Debate has raged for decades about the benefits of integrated production facilities in the automotive industry. Arguably, Henry Ford and Ford Motor Co. (NYSE:F) started it at Rouge River in the 1920s when he built a complex capable of taking in raw materials such as iron ore at one end of a 2000-acre site and producing a finished car at the other. Although mass production received mixed reaction in those days, the concept of owning the production process from raw material to finished product still has attractions in some quarters. A recent article exploring Hyundai Motor’s (OTC:HYMTF) vertical integration up the supply chain to steel production makes interesting reading as the latest effort to benefit from this concept.
Hyundai Motor Group also owns Kia Motors and between them they are the world’s fifth-largest carmaker by sales with over 5.5 million cars consuming in the region of 6 million tons of steel per year. Unlike India’s Tata (NYSE:TTM) that was a steel producer drawn to auto manufacturing, Hyundai Motors is a car producer drawn to steelmaking. Although Hyundai’s steelmaking origins stretch back to 1957, the company was only bought by Hyundai Motors Group in 2004 and its first integrated blast furnace was only fired up last year at Dangjin. But a second followed soon after and a third is planned by 2013 at a combined cost of $8 billion.
In total, Hyundai Steel is targeting 24 million tons of steel production by 2013 up from last year’s 20 million tons and putting them in the top ten steel producers worldwide. Each of the new blast furnaces is designed to produce 4 million tons per year and from the first two furnaces, about 2.4 million tons is currently supplied “in-house” to Hyundai Motors and Kia. The rationale is that by owning the steel producing facilities, Hyundai can shorten the concept to delivery of higher-strength, lower-weight steels compared to their competitors, a trend that is gathering pace as automakers seek to reduce weight to improve fuel efficiency.
The Whole Story
Not discussed in the FT article is a wider issue of specialist steel supply in Korea. Several of the country’s steel finishers rely on Japanese supplies of special grade HR coil, making them vulnerable to currency costs and supply disruption. Part of Hyundai Motors’ rationale is no doubt to reduce such issues in the future, as they increase the percentage of in-house steel supply for their car plants towards half, once the third blast furnace comes online in 2013.
Not all are on board with the direction of Hyundai’s investments, though. Some analysts (who ultimately will have an impact of the firm’s share price before we discount them as a bunch of armchair scribblers) complain that with rising raw material prices and a weak steel market, Hyundai Steel will create a drag on the group’s overall profitability and reduce the return on capital employed. Hyundai Steel faces a forex risk buying in dollars but largely selling in won, and profits from steel production have been in decline; whereas Hyundai Motors and Kia are both doing well.
Short-term measures should not be the arbiter of such strategies; however, a steel mill is a long-term investment and if it proves to provide Hyundai with a long-term competitive advantage, maybe the short-term opportunity to better employ capital elsewhere will prove less important. It’s interesting that of the many synergies that Tata put forward for the purchase of both carmakers and steel mills domestically and abroad, vertical integration of steel supply for car bodies and fast-tracking of high-strength alloy research and development through consumption in carmaking was not high on the list – are they missing something?