Chinese Automakers Pledge 60-Day Payment Terms: A Make-or-Break Test for Cash Flow?

Regarding the next Evergrande issue in the automotive sector, Dolphin Research provides a detailed analysis of the accounts payable issues in the automotive supply chain through the article "BYD: Will It Become the Next Evergrande?" and points out:

Companies like $BYD(002594.SZ) requires maintaining stringent high sales volumes, whether through supply chain financing or vertical integration of heavy asset operations. Once fierce competition in the automotive industry leads to stagnant sales, even strong supply chain finance could fail, severely impacting the financial statements of car companies and potentially triggering systemic risks of capital breakdown in the upstream supply chain.

However, shortly after Dolphin Research completed this analysis, the situation changed after a meeting of car companies: Starting from the evening of June 10, within just one day, over 15 car companies announced they would shorten their supply chain payment terms to 60 days, aligning with the global industry average (45-60 days). Now, almost all car companies have stated that their payment terms will be shortened to 60 days.

However, among the automotive companies we examined, only Tesla meets the 60-day payment term standard in 2024. Chinese car companies have an average accounts payable cycle of 5-6 months (BYD nearly 7 months, Haima/BAIC BluePark reaching 8-9 months).

If the 60-day payment cycle is enforced immediately, the cash flow of car companies will deteriorate sharply. Those with the longest turnover days and insufficient cash reserves will directly face a crisis.

So the question arises: How significant is the impact of strictly enforcing the 60-day payment term on each company? Which car companies are running naked? What are the potential impacts on capital market investments behind possible coping strategies? Dolphin Research will further investigate these issues in this article.

Let's get straight to the point:

1. If strictly adhered to, what is the impact of the 60-day payment term on car companies, and how can they respond?

Under the most conservative assumption, a. Companies do not manipulate anything, and the 60-day payment term is strictly enforced; b. Not only are future accounts payable cycles changed to 60 days, but past accounts payable cycles are also uniformly cleared to 60 days; c. The 60-day accounts payable cycle applies to all suppliers (not just small and medium-sized suppliers);

In this way, Dolphin Research adjusts the accounts payable turnover days of each company for 2024 and the first quarter of 2025 to a uniform 60 days, and can calculate:

a. The amount each company can occupy under the 60-day accounts payable turnover days;

b. Then use the actual accounts payable amount on the company's current financial statements to subtract the payable amount under the 60-day cycle, and the difference is the amount each car company needs to repay to suppliers after changing to a 60-day accounts payable term. Dolphin Research temporarily calls this difference the "payable gap."

c. Theoretically, this payable gap should first be filled by the company's cash on hand, to see if the cash on hand (including short-term investments) can fill this payable gap. Cash on hand greater than this payable gap is considered basically safe (cash on hand/payable gap>1).

In reality, Dolphin Research understands that the ability of car companies to offer longer payment terms is essentially due to the significant bargaining power of car companies as integrators in the entire automotive chain. Although they promise a 60-day payment term, there should be other operational spaces, but Dolphin Research does not consider this here and assumes strict adherence to commitments for each company.

Calculated this way, the current payable gap for car companies is:

a. BYD: Nearly 300 billion yuan, in extreme cases requiring a one-time payment of 300 billion to suppliers;

b. SAIC (142 billion), Geely (108.7 billion) follow closely;

c. Other car companies need to make up the accounts payable gap, as shown in the figure below:

2. Do car companies have enough cash flow on hand? How high is the safety margin for car companies?

Directly looking at the data:

1) The safest first tier, with the highest safety margin: Tesla (short payment term + high cash on hand) and Li Auto (abundant operating cash flow), have enough cash on hand to cover the payable gap and can use some cash surplus to cope with daily operations, completely without the need for additional bond or equity financing;

2) Relatively high safety second tier: GAC and BAIC are two state-owned enterprises (SAIC is not included in the second tier due to high interest-bearing debt ratio and less net cash), because the accounts payable days are not excessively extended (below the industry average).

These two have cash that is 2-3 times the payable gap, and have enough funds to bear the shortening of the payment term. This reflects the relatively stable expansion of these two state-owned enterprises (without excessive reliance on supply chain financing), with relatively sufficient cash flow on hand.

3) Red line warning type: Leapmotor, Nio, Jiangling, Changan, Seres are also on the edge of danger, although cash can make up for the gap caused by the shortening of the payment term. But the actual normal operation of the company itself requires a certain cash turnover, theoretically also needing to raise funds.

4) Dangerous companies: Strict enforcement is likely to require immediate external financing. Ranked by cash gap from high to low are BYD, Geely, Great Wall, FAW, JAC, BAIC BluePark, and Dongfeng. Direct cash is not enough to repay, requiring immediate external financing.

Therefore, it can be seen that in the most extreme negative situation of policy enforcement, only Tesla and Li Auto, two car companies with extremely safe cash flow, and GAC and BAIC, two state-owned enterprises with relatively high safety levels, can avoid the negative impact of the most extreme policy situation. Other car companies, whether state-owned or private, will face a cash flow crisis and need external financing to fill the cash flow gap.

Continuing to deduce under this strict situation, it can be foreseen:

① High cash flow gap, low safety margin (measured by cash/accounts payable gap and net cash/accounts payable gap ratio excluding interest-bearing debt);

② The proportion of interest-bearing debt to total assets is already high, refinancing (whether issuing shares or bonds) is very difficult, and financing costs are higher.

③ Private enterprises find it more difficult to borrow compared to state-owned enterprises;

Car companies that simultaneously fall into these three categories may be the players with the highest refinancing risk in extreme negative situations. Dolphin Research scores using four indicators (see figure below: each of the four indicators is given a 25% weight, and the final score is sorted from low to high according to the weighted total value), the car companies with the highest risk are: Nio, Geely, Great Wall, and BYD.

In addition, although BAIC BluePark also scores low, since BAIC BluePark is a state-owned enterprise, short-term risks are basically controllable.

3. Why are car companies shortening payment terms?

The average accounts payable cycle of 6 months in the Chinese automotive industry implies that car companies heavily occupy upstream supply chain funds, and with the smart turning point not yet reached and electrification innovation nearing its end, the actual barriers of car companies are not high, and the industry is highly competitive. In this situation, "price war" is a very effective tool, especially for the necessary price range.

But under the constant impact of price wars, car companies not only suffer from their profit margins (2024 car companies' net profit margin <10%, and many car companies are still facing huge losses), but also transfer cash flow pressure to upstream automotive supply chain manufacturers with weaker bargaining power, especially since car parts themselves are quite numerous and scattered, so except for upstream industries with high value and relatively high barriers (such as battery leader CATL), other especially small and medium-sized parts manufacturers are in an weak position relative to car companies, and can only passively accept the "annual price reduction + extended payment term" double pressure.

In other words, most car companies currently have the characteristics of "one loss, two highs": a. Continuous losses; b. High operating liabilities; c. Some also have high-interest-bearing liabilities.

If the price war continues, those car companies that fully occupy "one loss, two highs" will face "capacity clearance," and the clearance process will simultaneously trigger bad debts in the upstream supply chain. In other words, the current chaotic price war in the Chinese automotive industry has evolved into a comprehensive, deep war involving the upstream and downstream industrial chains.

The official attitude has shifted from initial calls to what seems like verbal guidance this time, emphasizing price war control to prevent systemic risks in the automotive supply chain, thereby protecting the upstream supply chain. Otherwise, it is easy to see major car companies bomb, leading to industrial chain collapse, especially the dangerous line companies listed by Dolphin Research above: BYD, Geely, Great Wall, Nio, all are giants in the car industry.

If the policy strictly limits the upstream accounts payable turnover days, it will naturally and indirectly limit:

① Unordered capacity expansion using supply chain leverage: Car companies previously heavily utilized upstream supplier funds (while still facing losses) to continue capital investment, leveraging supply chain leverage for rapid capacity expansion. However, the automotive industry is already severely overcapacity, and limiting the use of supply chain leverage can somewhat restrict unordered capacity expansion behavior.

② Suppress industry price wars: The government compresses car companies' accounts payable terms, high-term car companies' cash gaps increase sharply, cash flow on hand will be quickly consumed, leading to reduced funds for price cuts, thereby cooling down the price war.

At the very least, curb the price war fought by car companies relying on upstream funds; if companies still want to fight a price war, they can only rely on their own resources, and using their own money to fight the war will naturally more cautious.

But Dolphin Research expects that this regulation of the automotive industry will be more inclined to a "soft landing" approach, likely adopting a method of industry self-discipline first, then gradually incorporating financial regulation, while not clearing past payment terms, but more controlling new accounts payable terms.
Otherwise, if the 60-day payment term is strictly enforced this time, clearing past terms together, the players who can safely withstand the policy "hard landing" are only Tesla, Li Auto, and state-owned enterprises BAIC and GAC. (PS: Refer to the real estate 2020 "three red lines" pilot, 2021 industry-wide hard coverage)

Other car companies facing a "hard landing" situation can only trigger a new wave of automotive industry financing, most likely using the original interest-free debt belonging to the upstream supply chain to replace it with bank "interest-bearing loans," or equity financing.

But the risk is once again transferred from the upstream supply chain to banks (bank loans) or investors (issuing corporate bonds or increasing shares for financing), and may lead to accelerated industry mergers and acquisitions, not excluding the possibility of chain collapse similar to real estate "three red lines" control, which contradicts the policy's original intention to strictly control upstream industrial chain risks and limit unordered capacity expansion and endless price wars by car companies.

In summary, the policy forces the automotive industry to return to competition based on "product strength" by cutting off the cycle of "car companies heavily relying on payment term financing - using supply chain leverage for unordered capacity expansion and price wars."

4. Will the investment logic for car companies change?

From a short-term investment logic perspective, although Dolphin Research expects the policy will not adopt a "hard landing" approach this time, car companies still have room for transition and regulation in the short term. Dolphin Research believes the policy's fundamental purpose of preventing systemic risks in the automotive supply chain will not change, so the hard requirement to control supply chain payment terms is expected to be a high-probability event, but car companies will be given a buffer transition period, and will not be required to quickly clear past old debts.

In the industry observed by Dolphin Research, under the current background of abundant capacity in China, such supply-side policies aimed at limiting price wars are not uncommon.

Supply-side restrictions, for industry players with relatively rigid terminal demand, short-term price war slowdown, and price recovery, do not affect terminal demand, and are a valuation recovery for most players in the industry. But in the long term, for companies with a logic of market share improvement, the long-term imagination space, or the growth space of valuation, is suppressed.

But cars are not necessities; they are typically optional, large, electrical consumption items, and car companies have strong, heavy asset attributes, with strong demands for cash flow, so short-term is not a universally beneficial logic:

1. But in the short-term investment logic (may be relatively negative for long-term car companies, but beneficial for upstream suppliers):

① BYD's investment logic may face impact: In "BYD: Will It Become the Next Evergrande?", Dolphin Research has emphasized that BYD is highly dependent on supply chain financing + its vertical integration degree is the highest, with the highest requirements for high sales growth, and the effect of the new wave of product cycle initiated by the "Intelligent Driving Equality" strategy in 2025 is average:

a. The demand for high-speed NOA from necessary users is not high;

b. Geely directly targets BYD's popular models for "close combat";

c. XPeng Mona successfully creates a hit through excellent product definition (user-oriented thinking) + upgraded marketing tactics + high-level city NOA sinking to the 100,000-150,000 yuan price range;

d. Leapmotor B series also plays cards against BYD.

Behind these competitions, to some extent, exposes the problems brought by BYD's engineering thinking rather than user-oriented thinking, + marketing shortcomings.

Originally, Dolphin Research believed that BYD's short-term worry-free logic was that even if users' demand for high-speed NOA was insufficient, cost-effectiveness in the necessary price range was still a "big weapon" (although the moat of cost-effectiveness is constantly being eroded), BYD's high gross profit margin + high overseas growth (higher gross profit for overseas models, can support domestic through overseas) advantage can provide enough cash flow and gross profit safety cushion to continue fighting the price war, and the possibility of peers continuing to follow is relatively limited (such as Geely).

Dolphin Research expects that although this regulation will give car companies a buffer transition period, the regulation of supplier payment terms will gradually become stricter, and the behavior of launching large-scale price wars in the industry will be strongly controlled (especially car companies that heavily use supply chain leverage to fight price wars), which means that BYD is very likely to find it difficult to continue launching large-scale "price war" this big weapon in the current weak demand, and the pressure to continue climbing sales is very high, this year can only rely on overseas increments (but even if the expectation of 900,000 units is fully met, it still contributes relatively limited to the overall target of 5.5 million units).

And if the policy is strictly implemented under extreme assumptions, BYD, Geely, Great Wall, and Nio will all face refinancing pressure, with Nio being more dangerous, as it currently lacks self-sustaining capability.

② But for upstream suppliers, they may be able to quickly receive payments, and short-term benefits for upstream suppliers:

Upstream suppliers' payment cycle is shortened (no need to pay interest to discount the super-long notes given by car companies), receive cash payments in advance, discount costs decrease, and cash flow and profit statements will further improve.

③ Li Auto and Tesla are the least affected by the policy, whether hard landing or soft landing, currently appear to be the safest.

2. In the long-term logic, the core of industry competition will shift from "payment term financing ability" to the dimension of car companies themselves:

From a long-term logic perspective, the policy also forces car companies to shift from "highly relying on operating leverage to drive growth" to "driving competition through self-sustaining capability": the mode, car companies' competition will also shift from relying on operating leverage to launch unordered price wars and capacity expansion, to more compliant car companies relying on self-sustaining capability to launch orderly and controllable price wars.

And car companies' competition will also shift more towards internal strength players (relying on self-profitability):

a. Product definition ability (gradually shifting from engineering thinking to user-oriented thinking);

b. Lean management efficiency (single vehicle cost control, cost control ability);

c. Technological moat (the intelligent driving turning point is not far away) direction shift.

References to past articles by Longbridge Dolphin:

"BYD: Will It Become the Next Evergrande?"