Hyundai's Turbocharged Quarter

Superb sales at home and a big product push in the U.S. are starting to make the Korean carmaker look like a turnaround story

Killer profits at home, coupled with a daring upscale product push abroad: That more or less sums up the strategy of Hyundai Motor (HYMTF). South Korea's champion automaker has big ambitions to move into the big league of the automotive world. It certainly nailed some impressive numbers in the second quarter, and on July 26 halted a recent earnings slide and posted the first year-over-year profit jump in six quarters.

The company reported that its net income rose 52%, to $666 million, in the April-June period from the year-ago quarter. Hyundai officials say the upbeat outlook for the Korean economy, along with the prospect of a stable currency, spells even better days ahead. Barring unexpected circumstances, "we expect our earnings will steadily improve," Hyundai Motor Executive Vice-President Chung Tae Hwan said. Revenues jumped 15%, to $8.74 billion.

The biggest contributor to the earnings gain was robust domestic sales. Hyundai, which generated nearly 40% of its revenue and some 90% of its profits at home last year, reported a 16% sales increase in the Korean market. "The favorable local market will serve as a big windbreaker for Hyundai, which has been exposed to the cold because of the rapid appreciation of the Korean currency," says Suh Sung Moon, senior auto analyst at brokerage Korea Investment & Securities.

Wealth Effect Fueling Demand

Hyundai's results were released one day after the Bank of Korea, the nation's central bank, confirmed that the economy was expanding faster than expected. Compared to the previous three months, gross domestic product grew 1.7% in the second quarter, which economists say translates into a 7% annualized growth, the highest since the fourth quarter of 2003.

The solid economic expansion and the expectation of better profits in 2008 by Korean companies have fueled a rally on the Seoul Stock Exchange in recent months. That has created a wealth effect and underpinned a rise in local vehicle sales. "The booming stock market has served as a catalyst in creating demand for expensive cars," Suh says. The Seoul bourse's benchmark Kospi index has soared some 40% so far this year. Local sales of the Grandeur (called the Azera in the U.S.) premium sedan, for example, jumped 20% in the quarter.

Hyundai executives hope the sales gain at home will herald a jump in exports as the company adds new models to its lineup to improve its brand image. In the U.S., where it introduced the Azera last year and the Veracruz crossover sport-utility vehicle this year, Hyundai plans to launch a rear-drive, near-luxury sedan next year to compete with the likes of the BMW 5 Series (see, 4/2/07, "Hyundai Pitches Luxury in the U.S."). In Europe this fall, it will start selling a new compact car, the i30, designed and developed in Europe to cater to drivers there.

Currency Fluctuations Subsiding

There are signs its game plan to go upscale might be paying off. Hyundai's average selling price for overseas shipments hit an all-time high of $13,057 in May, up 11.4% from a year earlier. In the all-important U.S. market, it sold 132,390 vehicles in the second quarter, up 27% from the previous quarter and 3.4% from a year earlier. In June, its U.S. market share rose to 3.39%, from 2.97% a year earlier (see, 5/21/07, "At Hyundai, Branding Is Job 2").

Just as important, Hyundai's profit margin has begun expanding again. Its net profit margin, which dropped to 5.6% last year, from 8.5% in 2005, is expected to rise to 5.9% this year and 6.5% next year, according to Prudential Investment & Securities.

The improvement is largely attributed to the slowing appreciation of Korea's currency, the won.

The won, which gained in value by as much as 29% against major currencies in the past two years, rose 2.2% against the dollar in the second quarter. However, it depreciated against the euro by 4.9% in the same period, offsetting the impact on profitability from other currency fluctuations. "It appears the days of sharp appreciation are behind us," says analyst Yoo Young Kwon at Prudential Investment. Yet he reckons profit improvement will be limited until the second half of 2009 because cars under production now were developed several years ago, when the won was low and cost savings was not a priority.

China Misstep Has Been Costly

Yoo drew parallels between Toyota Motor (TM) in the 1990s and Hyundai now. Toyota began making serious efforts around 1994 to cut costs after the shock of a high yen in the early 1990s. However, the results of such campaigns weren't reflected until 1998, when new models were introduced that fully took into account the high yen. "Given a lag time for development, Hyundai will have to wait until new models developed in such a way will be rolled out," says Yoo.

Keeping costs in check isn't the only challenge Hyundai faces. A misstep in fiercely competitive China pulled Hyundai down to 11th place in June, with a market share of 3.2%, from No. 2 two years ago when it controlled 9.2% of the market. In the second quarter of this year, Hyundai suffered a year-over-year sales plunge of 27.3%, to 48,077 cars, in China, where it has failed to introduce a new model in the popular compact segment for four years. At the same time, Toyota, Honda Motor (HMC), and Volkswagen all stepped up marketing with new models in the world's fastest-growing car market (see, 2/5/07, "Hyundai's True Trial: Better Performance")

A more fundamental problem lies in the Hyundai union's confrontational relationship with management. "The big difference between Toyota and Hyundai is the total lack of labor flexibility at the Korean company, which means poor productivity," says Chang In Whan, chief executive at fund manager KTB Asset Management in Seoul. "Unless Hyundai resolves this issue of the rigid union, any improvement in its results will be temporary, and the company will remain a trading buy, and not a long-term buy."

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