• Quality related expenses will hit profitability for 2020 and raise quality management concern
  • Third consecutive year of sizeable quality related expenses, with uncertainties over further financial impact

Moody's Investors Service said in a new report the latest round of quality related expenses reported by Hyundai Motor Company and affiliate Kia Motors was "credit negative and highlights the continued quality control challenges facing the two automakers".

"That said, this development can be absorbed by the negative outlooks on the companies because of their adequate financial buffers and improving product mix," the ratings agency added.

The two automakers earlier this week announced they would each incur quality related expenses of KRW2.3trn (US$2bn) and KRW1.3trn ($1.2bn), respectively, in Q3 2020, related to previously sold vehicles equipped with Theta II petrol engines, mainly during 2011-18. Hyundai said today (21 October it would overhaul its product quality control process.

"These expenses will significantly weaken the two companies' profitability in 2020 and lead to cash outlays over the next one to two years, and come on the back of similar large expenses over the past two years," said Wan Hee Yoo, a Moody's VP and senior credit officer (SCO).

"If Hyundai and Kia continue to report similar large expenses in coming years, it could further increase concerns over product quality and undermine brand equity, which in turn could pressure the ratings."

According to Hyundai and Kia, the additional expenses were caused primarily by an increase in the projected costs associated with life time warranties provided in 2019 mainly for 2011-18 models equipped with the Theta II GDI (gasoline direct injection) engines in the US, to reflect higher than expected engine replacement rates and longer than previously assumed vehicle life cycles.

With the large Q3 losses, Moody's expects Hyundai and Kia's adjusted EBITA margin to fall to 1.1%-1.3% in 2020 from 3.5% and 4.0% respectively in 2019.

While margins are expected to rebound to 4.0%-5.0% and 3.5%-4.0%, respectively, over 2021-2022, uncertainty around the severity and duration of the coronavirus pandemic and lingering product quality issues pose significant downside risk.