At Small Japan Auto Makers, Advanced Gas Models Match, Undercut Green Cars

Instead of investing heavily to develop hybrids and plug-in cars, like the Leaf being unveiled in Japan Friday by Nissan Motor Co. (7201.TO), Mazda Motor Corp. (7261.TO) and Daihatsu Motor Co. (7262.TO) are rolling out new-generation gasoline-powered cars boasting enhanced fuel economy and cheaper price tags. And it's a gambit that some analysts say could pay off in the near term -- as long as gas prices stay low.

Back in 1997, when Toyota Motor Corp. (7203.TO) proudly unveiled the world's first mass-market hybrid, the auto maker trumpeted the first generation Prius' fuel economy of 28 kilometers per liter. Next year, Mazda plans to launch a comparatively inexpensive compact car it says will run for 30 km on a liter of gas -- without the help of electric motors.

"Gasoline prices are relatively stable. They are neither cheap nor expensive," said Koji Endo, analyst at Tokyo-based independent research Advanced Research Japan, referring to pump prices now about 29% below record highs. "In this environment, electric vehicles or hybrids won't likely become the top popular models immediately...There is a chance in the short-term" that compact cars could beat some hybrids."

German and Japanese car makers, such as Volkswagen AG (VLKAY) and Toyota, have long set the pace for the industry on introducing fuel-saving technologies. For Mazda and Daihatsu, analysts say the new, high-efficiency compacts could offer a way to make up ground while operating with R&D budgets that are between less than a tenth and a fifth of such spending by Japan's 'big three' -- Toyota, Nissan and Honda Motor Co. (7267.TO).

With shares of about 4.4% and 13% respectively of Japan's market for new cars, Mazda and Daihatsu are firmly stuck in the big three's shadow at home. But the pair aim to tap overseas markets with plans to introduce their new technologies in North America, Europe and other markets in the coming years.

In Japan, hybrid car sales more than tripled last year from the previous year, driven by the red-hot remodeled Toyota Prius and also helped by government buying incentives, bucking the downtrend in the overall market of a 9.3% fall as budget-conscious consumers concerned about the fate of Japan's then-recessionary economy reined in spending. Still, hybrids accounted for just 7.8% of the whole market in 2009, or 347,729 vehicles in total.

Mazda, Japan's fifth-biggest car maker by sales volume, said last month that it will market its redesigned gasoline-engine Demio compact in the first half of next year in Japan. The Demio is set to become one of the most fuel-efficient gasoline cars in the country with a fuel-economy rating of 30 km/l.

That's below the 38 km/l Toyota's latest Prius model gets, but it matches other hybrids including the recently launched new version of Honda's Fit hybrid.

And Mazda plans to undercut the price of hybrids like the Fit, according to Mazda Chief Executive Takashi Yamanouchi. "We will probably have to set the prices (for the new Demio) lower" than the bottom price of the Fit hybrid of Y1.59 million ($19,157), Yamanouchi told reporters last month.

How will the big three respond? Not with any radical moves, analysts say: operating margins on lower-priced compact cars are wafer-thin, and the business model for the new-generation cars is entirely dependent on one factor beyond the control of any auto maker on the planet--gasoline prices. And the likes of Goldman Sachs expect crude oil futures to bubble up to $101 over the next 12 months on the New York Mercantile Exchange - from the recent levels around $84.

Nissan Chief Operating Officer Toshiyuki Shiga agrees that there is no single technology to meet all customer requests. Asked last month about the potential competitiveness of the company's Micra compact -- offering 26 km/l with a price tag of around Y1.2 million -- Shiga said those who often drive in the city probably prefer hybrids.

Still, there will soon be another potential rival from Daihatsu. Japan's seventh-largest car maker is developing a new mini car based on a concept vehicle called 'e:S' unveiled at last year's Tokyo auto show. The new 660cc-gasoline engine car will be as fuel-efficient as the new Mazda Demio, and will hit the domestic market next year.

Proponents of the new wave of ultra-efficient gasoline engine cars need to make hay not just in terms of low gas prices, but also while they have closed the gap in terms of fuel economy.

Just as the big guns dip into their R&D coffers to develop more advanced electric systems for their hybrid cars, they are also aiming to improve the efficiency of the conventional engine side of the hybrid systems.

Toyota, for instance, said earlier this month that it will begin sales of its first compact hybrid that can drive more than 40 km/l by the end of 2012. And by early 2012, it plans to sell the plug-in version of the Prius hybrid, whose prototype can run 57 km/l.

-By Yoshio Takahashi, Dow Jones Newswires; 81-3-6269 2791; yoshio.takahashi@dowjones.com

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