Toyota (NYSE:TM) has had a longstanding commitment of producing at least three million vehicles in Japan to support Japanese employees and economy with around half of these destined for overseas buyers. But the land of the rising sun has now become the the land of the rising Yen which is making vehicles made in Japan more expensive for international customers. Falling demand in Japan and the U.S. is not helping and indeed making the company’s commitment to support Japanese manufacturing a huge liability for the company. Toyota produces almost half its vehicles in Japan while other Japanese auto-manufacturers – Honda (NYSE:HMC) and Nissan (PINK:NSANY) produce around one-third of their vehicles in the country. Toyota also competes with American manufacturers like GM (NYSE:GM) and Ford (NYSE:F), which have been gaining U.S. market share at the expense of Toyota since Toyota’s production capacity was beset by earthquake and tsunami in Japan in March.
Our price estimate of $76 for Toyota’s stock is around 20% above the current market price.
Choosing profitability over patriotism
Even though Toyota is officially still committed to support its manufacturing base in Japan, it hopes to ride out the current slump in demand and adverse foreign exchange movement through cost-cutting, hyper-efficiency and collaboration on new technology with parts suppliers. Also the company is reportedly increasing use of cheaper imported parts by trying to convince its existing network of Japanese suppliers to set up manufacturing in China and U.S.  But to protect its profit margins against the rising Yen, Toyota will eventually need to shift its Japanese production overseas, closer to its international customers.
An official of one of Toyota’s suppliers said the auto maker was looking into moving production of some Miyagi-made cars to a plant in Baja California, Mexico. While Toyota officially denies such plans, Toyota’s president Akio Toyoda recently indicated he favored shifting more compact-car production out of Japan to stay competitive if the yen remains at record highs against the U.S. dollar or strengthens further. ((ref:1))
In any case it will take at least two years for Toyota to effect this shift and thus Toyota’s profit margins will continue to remain under pressure in the medium-term, resulting in downside risk to our present estimates for Toyota’s stock.
You can drag the trend lines in the modifiable chart above to see the impact of these trends on Toyota’s stock value.Notes: