Earnings Preview: Strong U.S., China Performance Should Boost Toyota’s Profits

Toyota Motors (NYSE:TM) is scheduled to announce its second quarter earnings on November 5. The world’s largest automaker has relied on strength in the U.S. auto market to offset weak performance in emerging markets over the last couple of quarters. In the previous quarter, strong sales in the U.S. helped  the company overcome weakness in emerging markets like Thailand, India and Brazil, and post a net income gain of 4.6% in the first quarter of fiscal 2015. ^[1] Consolidated net vehicle sales increased by 9,000 units driven by a 3% increase in North America sales where refreshed SUV models, pickup trucks and Camry sedans sold extremely well during the quarter. Sales in Europe increased by 7% on the back of increasing sales of Toyota’s compact hatchback Auris and subcompact Yaris, while sales in Japan dropped as expected following the hike in sales tax and drop in real wages as a result of Prime Minister Shinzo Abe’s inflationary policies. ^[2]

Below, we take a closer look at the figures we will be watching out for in this quarter’s results. We have a $129 price estimate for Toyota, which is about 6% higher than the current market price.

Higher SUV and Lexus Sales Can Boost Margins

In the U.S., Toyota has been able to largely maintain its strong performance through the July-September period. The Japanese auto maker retained its position as the leading retail brand in the automotive market for the ninth straight month in September, on the back of strong SUV and crossover demand. Its new models have continued to show strong positive sales trends. Although, sales for the Toyota brand grew by only 0.3% in the month of September, with slowing sales of the Corolla and Camry dragging down the overall figures, sales for Lexus, Toyota’s premium car brand grew by nearly 12%. ^[3] This performance is good for the company’s margins, as a higher percentage of luxury cars in the overall sales mix leads to higher cash profits. Moreover, the RAV4 and Highlander SUVs have also shown positive sales trends, growing by 43% and 22% respectively in the month of September.

Cautious on Emerging Markets

Consistent with the previous quarter, we are cautious on Toyota’s sales in emerging markets. The gradual withdrawal of the Fed’s quantitative easing, or tapering as it is known, is causing currency fluctuations in developing economies, which is driving uncertainty in these markets. Political turmoil in Thailand, one of Toyota’s key markets, could also drive down sales in 2014. In the previous quarter, Toyota’s units sold in Asia were down by 9,000 units year-on-year, affected by weaker sales in Thailand and India, where demand shrank and competition increased. ^[4] Unit sales from emerging markets, including China, account for about 45% of the automaker’s sales. ^[5]

China Provides Some Reasons For Optimism

In China, Toyota’s nine month consecutive spell of sales growth ended in June as the automaker posted a 7.6% year-on-year decline. The Japanese auto maker attributed the decline to changes in its model line-up, especially its Corolla sedan. Planning for the launch of a redesigned Corolla in mid-June, the company had stopped taking orders for the older model in May. ((Nissan, Honda China Car Sales Accelerate, Wall Street Journal, July 2014)) Toyota, like fellow Japanese car makers Nissan and Honda, has been attempting to recover from the setback it received following a territorial dispute between China and Japan, which centered on uninhabited islands in the East China Sea. The dispute led to public protests in China in 2012 which led to some people attacking drivers of cars with Japanese auto makes. Sales of Japanese cars fell in the aftermath of these events.

Sales fell in July by 1.1% on a year-on-year basis, but the company returned to growth in the month of August, posting a 8.9% year-on-year rise. ^[6] Toyota, which aims to sell 1.1 million vehicles this year in China, experienced a massive boost in September as sales grew by 26% from a year earlier. In the first nine months of the year, the company sold over 710,000 vehicles, an 11.5% increase compared to the previous year. Since, the company sold 917,500 vehicles in China in 2013, maintaining the same growth rate will see it fall short of its stated target for the year by about 78,000 units. However, the company has stated that it remains on target to achieve its 2014 targets. This may seem possible given the 27.1% growth in sales in October. ^[7]

Going forward, Toyota is looking to bolster its presence in the hybrid segment in the Chinese auto market. The Chinese government wants the unit sales of electric vehicles and hybrids to touch at least 5 million units annually by 2020 and is providing incentives to automakers who are developing such vehicles. More than 22 million vehicles were sold in China last year, and the government is trying to encourage hybrid sales to combat pollution issues. Toyota has signaled its intent to grow in this segment by partnering with two local automakers in order to develop new hybrids. Additionally, Toyota’s Prius is the highest selling gasoline electric vehicle in the world, with unit sales of 315,500 in 2013. However, only 1,400 of those were sold in China. There is clear upside potential for Toyota in this segment. The low subsidies offered by the Chinese Government to gasoline backed EV’s ($3000 vs $9000 for hybrids and fully electric vehicles) and the high import costs associated with vehicle parts push up the price of the Prius. In fact, a Prius in China costs almost as much as an entry-level Audi. Unless, Toyota decides to considerably lower the price of the Prius and accept lower profits, sales are unlikely to go up.

See our complete analysis for Toyota Motors here

1. Toyota Motors Investor Relations [↩]
2. FY2015 Q1 Results Investor Presentation, Toyota Motors Investor Relations [↩]
3. September 2014 Sales Chart, Toyota Press Room, October 2014 [↩]
4. FY2015 Q1 Results Investor Presentation, Toyota Motors Investor Relations [↩]
5. Toyota Motors 2014 Results Earnings Call Transcript, Seeking Alpha, May 2o14 [↩]
6. Toyota says September China auto sales up 26.1 pct y/y, Reuters, October 2014 [↩]
7. Toyota sees strong rise in China car sales, BBC, November 2014 [↩]