Japan Auto's Talented B-Team

Toyota and Honda may get all the press among Japanese car makers, but second-tier players like Mazda and Suzuki are making impressive gains

Compared to the possible sales drama at Chrysler, the financial travails of Ford (F), or Toyota's (TM) quest for industry supremacy, this bit of industry news out of Japan barely registered. Yet on Feb. 6, the once-hapless automaker Mitsubishi Motors (MMTOF) actually managed to post a $35 million quarterly net profit for the first time since it started reporting quarterly in 2004.

While Japan's first-tier car companies such as Toyota, Honda (HMC), and Nissan (NSANY) tend to grab all the attention, the fact remains that smaller Japanese automakers operating under the radar are making some interesting strides as well.

In the case of Mitsubishi, whose brand was crushed by a product recall scandal several years back, the fact that it is on track to post its first full-year profit since 2003 for the fiscal year ending this March is a big step in the right direction. And other second-string Japanese players such as Mazda (MZDAF) and Suzuki (SZKMF) are wowing consumers and impressing rivals with smart designs and imaginative business plans that offset their lack of scale and production muscle in the hotly contested global auto industry.

Crossover Success

Despite the unrelenting bad news from Ford these days, one big positive is the U.S. company's alliance with Mazda. This financial year Mazda, which is one-third owned by the U.S. automaker, is set to post record profits of $634 million, a rise of 12% on a year earlier, and will increase unit sales by 3% to 1.18 million.

Its stock price, at $5.80, has increased almost five-fold from 2001 when the company lost $1.25 billion. And having fought hard to reduce debt and straighten out its balance sheet, new designs such as the CX-7 and CX-9 crossover SUVs are winning plaudits (see BusinessWeek.com, 5/9/06, "Mazda Crosses Over to U.S. Opportunity").

Christopher Richter, an analyst at CLSA in Tokyo, adds that Mazda's recovery, which dates back to Ford taking a stake in 1996, has been achieved without Ford investing heavily in Mazda. "Ford has helped through co-purchasing agreements, sharing R&D and other peripheral benefits, but there was no big infusion of cash," Richter says. "They've restructured this company the old-fashioned way—from their own operating cash flows." Nissan's recovery under Carlos Ghosn, while spectacular, was aided by several billion dollars of investment from Renault (RNSDF).

Real Innovator

Suzuki is just as impressive. While a small player in the U.S., this pint-sized automaker last year sold 690,000 cars in Japan. That's only 10,000 fewer units than mighty Honda. It did so by its mastery of Japan's white-hot demand for minicars—ultra-small compacts with engines that typically don't deliver more than 60 horsepower. In other words, by thinking small, Suzuki managed to grow smartly in a car market that overall shrank by 2% (see BusinessWeek.com, 11/16/06, "Land of the Lilliput-Putt").

However, it is Suzuki's overseas strategy that really marks the company as an innovator. Last week, Nissan and Renault, in a deal with Indian automaker Mahindra & Mahindra (MAHMF), became the latest car company to announce expansion plans in India, one the world's most promising emerging auto markets outside of China at the moment. Toyota, Honda, General Motors (GM), and others are also bolstering India plans.

However, Suzuki has been there for ages. It struck a deal with the Indian government in the early 1980s and has been building cars in India for almost 25 years and exporting for almost as long. Even today, domestic market share of Suzuki's India subsidiary, Maruti Udyog, is almost at 50%—10 times that of Toyota. In February, Suzuki announced plans to invest an additional $1.7 billion in India by 2010 to raise its production muscle at existing plants, build a new research and development center, and launch new car models (see BusinessWeek.com, 11/13/06, "India Wants to Build Your Small Car").

Some Sluggish Performers

Suzuki has also been ahead of the curve in Eastern Europe, another growing auto market and hot investment destination. It opened a plant in Hungary in 1993, and today its share in Eastern Europe is around 8%, notes CLSA's Richter. All of which is helping the company's bottom line. In the year through March, UBS projects Suzuki's net earnings will rise 36% to $761 million. "I remain bullish about Suzuki's growth, driven by overseas business," says UBS analyst Tatsuo Yoshida, who has a buy recommendation on the stock.

Not all second-tier Japanese automakers are basking in the sun, however. The performance of Fuji Heavy Industries (FUJHY) has been less spectacular. Faced with sluggish performance at home and loss-making U.S. operations, profitability has been falling in recent years. Despite rising sales, the Tokyo-based company expects to post operating profits of just $430 million in the year through March, 2007, compared to $502 million a year earlier.

A new three-year business plan announced on Feb. 28 received a lukewarm response from some analysts. Under the new plan, the company aims to increase unit sales from 575,000 to 683,000, raise operating profits by 60% to $676 million by 2010, and produce a global compact car. "What we believe is needed is a sense of urgency throughout the company and quick action aimed at improvement," UBS's Yoshida wrote to clients in a research note following the announcement.

Win-Win Situation

Still, there are hopeful signs for Fuji Heavy's Subaru brand in the U.S. First, under its new plan, Fuji Heavy expects its U.S. sales to rise by 57,000 to around 250,000. Chief Executive Officer Ikuo Mori told BusinessWeek late last year that he'd like to double Subaru's U.S. market share to 2%. Also, this spring Subaru of Indiana Automotive will begin building Camrys for Toyota, which owns an 8.7% equity stake in Fuji Heavy. The plant will eventually churn out 100,000 units of the popular sedan annually.

The move is a welcome one for Fuji Heavy's U.S. operations. For one, Camry production solves an excess-capacity problem at the Indiana plant since former co-owner Isuzu Motors, a Japanese truck maker, stopped production there and sold its share to Fuji Heavy in 2003.

In addition, Toyota is introducing its quality-control systems at the plant as part of the agreement, which will benefit the Subarus built there. "That's quite an advantage," Mori told BusinessWeek. "For us there's improved efficiency and we can learn from Toyota. For Toyota, without much investment they can increase capacity."

Small Is Beautiful

Executives at Mitsubishi, of course, would be delighted to get close to Subaru's profits. In the current year, the company expects a net profit of just $66 million. Yet being in the black at all is an achievement for President Osamu Masuko, who took over at Mitsubishi in 2005 after a botched U.S. sales campaign and a recall scandal at home had left the company as Japan's only loss-making automaker.

Masuko also had to deal with the aftermath of Mitsubishi's failed alliance with DaimlerChrysler (DCX), which sold its remaining stake in the Japanese company in November, 2005. Since then Mitsubishi has restored some pride by releasing successful, well-designed models, including the Outlander SUV and award-winning i minicar.

Longer term, Masuko still has plenty to do to revive Mitsubishi's brand, not least in Japan where memories of covered-up recalls linger and competition is especially intense. "It's still early days [for Mitsubishi's recovery]," says CLSA's Richter. "Being the comeback kid in the auto industry is tough—they have some scary competitors out there." Still, small can be beautiful—for car companies with killer designs and smart expansion strategies.

Click here for a slide show of recent groundbreaking models from Japan's strong second-string of carmakers.

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