HMC has a dominant share of the domestic auto market both as a company and a core component of Hyundai Motor Group. The company’s share of the domestic market hovered around 50% before 2010 but fell to 45%-47% in 2010-2012, mainly due to gains by subsidiary Kia Motors Corp. (Kia; BBB+/Stable/--). Hyundai Motor Group, including HMC and Kia, has a combined share of around 80% of the domestic market.
Standard & Poor’s Ratings Services expects HMC to continue to maintain its position in the global market along with its good profitability over the next two years, though we expect some gradual erosion during the period. The company has fundamentally enhanced product quality and brand, reducing costs through platform integration, and advancing its global marketing capability. We believe that to maintain its profitability, HMC will avoid an aggressive pursuit of market share, as evidenced in its modest target for sales growth in 2012. Still, in our view, the combined global sales target for HMC and Kia of 7.0 million units, about a 7% increase on last year’s results, would likely see it maintain a global market share of around 8.8%.
Based on our view that the company will maintain both its solid position in the global market and its profitability, we expect robust free operating cash flow to enable HMC to maintain its modest financial profile. We expect the company to generate strong operating cash flow in 2012. As a result, we believe its debt to EBITDA will remain below 1.5x, our current downgrade trigger, over the next one to two years.
In our view, HMC faces rising competition in the global auto industry amid high cyclicality in demand for passenger vehicles, which is dependent on the health of the global economy. The company generates more than 90% of its revenue from auto sales. We believe the uncertainty in the global economy could cut global demand for passenger vehicles and expose HMC to more competition that could undermine its market position and profitability.
In addition to macro-economic factors, we believe HMC is likely to face more challenges in trying to improve its market position and profitability than it has in the past. We see high likelihood of gradual decline in its market share over the next one to two years from a recent peak. In our view, this decline will be due to its strategy of having focused on profitability by responding to its competitors’, particularly Japanese major automakers’, significant recovery in production and capacity addition. We expect HMC and Kia’s combined market share to be flat at 8.8% in 2012 and 2013 and to decline to 8.4% in 2014.
Also, in our view, we see several obstacles to HMC’s ability to continue the profitability improvements it has made in the past three years. Profitability could be somewhat weaker over the next one to two years than the historical highs it achieved in the first half of this year, owing to rising costs, including for labor and utilities; weak domestic demand for vehicles; rising sales of imported cars in Korea’s market; a slower improvement in product quality; and a peak in its launch cycle for new models, which could leave the company vulnerable to increasing competition.
Weak corporate governance is another possible constraint on the rating. HMC demonstrated poor corporate governance in last year’s roughly Korean won (KRW) 5 trillion acquisition of Hyundai E&C (not rated)--which it made with Kia and Hyundai Mobis Co. Ltd. (Mobis; BBB+/Stable/--), a captive auto parts supplier of HMC and Kia. In our view, the acquisition demonstrated weak corporate governance because HMC lacked a clear rationale and it is uncertain how the purchase fits into the companies’ future plans or affects financial policies on how to use free cash flow, which we expect to be robust over the next 24 months. Also, we see the prospect of several corporate governance-related transactions that could streamline HMG’s complex and circular ownership structure.
HMC’s liquidity is strong. We expect the company’s sources of liquidity to exceed 1.5x uses this year. In our view, the company’s relatively large cushion of liquidity can help it weather high cyclicality and competitiveness in the auto industry, which can feature volatile operating cash flow and heavy capital expenditure.
We assume HMC’s sources of liquidity this year will be as follows:
-- KRW16.0 trillion in cash and short-term investments as of Dec. 31, 2011; and
-- KRW7.9 trillion in cash flow from operations.
We assume HMC’s uses of liquidity this year will be as follows:
-- KRW3.5 trillion in capital expenditure and equity investments;
-- KRW3.6 trillion in debt due to mature within a year of Dec. 31, 2011; and
-- Modest dividend distributions.
The stable outlooks on the ratings on HMC and Kia reflect our expectation that the companies will continue to maintain their market positions and profitability despite increasing competition in the global auto industry. Also, their solid financial risk profiles and strong liquidity will likely enable the companies to weather any negative developments.
Given our equalization of the ratings on HMC and Kia, we may lower our ratings on the two companies if HMC’s adjusted debt to EBITDA exceeds 1.5x for a protracted period. In addition to a significant erosion in HMC’s profitability or its global market position, negative rating factors include major additional investments as a result of weak corporate governance and deterioration in operating efficiency due to lack of stability in labor relations.
Though the potential to upgrade HMC and Kia is limited in the next year, we could raise the ratings on the companies after that if both companies improve profitability by further enhancing their brands as well as their global market positions without significantly undermining their financial risk profiles. If the company were to fully meet these triggers, we would also need to consider whether HMG had improved its corporate governance or streamlined its circular and complex ownership structure.