Hyundai Rides Demand for Small Cars

Its plans for luxury models may slow, but the Korean automaker will still benefit from high gas prices thanks to its gas-sippers

Oil may have retreated from record highs over the past week, but the painfully high price of gasoline has dampened Hyundai Motor's campaign to go upscale (, 12/7/07) with sport-utility vehicles and bigger, more luxurious cars. But $4-a-gallon doesn't seem to be hurting its growth strategy. The reason: It has a solid lineup of small gas-sippers, and just as important, ready capacity.

The numbers show this isn't the time for Korea's top automaker to shed its image as a maker of small, inexpensive cars. As its bigger global rivals slumped, Hyundai on July 24 posted a quarterly revenue record of $9.03 billion in three months ending in June, up 13% from a year earlier. Its operating profit in the quarter rose 6%, to $657 million, but currency-related losses pushed net profits down 11%, to $542 million. (The company lost $149 million in currency-derivatives investments and $99 million in its Indian operation because a sharp fall in the Indian currency increased its debt costs.)

Now Hyundai is once again trumpeting its small cars (, 7/18/08), and it's considering building them in the U.S. starting next year (it already builds the midsize Sonata sedan and Santa Fe SUV at a plant in Montgomery, Ala.). "Just as Honda established itself with a fuel-efficient engine when the world was rocked by the first oil shock, this new era of high oil prices will serve as a similar opportunity for us," says Yoon Mong Hyun, Hyundai's managing director in charge of business strategy planning.

Small-Car Opportunity

Early signs are encouraging. In June, as overall U.S. auto sales fell by 8%, Hyundai hit a monthly record, selling 50,000 vehicles, up 14% from a year earlier, according to selling-day-adjusted statistics from researcher Autodata. Sales of the compact Elantra jumped 51%, the subcompact Accent was up 70%, and the Sonata climbed by 12%.

Hyundai is adding to its offerings of diminutive vehicles to take advantage of that opportunity. The company this year will introduce a new Elantra wagon in the U.S., based on a compact called the i30 sold in Europe. That will be the first of about a half-dozen new small models the company plans to introduce in the U.S. over the next five years, quadrupling its current small-car lineup. It may also make small cars such as the Elantra at a new plant in West Point, Ga., that its affiliate Kia Motors expects to open next year.

Hyundai's small cars are a hit in fast-growing emerging markets, too. In China and India, Hyundai's sales rose a combined 27%, to 263,500 in the first six months of this year as it has added new, small models (, 1/30/08): the European-styled, $7,850 i10 mini in India, and the $14,600 Yuedong compact in China. The company's target is to boost market share to more than 20% in India this year, from 17% last year, and to 6.1% in China, from 4.6%. Another looming market is Russia, where Hyundai nearly doubled its car sales, to 47,100, in the first half of this year.

A Good Small-Car Environment

The ambitious growth target is linked to Hyundai's aggressive plan to add new capacity. In the past year, it has opened two new plants—one in Beijing and the other in the southern Indian city of Chennai—each with annual capacity of 300,000 small cars. The company is also building a factory of similar size in the Czech Republic for completion next year, and in June it broke ground for one in Russia that it hopes to open in 2010. "The capacity appeared excessive before high oil prices sparked a sudden hike in small car demand," says Ahn Soo Woong, head of research at brokerage LIG Investment & Securities. "Now, Hyundai looks smart with the additional facilities."

Korea offers a favorable environment for small cars. The country not only has such basic industries as steel, plastic, glass, and rubber to support automakers, but also provides the right mix of price and quality. At nonluxury levels, Korean quality roughly matches that of Japanese makers while production costs are at least 10% cheaper. And Korea compares well against U.S. rivals, too. Industry officials figure engineering costs to develop small cars are some 40% less in Korea than in the U.S.

Part of the gain comes from economies of scale. Since early this decade, Hyundai and Kia have been sharing the same platform for four compact sedans and two compact sport utility vehicles—the Elantra, i30, Ceed, Forte, Tucson, and Sportage. For each model, hundreds of engineers from scores of primary part suppliers join a team of Hyundai developers to seek innovation for lowering costs.

It All Adds Up to Profits

Another key factor bolstering Hyundai's balance sheet is a weak Korean currency (, 3/28/08). The average value of the Korean won lost 8.6% against the dollar in the second quarter from a year earlier and dropped 21.2% against the euro, according to the Bank of Korea, the country's central bank. So far this year, the won has fallen more than 10% against the yen, making Hyundai's cars more competitive against vehicles of Japanese rivals such as Toyota (TM) and Honda (HMC).

The small-car windfall and a weak won are adding up to profits. The company will post record operating earnings of $2.26 billion this year, up 25% from last year, on sales of $33.72 billion, up 11%, brokerage Korea Investment & Securities estimates. "Of all major carmakers, Hyundai will probably be the biggest beneficiary of high oil prices," says Kim Jun Kyu, chief researcher at the Korea Automobile Manufacturers Assn., a trade group.

SUV Sales Tumble

That's not to say the company has a totally smooth road ahead. Its unions are balking at plans to switch production to smaller cars from SUVs and other big vehicles. Earlier in July, unionized workers staged partial strikes for four days over a wage deal, which the company estimates cost it about $240 million in lost output (although those losses are usually made up later).

Hyundai is also behind in developing greener vehicles. Its first hybrid, a version of the Elantra (, 7/10/08), isn't expected until next year. Its overseas hybrid debut won't be until 2010 when it plans to introduce a version of the Sonata in the U.S. And even as Hyundai's small cars are jumping off the lot, it can't unload its bigger models. U.S. sales of Hyundai's SUVs tumbled by 41% in June and are off by 27% in the first six months of this year.

When it launches U.S. sales of its first premium sedan, the Genesis, this fall, the company could well face a similar fate. The Genesis, a $38,000 V8 rear-wheel drive, is designed to take on luxury icons such as BMW (BMWG.DE) and Mercedes (DAI). Yet Hyundai executives say they remain optimistic. "We must press on with our campaign to move into the premium segment," says Hyundai strategist Yoon, "but the focus right now is on small cars."

Before it's here, it's on the Bloomberg Terminal.