Competition for Tesla in China is fierce - the USA is next

In terms of the uptake of electric vehicles, China is well ahead of the US. That has a two-pronged effect on Chinese EV manufacturers. Compared to US EV manufacturers, their products have a considerably broader market, but the competition is much fiercer.

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The Chinese EV market has grown for years, but it is now oversupplied. The current situation of the Chinese EV market provides American investors with a glimpse into potential future events in the U.S. and how those developments may affect Tesla TSLA +0.19%. (ticker: TSLA).

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In 2022, China produced nearly 4.7 million all-electric vehicles, an increase from about 2.6 million in 2021. Almost 17% of all cars produced in the nation are battery-electric, up from 10% a year earlier.

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The battery-electric car market in the US is far less than that in China. In the United States, 810,000 all-battery electric vehicles were sold in 2022, up from 488,000 in 2021. Around 6% of all light-vehicle sales in the U.S. last year were battery-electric vehicles.

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Yet, Tesla hasn't suffered domestically from a smaller U.S. market. In 2022, Elon Musk's electric vehicle business controlled over 65% of the market.

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China is a unique case. There are a large number of EV vehicles available at various pricing points. Over 440,000 electric vehicles were sold by Tesla in China last year, accounting for 10% of the market.

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The EV market in China is still expanding right now, albeit more slowly. In the first two months of the year, battery-EV sales increased by around 6%. That's a challenge for EV manufacturers. They have too much capacity, and sluggish sales have forced many businesses to lower their prices.

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Tesla reduced its costs in China in January. Others adopted. Early this week, Volkswagen (VOW3.Germany) reduced the cost of its electric vehicles in China.

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Chinese auto analysts are also sounding more like traditional auto analysts, who consider GM and other automakers' pricing, inventories, and production levels (GM).

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In a recent research study, Citi analyst Jeff Chung stated, "We estimate simultaneous ICE and NEV inventory destocking of mid- and low-end priced products might represent a potential margin shock for all auto manufacturers." He thinks that in order to reduce an inventory surplus, auto manufacturers must slash both output and pricing. NEV is short for new energy vehicles; ICE (internal combustion engine).

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That certainly doesn't bode well for Tesla. It will undoubtedly have an effect. Wall Street's 2023 earnings projections have decreased from approximately $5.50 per share to nearly $4 per share since Tesla's January pricing decreases.

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But, there is a bright side. Discounting and market turbulence appear to be working in lower-cost producers' favor.

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According to Wedbush analyst Dan Ives, "the fight is an MMA [mixed martial arts] bout between BYD, Tesla, Nio, XPeng, and others for EV market share in China. This market is difficult for companies like Xpeng that cannot scale quickly because of a price war.”

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The battery-EV market share of Tesla and BYD (1211.Hong Kong) has increased recently, averaging close to 45%, from roughly 30% over the same period last year.

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In 2023, NIO (NIO), XPeng (XPEV), and Li Auto (LI) collectively hold less than 10% of the market, compared to about 11% a year earlier. NIO, XPeng, and Li have not yet achieved sustained profitability. Tesla and BYD are.

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The EV wheat and EV chaff are being separated by the Chinese market shakeout.

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As EV capacity increases and EV models proliferate in the United States, U.S. auto investors will have to contend with the Chinese dynamic. In 2019, less than 20 all-electric automobile models were offered for sale in the United States. In 2022, there were more than 40. In 2023, more will start to appear, including Tesla's Cybertruck.

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In the United States, Tesla's market share will decline, but if China's experience is any indication, Tesla will prosper as long as it can build EVs at a reasonable price.

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Tesla is currently a cost leader. In 2022, it had an operating profit margin of close to 17%. Ford Motor (F) and General Motors (GM) both reported operating profit margins of roughly 7% and 9%, respectively.

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In Friday's premarket trade, Tesla is up 0.2%. Futures for the Nasdaq CompositeCOMP +0.31% and S&P 500SPX -0.19% are down 0.4% and 0.1%, respectively.