Hyundai Group revises policy of rapid growth and prioritizes quality

 The Hyundai Group (Hyundai Motor and Kia Motors) achieved remarkable growth over these past few years. However, in 2012, it suffered from a string of setbacks for lower production capacity as a result of pre-set strikes in Korea and labor agreements that limited per-employee work hours. Other negative factors include  the high valuation of the won, overstated fuel-consumption ratings issue and large-scale product recalls in the U.S.

 Having achieved rapid and remarkable growth these past few years, the Company's global  plants were busy building products, running at high operating levels. For example, Hyundai Motor's global plants were operating at 107.4% in 2011 and 108.4% in 2012. However, this year, in line with reduced working hours at its plants in Korea, there has been a supply capacity shortage in the U.S. and other regions where market growth is expanding. In the U.S., the Group's market share between January and July 2013 dropped to 8.2% from 9.0% of the same period in the previous year.

 On the other hand, the Hyundai Group is very cautious about enhancing the capabilities of its production facilities. The Group's production levels significantly and rapidly increased for the past several years. If the Group continues on its current roadmap for high-volume production levels, its parts suppliers' might not be able to keep up with demand and problems with quality might surface. As a result, the Group's plan for increases in production capacity from the second half of 2013 will be limited as follows; Raising the production capacity at its plant in Turkey from 100,000 units to 200,000 in 2013; and launching commercial production at Kia's third production plant in China in the second half of 2014. (Also, it has been reported that Hyundai will construct its fourth plant in China.)

Even if Hyundai Group ends up losing market share temporarily, its main priorities will be first to enhance quality, ensure customer satisfaction, and raise earnings at the Group and its dealers. It will raise its administrative/management efficiencies and prepare for its future growth.

 As for the Hyundai Group's business results, Hyundai Motor's profit margin is around 10% and Kia's is around 8%, indicating a rather high level of profitability, even though increase of sales are falling (Kia's were down 0.6% for the first half of 2013).

 At the end of this report, we've provided production forecast by country for the Hyundai Group compiled by LMC Automotive. Although the Hyundai Group's growth rate may taper off, it is still estimated that its production volume will reach 8.35 million units in 2016.

 Also, we plan to write a separate report about the Group's operations in China, the country where the greatest amount of growth is expected to occur.

Related report: Hyundai Group plans to sell 7 million vehicles in 2012, up by 400K over 2011 (posted in April 2012)

 Over the past few years, the global sales volume of the Hyundai Group has grown remarkably. The sales volume increased by  1.08 million units year-on-year in 2010, by 860,000 units year-on-year in 2011, and by 530,000 units year-on-year in 2012, reaching an annual total of 7.13 million units sold in 2012. This put Hyundai in fifth place among the world's OEMs, ahead of Ford that sold 5.67 million units in 2012. The Group's level of quality has also improved quickly. (Please refer to the above-mentioned related report for further details.) However, due to new working conditions introduced in the Group's plants in Korea, which includes reduced working hours, a worldwide shortage has surfaced in its ability to supply products.

 The volume of units shipped worldwide for the first half of 2013 rose from 3.578 million to 3.836 million units year-over-year, an increase of 258,000. On one hand, the number of units shipped from the plants in China, Brazil and the U.S. increased by 350,000. This increase was achieved through two plants, one in China and another in Brazil, which started production, and an addition of third shift in its plants in the U.S. On the other hand, the number of units exported from Korea fell by 89,000 units. This led to a decrease in sales volume by  8,000 units in the U.S.. The sales volume in  other areas  stayed at the same level or fell slightly.

Source: Hyundai and Kia's Financial Results for 2012 and January-June 2013, Hyundai Motor Investor Presentation June 2013

(Note) Sichuan Hyundai Motor Company(CHMC) is a joint venture between Hyundai Motor and Sichuan Nanjun Automobile Group, a commercial-vehicle OEM based in China. A new plant building is under construction, with the plant's commercial operations scheduled to begin from the latter half of 2014. The 2013 unit sales shown are for Sichuan Nanjun's existing models being built at the joint-venture company.

 As you can see in the following table, the Group either already finished or is planning to increase its production capacity between 2012 and 2013. For its plans in the latter half of 2013 and after, it has already decided to add facilities at its plant in Turkey so as to increase the production capacity there from 100,000 units to 200,000. It also plans to build Kia's third production plant in China. The Group has not announced any more plans after these.

 Hyundai Group reportedly has a policy not to speed up plans to increase production volumes to 8-million unit-range, due to various issues both inside and outside Korea, including quality problems. These issues will be reported in the latter half of this report. The Group also reportedly had plans to build its third production plant in India, which was rejected by the Group's management.

New plants and Capacity increase from 2012

 The low valuation of the Korean won (KRW) is one of the factors that have supported the Group's performance these past few years. The value of the won has been rising these past few years. In January 2013, it rose to KRW 1,060 to USD 1, compared to when it was relatively lower at around KRW 1,180 to USD 1 around May and June 2012. However, as of August this year, it has again dropped to around KRW 1,120 won to USD 1, which is the average rate over the past two to three years.

 Against the yen, the won has continued to drop steadily for the past 30 years and more. Beginning in 2013, however, the period of extremely high appreciation of the yen that continued until 2012 ended. The valuation of the won to the yen, which was around KRW 100 equal to JPY 6.8  in May/June 2012, has been continuing to rise around 30% these past two to three months, with KRW 100 equal to JPY 9. This has created a huge impact on the Group's business to compete with Japanese OEMs around the world. Hyundai Motor has reduced the portion of exports from Korean plant in order to minimize the impact that negative currency translation has on its business performance.

Hyundai's Portion of Export from Korean Plant and KRW/USD Exchange rate

Source: Hyundai Motor Investor Presentation June 2013
(Note) The portion of exports means: units exported from Korean plants/(total shipment from Korean plants + total shipments from plants outside Korea).

 A union leader with a strong confrontational attitude came onto the scene at Hyundai Motor's labor union in the fall of 2011, a time when public consensus was against huge corporations.

 Between July and August 2012, Hyundai Motor's labor union demanded improved working conditions, conducting pre-set strikes. Hyundai compromised from fear of longstanding production decrease, agreeing to raise wages, limit the per-worker working hours, and end late-night/graveyard shifts. (It previously had operated under two 10-hour work shifts. It changed this to an 8-hour morning shift and a 9-hour evening shift which ends at 1:10AM.) The pre-set strikes, which were held for 28 days in total, reduced production by 82,000 units. In addition, the Company proposed that it would give 3,000 of the 6,800 part-time workers full-time status within 2013; however, the labor union has not agreed with this offer.

 Further to this, from the beginning of March 2013, week-end production was stopped for about three months  due to the 2013 wage negotiations. This was said to have lowered Hyundai Motor's production volume by 83,000 units.

 To respond to the fall in production caused by the reduction in work hours, the Group will invest KRW 300 billion, to increase its production facilities and will work to enhance its production efficiencies as well. However, the actual benefits from these actions are still unknown. Hyundai Motor's largest Ulsan plant has an annual production capacity of 1.5 million units, but it is estimated that this level will drop by 234,000 units or by 15%. The total wholesale volume of Korean plants for the first half of 2013 by both Hyundai and Kia dropped by 100,000 year-over-year, from 184,000 to 174,000. ("wholesale volume of Korean plants" refers to the number shipped to the Korean domestic market as well as the number exported.)

 Total vehicles sales in the Korean market have remained in the range of about 1.55-1.60 million units since 2010. Under the free-trade agreement with Europe and the U.S. more vehicles are imported from those areas, with its share exceeding 10% in the Korean market for the first half of 2013. While Hyundai Group (Hyundai and Kia combined) still maintain a 70% market share, the share has been on a slightly downward trend in 2012 and for the first half of 2013. Hyundai Group invested the profits achieved from its overwhelming market share of Korean market to its business outside of the home country. Therefore, the heating up competition in the Korean market is said to have a huge effect on Hyundai Group.

Domestic sales in Korea

U.S. Market: Group's Market Share Drops 0.8%, to 8.2% through July 2013

 Hyundai Group's sales in the U.S. between January and July 2013 were 753,000 units, a slight decrease from the 755,000 units sold the year before. As a result, its market share dropped from 9.0% to 8.2%.

 Hyundai's plant in Alabama builds the Sonata and Elantra, working in three shifts. Between January and July 2013, the number of U.S. -made Hyundai- and Kia-brand vehicles sold in the U.S. was 480,000, a 7.3% increase y/y. However, the number of imported Hyundai and Kia vehicles sold in the U.S., fell to 270,000, an 11.2% drop y/y.

 However, according to reports published on June 10, 2013 in Automotive News and other sources, Hyundai Group's head office in Korea and its sales company in the U.S., were said to be aggressively emphasizing quality, customer satisfaction, and profitability, even at the expense of sacrificing some market share and curtailing sales incentives.

 According to Hyundai Motor, the value of its incentive programs in 2012 in the U.S. amounted to USD 946 per vehicle. This is less compared to the USD 1,804 and USD 2,206 per vehicle offered by Toyota and Honda, respectively. Since April 2011, the Group has maintained its vehicle inventory turnover at less than 60 days.

Source: Automotive News

 In November, 2012, The U.S. Environmental　Protection Agency (EPA) announced that 900,000 vehicles that had been sold by Hyundai and Kia combined, had overstated fuel efficiency. In response, the Hyundai Group showed its sincere apologies to both its customers and its dealers. The Group offered a comprehensive compensation program, which was viewed favorably by a majority of its customers, who remained relatively cool over the situation. Furthermore, 1.68 million Hyundai/Kia vehicles were subject to a recall for faulty brake-light switches.

Thirteen types of models (900,000 Units Total) were found to have overstated fuel efficiency

Source: EPA 2012.11.2

Recall of 1.6 million vehicles due to faulty brake-light switches

Source: National Highway Traffic Safety Administration (NHTSA) 2013.4.1、Automotive News 2013.4.15

 Since 2011, it became mandatory for companies listed on the Korean stock market to switch from reporting their consolidated financial results based on the K-GAAP Standard to the K-IFRS Standard. Hyundai owns 33.88% of the stock shares in Kia, thereby making Kia a Hyundai subsidiary based on the equity method of accounting. For the most part, the majority of operations outside Korea are accounted on a consolidated basis, while the operations in China are accounted based on the equity method.

 Both Hyundai and Kia, which had continued to maintain a high level of earnings, found themselves posting lower profits in the fourth quarter of 2012  This was due to a shortage in production capacity resulting from  changes in its labor agreements and the negative currency translation due to the high valuation of the won. (The companies did report higher operating profits over the entire year in 2012.)

 Between January and June 2013, Hyundai Motor's operating profit fell by 7.7% and Kia's fell by 21.0% y/y. As for Kia, its financial results were affected by the production issues in Korea and the high proportion of vehicles built for export significantly. In spite of these temporary setbacks, Hyundai Motor and Kia had a 9.6% and 7.6% operating profit margin respectively. Furthermore, net profits remained high at both companies, especially after the figure was added based on the equity method from the  profits made by affiliated companies including the Group's companies in China. Hyundai Motor's net profit was KRW 4.6 trillion and Kia's was KRW 2.0 trillion.

 According to LMC Automotive's forecast in June 2013, Hyundai's light vehicle productions in 2013 will increase by 5.9% to 7.65 million units and reaches 8.35 million units in 2016.

 Hyundai's China production supports the steady increase which  shows a 15.9% growth y/y in 2013 to 1.54 million units. By 2016, the country's production is expected to increase to 2.0 million units, which is a significant growth of 30.0% compared to the volume of 2013. LMC automotive indicates, "The Hyundai Group is going strong in Asia Pacific on the back of rising demand in China and India, but both Hyundai and Kia continue to make inroads in North America and Europe."

 Hyundai Group's Korean production volume is expected to hover around 3.5 million units until 2016.

 The global research company points out "Hyundai and Kia are facing increasing wages at home that would impact their global competitiveness but both are unlikely to make any major production shifts out of Korea in the next few years. This is because global demand for some key models is expected to rise faster than their ability to expand oversea build."

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