Toyota’s Earnings: Weak Chinese Sales Could Spoil An Otherwise Strong Quarter

Toyota Motors (NYSE:TM) announces its Q2 earnings on November 5. The Japanese automaker, which raised its sales guidance after an impressive first quarter, might have to cut the forecast this time on account of weak Chinese sales. Even Honda Motors (NYSE:HMC), which released its earnings on October 29, lowered its guidance due to weak Chinese sales and the company now expects the situation to normalize post February.

Japanese automakers have been struggling in China due to tensions between the two countries over claims on the disputed islands. Other non-Japanese auto companies such as Hyundai, Volkswagen and BMW have benefited in turn. Toyota’s China sales plummeted 40% in September. Mazda’s and Honda’s sales were down 35% and 41%, respectively.

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Although China remains a worry for the automaker in the near term, the contribution of emerging economies to the top-line is likely to rise in subsequent years. Toyota is in the process of developing eight new compact models aimed specifically at China, Brazil, Indonesia, India and other emerging markets. By 2015, the automaker hopes to achieve half of its sales from emerging markets, up from 45% currently. For the fiscal 2013, management expects its capital expenditure in Asia to surge 25%. The company-wide capital expenditure is expected to jump more than 15% over the previous fiscal.

The company continues to perform strongly in the U.S. Toyota relies on the U.S. for more than a fifth of its total vehicle sales. Overall, the automaker’s sales are up 32% in the country through September. The coming quarters will be challenging for Toyota as its best selling vehicle, Camry, faces stiff competition from the new Honda Accord and the Ford Fusion. The mid-size sedan segment is highly competitive in the U.S. with Camry, Accord, Altima, Sonata, Malibu and Passat all in the fray. The segment has traditionally been dominated by Japanese automakers, but American, German and Korean automakers have upped their games.

Margin Expansion

On the margins front, shifting production overseas (from Japan) to combat the effects of a strong Yen remains a priority. Earlier in the year, the automaker announced its decision to ramp up output in its U.S. and Canadian plants and has poured in more than $1.6 billion since. In India too, the automaker is investing more than $160 million to expand production of Etios and Innova in the country. The investment will see the capacity of its South Indian plant rising from 210,000 units currently to 310,000 units by 2013. Similarly, in Thailand, Toyota looks to boost its production to 1.2 million units as the country aims to become one of the top 10 auto producing nations.

Margins are likely to see a significant improvement this quarter due to weak results in the previous year quarter. Sales last year were badly affected by production and supply chain constraints caused by the tragic tsunami. Toyota’s sales in the first nine months of the year are up 28% to 7.4 million and so the fixed costs will spread out over a larger base. Hence we expect margins to rise substantially in the upcoming earnings. ^[1]

We currently have a $90 price estimate for Toyota’s stock, which is about 15% higher than the current market price.

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1. Toyota global vehicle sales up 28 pct in Jan-Sept, October 26, 2012, sltrib.com [↩]