The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

By Katrina Hamlin and Ka Sing Chan

HONG KONG, Feb 11 (Reuters Breakingviews) - China's automotive industry might soon embark on much-needed consolidation. Carmakers Dongfeng Motor 0489.HK and Chongqing Changan Auto 000625.SZ may be about to merge. A combined entity could, on paper, replace BYD 002594.SZ, 1211.HK as the country’s largest automaking group by sales. But size alone won’t solve their problems.

In the past couple of days both companies separately issued filings saying their respective controlling shareholders, both government-owned, are planning a restructuring with a fellow state-backed enterprise. If that means the two parent groups are hitching up, it would create a behemoth that sold roughly 5 million vehicles last year. The prospect sent $4 billion Dongfeng’s stock up as much as 86% on Monday.

It's not only scale; it also probably reflects shareholders' hopes that a tie-up would create a leaner machine by cutting costs. But the reality may not be so rosy.

Like other legacy automakers, the two are in a difficult position. Changan’s operating margin fell to a slim 2% for the full year 2024, while Dongfeng was in the red, according to Visible Alpha.

A major problem is the rapid rise in popularity of electric cars. New energy vehicles - meaning both pure EVs and hybrids - accounted for around half of industry sales in the country last year, yet just 21% and 27% of Dongfeng and Changan's total deliveries. As demand for petrol cars continue to shrink at home, both are exporting more, but that leaves them prey to protectionist policies.

Dongfeng has also been hit particularly hard by Chinese consumers shunning foreign brands. Joint ventures with Nissan Motor 7201.T and Honda Motor 7267.T have floundered, with sales falling by more than 40% over five years. Yet such partnerships still account for the vast majority of Dongfeng’s deliveries, and their international counterparts’ varying designs and suppliers would make it tricky to squeeze out synergies. Changan shares some of those woes: deliveries from its JV with Ford Motor F.N dropped by around three quarters between the auto market’s peak in 2017 and last year, per Visible Alpha.

Stalling demand for many of their products is creating another drag: overcapacity. Hong Kong-listed Dongfeng shifted 2 million vehicles in 2023, but has the wherewithal to build closer to 4 million, per its last annual report. Even though Changan's utilisation rate was much better at 87%, a merged company would need to cut back.

Any deal would be closely watched by compatriots like state-owned FAW and Guangzhou Automobile 601238.SS. But bolting two clunkers together won’t make for a smooth ride.

Follow @KatrinaHamlin on X.

CONTEXT NEWS

Chinese automaker Dongfeng Motor Group Company’s controlling shareholder, state-owned Dongfeng Motor Corporation, informed the Hong Kong-listed company that it is planning a restructuring with “other central state-owned enterprise group”, according to a filing on February 10.

Shenzhen-listed Chongqing Changan Auto, which like Dongfeng is a state-owned enterprise, published a similarly worded statement about a restructuring plan by its parent on February 9.

Shares in Dongfeng Motor rose 25% to HK$4.06 by the market's close in Hong Kong on February 10. Shares in Chongqing Changan Auto rose 4.7% to 14.18 yuan.

(Editing by Antony Currie and Ujjaini Dutta)

((For previous columns by the author, Reuters customers can click on HAMLIN/ CHAN/katrina.hamlin@thomsonreuters.com; KaSing.Chan@thomsonreuters.com Reuters Messaging: katrina.hamlin.thomsonreuters.com@reuters.net))