VALUATION HIGHLIGHTS

1. Automotive Segment constitutes 90% of the Trefis price estimate for Toyota's stock.

WHAT HAS CHANGED?

1. Latest Earnings

Toyota posted stronger-than-expected results for Q3 FY'23, driven by a weaker yen and rising volumes. Toyota's operating profits for the quarter stood at about $7.3 billion on revenues of about $74 billion. Deliveries for the quarter rose by about 16% year-over-year to 2.33 million. However, Toyota's operating margins contiuned to face some pressure, declining from around 10.1% in Q3 FY'22 to 9.8% in Q3 FY'23, due to elevated raw material prices and energy costs. Toyota has reiterated its forecast for annual profit of about $18 billion for FY'23.

Note: Toyota's Q3 FY'23 ended on December 31, 2022

2. Impact of coronavirus outbreak

Toyota's business has faced significant disruption due to Covid-19. While sales declined in FY'21, as the initial lockdowns in 2020 hurt production and automobile demand, demand picked up nicely in FY'22. The company also gained pricing power, resulting in relatively strong topline growth. However, over Q1 FY'23, Toyota cut its global production targets due to a shortage of semiconductors and Covid-19-related restrictions in China.

3. Toyota gets more serious about EVs

Although Toyota was traditionally seen as a laggard in the electric vehicle space, the company is getting more serious about its EV business. The company is now targeting the sale of 3.5 million EVs and fuel cell vehicles globally by the end of the decade, with plans to market close to 30 different models. Toyota will also invest about $70 billion through 2030 towards R&D and capital expenditures for electric, hybrid, and fuel cell vehicles.

4. Shifting Car Market in North America

Toyota has dominated the U.S. passenger car market with its popular sedans. However, this market is now shrinking, with customers preferring crossovers and SUVs. The company continued to see a decline in volume and EBIT. The company is looking to review its current models to maximize vehicle sales and profitability and resolve the gap between supply and demand. Higher sales incentives and reduced production in North America adversely impact the company's profitability.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

• Toyota Automotive Gross Margins: Toyota's gross margins increased from 25% in 2017 to 25.5% in 2021. This level is higher than Toyota's competitors like GM and Ford. A 30 basis point growth rate per year over the rest of our forecast period could increase Toyota's valuation by more than 11%. A 30 basis point decline in growth per year over the rest of our forecast period could lead Toyota's valuation down by 22%.

BUSINESS SUMMARY

Toyota Motor Corporation is the world's largest automaker by sales and is headquartered in Japan. Toyota is engaged in developing, manufacturing, distributing, and selling a wide range of automotive products, mainly passenger cars, SUVs, and trucks. Toyota's sales are concentrated in Japan and North America, but Asia and South America have seen rapid sales growth in the recent past. Toyota sells its vehicles under mainly three brands: Toyota, Lexus, and Scion. It also has a majority stake in Daihatsu and Hino Motors and minority shareholdings in Fuji Heavy Industries, Isuzu Motors, Yamaha Motors, and Mitsubishi Aircraft Corporation. The company also runs a Housing, IT, and other services business in Japan.

SOURCES OF VALUE

International Sales are 2x more than the North American vehicle market

In 2020, Toyota's North America auto sales amounted to 2.7 million. In comparison, there were around 2.3x as many vehicle sales (6.2 million) internationally, including in Japan. We estimate that Toyota will be able to grow its international market share in the coming years.

Toyota has superior operating margins compared to the rest of the auto industry

Even though Toyota sells more vehicles than any other auto company, it still posts higher operating margins than most of its competitors. The Japanese automaker is an expert in the production process of vehicles and consistently designs and manufactures vehicles more efficiently than its competitors.

KEY TRENDS

Hybrid and electric technology to benefit Toyota in the long run

Toyota is one of the largest companies to push hybrid vehicles in the market and the first to commercially mass-produce and sell such vehicles, an example being the Toyota Prius. Toyota has said it plans to make a hybrid-electric system available on every vehicle it sells worldwide sometime soon. Toyota is speeding up the development of vehicles that run only on electricity.

Exchange rates play an important role in Toyota's profit

Toyota's profits are recorded in Japanese yen, but its sales are denominated in euros, dollars, pounds, Chinese yuan, and many other currencies. This is because 40-50% of Toyota's production still happens in Japan, and most vehicles are exported. Fluctuations in the exchange rate between these currencies and the yen can lead to fluctuations in Toyota's profits; these fluctuations can be substantial. Toyota hedges its exchange rate risk by arranging currency swaps and purchasing futures, but these operations are costly and threaten to cut the bottom line.

Cross-shareholding among Japanese firms often results in conflicting interests

Major Japanese firms have long practiced extensive cross-shareholding. This process serves to both smooth domestic business relations while at the same time preventing a widespread foreign acquisition of Japanese businesses.

This has several potential pitfalls for common shareholders: 1) A company can experience significant write-downs due to stock declines of other companies it owns, even when business is otherwise healthy. 2) Accumulating such ownership stakes means that capital is diverted from other, often more profitable tasks, such as reinvestment in the automaking business or dividends to shareholders. 3) Cross-shareholding makes it more difficult for shareholders to hold management accountable, as the managers at other significant firms who own the firm can frequently interfere with their counterparts.