Third-quarter profit for the Korean carmaker fell 47% year-on-year thanks to its chairman's legal troubles, a stronger currency, and labor strife
Has Hyundai Motor lost its groove? That's the question many investors likely are asking after the largest carmaker in South Korea posted its worst quarterly performance in recent years. Citing a summer strike by its labor union and a strong Korean currency, Hyundai reported on Oct. 30 that its net profit plunged 47% year-on-year to $299 million in the third quarter of this year. This was a 27% decline from the previous quarter.
Nobody really was expecting a smashing quarter, but the earnings haircut from Hyundai's chronic labor problem proved to be much more severe than consensus forecasts. Sales slumped a relatively mild 4.3% to $6.2 billion in the July-September period, but the company's operating profit margin plunged to 3.1%, the lowest since the company began reporting quarterly results in 2001. The margin compared with a peak of 10.4% in the first quarter of 2003 and last year's average of 5.1%.
The best that can be said about the just-finished quarter is that the worst seems to be over. The Korean dynamo still remains a surprisingly robust competitor to the big boys such as General Motors (GM), Ford (F), Toyota Motor (TM), and Volkswagen. "I see positive signs ahead," says Yoo Jung Sang, chief investment officer at fund manager PCA Investment Trust Management, which is investing $6.6 billion in Korean bonds and stocks. "The profitability problems of Hyundai appear to have bottomed out."
Hyundai has been coping with a triple whammy of challenges: management upheaval, a stronger won, and a militant labor union. Analysts believe the company has taken steps to mitigate these negative forces. Also, the operating profit plunge is somewhat exaggerated, given the parent results released excluded sales and earnings from overseas joint ventures and wholly owned subsidiaries, which account for about a third of total output.
The biggest shock by far in 2006 was the arrest of Hyundai Chairman Chung Mong Koo in April on charges of political bribery and illegal insider deals related to affiliated group companies he controls. Although Chung was released on bail after two months in jail, his prosecution prompted Hyundai's union to seek more concessions during this year's management-labor negotiations on wages and working conditions (see BusinessWeek.com, 4/27/06, "Where Will Bribe Scandal Steer Hyundai?").
Talks were protracted, and the union went on a strike toward the end of June. A month-long stoppage resulted in a painful loss in production of nearly 94,000 vehicles worth some $1.4 billion. Earlier this month, the Hyundai Motor group, which includes Kia Motors, cut its combined 2006 sales target to 3.85 million vehicles, from 4.1 million, thanks to the labor strife.
The hardest hit by the strike was the domestic market, where high-margin sedans such as the Sonata and Grandeur (known in the U.S. as Azera) and the Santa Fe SUV were already in short supply. The lack of these cars in the showrooms led to a 5.1% fall in the average selling price of Hyundai vehicles at home in the third quarter, versus the previous quarter.
The prosecution of Chung and the labor walkout also came just as the Korean won took flight against key currencies. The Korean currency has appreciated by about 26% against the dollar since the beginning of 2004 and by about 39% against the yen, thereby eroding the price competitiveness of Korean products in export markets.
Profits generated from overseas sales, which represent two-thirds of overall sales, are also reduced by the currency appreciation when translated into the won. "Going forward, the direction of the won will be a crucial factor for the fate of Hyundai," says Cho Yong Jun, auto analyst at Shin Young Securities in Seoul (see BusinessWeek.com, 3/6/06, "The Road Narrows For Hyundai").
Indeed, company execs and analysts agree that Hyundai remains vulnerable to changes in the won's value. Yet, they also point out that the Korean currency is unlikely to strengthen sharply, at least for the next several months, given political uncertainties stemming from North Korea's nuclear test earlier this month and forecasts of a slower growth for the Korean economy next year.
Also, with Chung now back at the helm at least for now, Hyundai Motor watchers expect a turnaround of the Korean company's profitability in the fourth quarter and next year. New products will help, too. A fully revamped subcompact Avante was rolled out earlier this year, and Hyundai will introduce a new SUV called the Veracruz in the U.S. next spring.
Auto analyst Cho figures Hyundai's operating profit margin will improve to 5% for all of this year. More importantly, he expects its pre-tax profit margin, which reflects overseas operations as well as domestic production, to return to last year's level of 10% next year, from a projected 7.1% this year (see BusinessWeek.com, 10/19/06, "Hyundai's Hot New Cars").
Hyundai execs are also putting on a brave face and remain optimistic. They maintain the group's ambitious aim of increasing sales to nearly 6 million units by 2011. "Fundamentals of our company remain strong and our expansion plan stays intact," says Hwang Yoo No, Hyundai's senior vice-president. "We still have homework to improve our management-labor relations, but long stoppages of this year were an aberration."
With Hyundai building new plants in the U.S., Europe, China, and India, future growth will come from abroad, says Hwang. He predicts that Hyundai's U.S. market share will rise to 2.8% this year, 3% next year, and 5% in 2010. (It was 2.6% in 2005.) Hyundai execs remain convinced the recent troubles were just a passing squall. If Hyundai can keep its restive labor union in line and the won settles down, it may well turn out that way.