Earnings Preview: Strong End To The Year Bodes Well For Toyota’s Profits

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Toyota Motor

Toyota Motors (NYSE:TM) is scheduled to announce its third quarter earnings on February 4. All things considered, 2014 was generally a good year for Toyota. The company had top sellers in many car categories in the U.S. car market, including Camry (best selling car), Corolla (best selling subcompact car), Avalon (best selling car in the premium segment), and several other cars achieving their one-year sales records, including RAV4 and Highlander. [1] The Japan-based auto maker increased its market share in the U.S., its biggest market, by 20 basis points to reach 14.2%. [1] On the back of strong performance by both Toyota and Lexus in North America, plus strong momentum towards the end of the year in China, we expect the company to report strong figures when it announce results on Wednesday.

Below, we take a closer look at the figures we will be watching out for in this quarter’s results. We have a $168 price estimate for Toyota, which is about 25% higher than the current market price.

Recap of First Half of Fiscal 2015 Results

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In the first half of fiscal 2015,strong sales in the U.S. helped the Japanese auto maker overcome weakness in emerging markets, Europe and Japan, as well as post a net income gain of 12.6%. [2] Consolidated net vehicle sales stayed flat despite losses in all regions except North America where refreshed SUV models and pickup trucks sold extremely well during the half. Sales in North America  increased by 12.4% on the back of increasing sales of Toyota’s SUVs, RAV4, and Highlander, 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. Net revenue for the period increased by 3.3% compared to the first half of fiscal 2014. The operating margin for the quarter increased by 40 basis points as a result of cost reduction efforts and favorable currency translations. [3]

Higher SUV and Lexus Sales Can Boost Margins

In the U.S., Toyota has been able to largely maintain its strong performance through the October-December period. The Japanese auto maker retained its position as the leading retail brand in the automotive market for the twelfth straight month in September, on the back of strong SUV and crossover demand. Its new models have continued to show strong positive sales trends. Sales for the Toyota brand grew by 12.2% in the month of December and the company’s premium brand Lexus reported all-time record single month gains of 14.7%. [4] 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 set sales records for the month of December. [1]

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, put downward pressure on sales in 2014. In the first half of fiscal 2015, Toyota’s units sold in Asia were down year-on-year, affected by weaker sales in Thailand and India, where demand shrank and competition increased. [5] Unit sales from emerging markets, including China, account for about 45% of the automaker’s sales. [6]

China Provides Some Reasons For Optimism

In 2014, Toyota narrowly kept its position as the global leader in terms of vehicle unit sales in 2014, ahead of German auto maker Volkswagen AG. [7] Toyota sales, including deliveries from its mini-car subsidiary Daihatsu,  and truck making affiliate Hino, rose by 3% in 2014 to reach 10.23 million units, while Volkswagen increased its sales by 4% to reach 10.15 million units sold in 2014. The company managed to achieve this target even though it missed out on its China sales target of 1.1 million units. The Japanese auto maker sold 1.03 million units in the calendar year 2014, an increase of 13% compared to 2013.

Toyota has missed out on the booms in the SUV and crossover segments in the world’s biggest auto market. The Japanese company has also been reluctant in expanding its capacity in the region. It hasn’t built a single plant in China since 2012 and decided to avoid using its cash reserves for that purpose in 2014, instead opting to buy back shares. The company is unlikely to add to its capacity in China for a year at least. In contrast, competitor Volkswagen is opening a new factory this year in Changsha. [8] The factory is expected to add capacity of 300,000 vehicles to the company’s operations in China.((Toyota may lose global sales lead to VW without new China strategy, Automotive News, January 2014)) Volkswagen expects to raise its vehicle capacity in China to more than 4 million by 2018. [8]  U.S. based auto maker General Motors, the holder of the second position for unit sales in China and third worldwide, is planning to add five new factories in China in the same time period.

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 ($3,000 vs $9,000 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

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Notes:
  1. Toyota Motor Sales Results Up 12.7 Percent in December; 6.2 Percent for 2014, Toyota Pressroom, January 2015 [] [] []
  2. Toyota Motors Investor Relations []
  3. FY2015 Q2 Results Investor Presentation, Toyota Motors Investor Relations []
  4. December 2014 Sales Chart, Toyota Press Room, January 2015 []
  5. FY2015 Q1 Results Investor Presentation, Toyota Motors Investor Relations []
  6. Toyota Motors 2014 Results Earnings Call Transcript, Seeking Alpha, May 2o14 []
  7. Toyota keeps top spot despite strong VW challenge, Automotive News, January 2015 []
  8. Toyota may lose global sales lead to VW without new China strategy, Automotive News, January 2014 [] []