Earnings Review: Toyota Posts Record Profits On Weak Yen But Faces Tough Road Ahead

Toyota Motors (NYSE:TM) announced record quarterly net profit for the first quarter of fiscal 2016 despite a marginal decline in overall sales. ^[1] The Japanese auto maker did this on the back of a strong quarter in North America, which meant that strong dollar sales translated into higher profits in a weak yen, and cost-cutting measures. ^[2] The company raised its forecasts for consolidated unit sales and revenue for the full fiscal year but left the operating income and net profit figures unchanged, signalling that more gains are to be expected because of a strong U.S. dollar in the rest of the year. ^[3]

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Increased Unit Sales in North America

Toyota sold around 729,000 units in North America in the first quarter, an increase of 19,000 units compared to the first quarter of last year. ^[4] Net revenues jumped by 25.7% on the back of this figure but a 130 basis point decline in operating margin meant that operating income only increased by $1.4 billion, or less than 1%. ^[4] Including valuation losses from interest rate swaps, operating income dropped by an alarming 23.4%. ^[2]

In recent months, Toyota has been focused on diversifying from its core base of loyal Camry and Corolla buyers into the light trucks market, traditionally the domain of U.S. based auto companies like GM, Ford and Chrysler. The company has been steadily gaining ground in that market. Toyota’s truck sales rose by 18% in the month of June, even as car sales fell by 6.2% (both year-over-year comparisons) on the back of an industry wide boom in the sales of SUVs, crossovers, minivans and pickups. ^[5] However, as Toyota’s model lineup is still largely filled with passenger cars, overall sales rose by only 3.7%. In the second half of the calendar year, Toyota is set to introduce a renewed version of the Lexus RX crossover. ^[4] Sales of the old version of the Lexus RX had been declining, so the new model launch should help the company reverse that trend.

Short lived Gains In China

Japanese car companies have had trouble negotiating the China auto market in recent years. In the 2008-2011 period, they had started making progress in China as competitors from U.S. had to deal with financial trouble back at home. But the twin impact of the Tsunami in 2011 and anti-Japanese protests in 2012 led to declining sales of their cars. Recently they had started to gain market share again with the combined market share of Japanese car companies reaching 20% in May, a level last seen before 2012. ^[6] However, the Chinese economy is experiencing a massive slowdown, the worst in 25 years in fact, and this is affecting profitability. Car makers are having to cut prices and offer incentives in order to drive unit sales.

Toyota’s profitability was affected by these trends in this quarter as strong sales of the RAV4 SUV did not translate into higher profits, as competitors aggressively cut prices in order to capitalize on surging demand for SUVs in China. This is a problem for Toyota as company dealerships in China had already been struggling with profitability over the last year or so. It was reported that 10% of dealerships were considering closing shop or switching to a different brand because they were struggling to make profit selling Toyota’s cars. ^[7] Moreover, 95% of showrooms were losing money. Following this, the company had to payout $200 million to subsidize the dealerships in the region. ^[8] This kind of payout increases the cost of acquisition of customers and puts pressure on margins. If the company loses revenue because of lower transaction prices and incentives, that puts further pressure on margins and a continuation of these trends makes it hard to be optimistic about the company’s prospects in the country going forward.

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1. Toyota Motor Corporation FY16 First Quarter Financial Summary, Toyota Investor Relations [↩]
2. Ref: 1 [↩] [↩]
3. FY 2016 First Quarter Financial Results, Toyota Investor Relations [↩]
4. Ref: 2 [↩] [↩] [↩]
5. Strong truck volume helps Toyota offset weak car demand, Automotive News, July 2015 [↩]
6. Japanese cement comeback in China as Toyota posts record sales, Automotive News, August 2015 [↩]
7. Toyota Agrees to Pay $200 Million to China Dealers, Bloomberg, February 2015 [↩]
8. Ref: 4 [↩]