Soaring Japanese Bond Yields May Lead Toyota’s Interest Expenses To Climb

by Trefis Team
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Japan’s most watched stock index, Nikkei 225, showed signs of stabilization after it tanked 7% last week. The panic in the stock market was caused by a sudden spike in Japanese government’s 10 year bond yields, which crossed the psychological 1.0% mark and sparking fears it might swell the country’s borrowing costs. At the start of April, the bond prices resulted in a yield of about 0.3%. Currently, the same bonds yield about 0.9%.

This tripling of bond yields can impact indebted companies’ due to higher interest expenses. Toyota Motors (NYSE:TM) recently canceled a 20 billion yen (~$200 million) debt offering citing rising bond yields as the reason. [1]

As part of the monetary and fiscal reforms going on in Japan, Mr Shinzo Abe, the country’s PM, intends to devalue yen and raise the inflation target to 2%. As a result, the Bank of Japan (BoJ) is now buying Japanese government bonds, or JGBs, at a rate of 7 trillion yen a month (~$70 billion). Bond prices have dropped as a result of this massive bond buyback program undertaken by the central bank. Note that bond prices and bond yields move in opposite directions.

Japan’s latest quarter saw the GDP rising at an impressive 3.5% on an annualized basis, suggesting that the country might actually be to overcome the deflationary environment and reach the intended inflation level. Furthermore, Ben Bernanke’s comments last week about a possible reduction in the Fed’s bond purchases caused the U.S. bond yields to jump, the effect of which was reverberated to the Japanese bonds and sparked a selloff. [2]

Japan’s bonds have historically had one of the lowest yields in the world since the deflationary environment results in higher real interest rates. Moreover, since the country has a current account surplus and the fact that most of the bonds are owned by domestic corporations and not by foreign investors, the yields have stayed extremely low.

See our complete analysis for Toyota Motors here

The yen has declined close to 30% against the U.S. dollar ever since Mr Abe came to the office in December last year. The country’s most valuable company, Toyota, has gained more than 50% in the last month on the back of soaring overseas profits. The automaker now expects its profits for the ongoing fiscal to be the highest in six years.

As of March 31, Toyota’s non-financial division had a debt load of about ~$13 billion and the financial division about ~$132 billion making it a total of ~$145 billion.  So, you can see that the company’s considerable level of debt makes it very sensitive to interest rate fluctuations. [3]

The latest round of events suggest that the yen devaluation might not be a complete fairy tale and it could have its potential side effects as well. Apart from concerns over the rising interest expenses, there are other challenges that remain for Toyota if it has to retain its crown of the world’s largest automaker. Some of those include ongoing weakness in China due to political tensions, slacking U.S. sales and a tepid Japanese automotive market.

Other Concerns

Toyota is losing out on sales in China due to the ongoing anti-Japanese sentiment in the country. The automaker, which earlier forecast its sales to normalize by the middle of the year, now expects the sales to recover not before fall this year. The automaker’s sales were down 6.7% in April after they slid 11.7% in March. [4]

In the U.S., the refreshed Accord and the Fusion are witnessing a solid growth at the expense of Toyota’s Camry. Similarly, the Honda Civic now outsells the Corolla in the U.S. Toyota’s sales have even turned negative recently. In Japan, the automobile market was artificially boosted in 2012 with the help of government incentives. Now that the subsidies have ended, the automobile market is expected to decline this year. Toyota forecasts its Japanese sales to fall by 10% in the ongoing fiscal. These are the three biggest markets for Toyota and any weakness in these markets will be evident on the company’s financials

We currently have a $110 price estimate for Toyota’s stock, which is about 10% lower than the current market price.

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Notes:
  1. Toyota Pulls Bond Deal Due To Soaring Yields: The Japanese “VaR Shock” Feedback Loop Is Back, May 19,2013, zerohedge.com []
  2. GLOBAL MARKETS-JGB yields surge, markets spooked by Bernanke remarks, May 22, 2013, cnbc.com []
  3. Toyota Motors Investor Relations []
  4. Toyota says April China auto sales down 6.5pc year-on-year, May 6, 2013, brecorder.com []
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