticipate that OEMs in general will incur higher research and development (R&D) costs and capital expenditure in the next few years. These expenses would be toward launching more competitive NEVs in different segments to capture consumer demand and fulfill the government's dual-credit scheme requirement. For example, Beijing Automotive Group Co. Ltd. recently launched ARCFOX, an NEV model targeted at the mid-to-high-end segment, jointly with Magna International Inc.China FAW Group Co. Ltd. also announced an NEV joint venture with Audi that targets the high-end segment. These efforts will enable producers to enhance their competitive strengths over the long term but may come at a slight cost of margins and leverage in the short term.

For lithium-ion battery producers, growth prospects look bright in the mid-to-long term on growing NEV demand. We anticipate these companies will persistently carry out technology upgrades to lower battery costs and increase energy density. Enhanced battery functionality is likely to expedite the whole industry's electrification progress. On the flip side, this may weigh on battery makers' margins over the next couple of years.

We anticipate that Contemporary Amperex Technology Co. Ltd. will maintain its dominant position in China, with 48% market share in the first eight months this year. The company will also gain market share overseas, especially in Europe, as international OEMs speed up NEV model launches while diversifying battery supply. This is underpinned by its cost leadership, good product quality, and ongoing technology innovation. Despite its high R&D and capital spending, the company is likely to remain in a net cash position because its strong operating cash flow is sufficient to cover its capital expenditure needs.

Other battery producers such as Gotion High-tech Co. Ltd. and Farasis Energy (Gan Zhou) Co. Ltd. have penetrated into international auto OEMs' supply chains. Volkswagen (China) Investment Co. Ltd. agreed to acquire a 26% stake in Gotion in May 2020 and Daimler Greater China Investment Co. Ltd. became a shareholder of Farasis Energy in July 2020.

Overall, we expect leading Chinese battery producers to play a more important role in the global supply chain in the next few years, consistent with China's industry development plan.