Toyota Faces A Challenging Time Ahead

by Trefis Team
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Toyota Motors (NYSE:TM) is one of the most profitable auto companies and also the biggest by market capitalization. When compared with General Motors, Volkswagen, and Ford, three companies which sell a comparable number of vehicles each year, its market capitalization exceeds the sum of all three. This is what makes it one of the most attractive investments in the auto market, of the 10 least attractive sectors to invest in. The auto industry as a whole averages around 5%-6% in revenue growth and an operating margin of around 4%-5%. Low revenue growth and low margins combined with the high amount of reinvestment required to keep the business in place, makes the auto industry one of the least attractive investments. Toyota fares much better than its peers on a number of counts — it sells a higher number of units than all others, its average transaction prices are higher than those of its peers, it posts higher operating margins because of its efficient production process, and it has a successful luxury vehicle brand in Lexus.

All of these still remain true but two current trends and two future trends threaten Toyota’s future prospects. In fiscal year 2017, the company saw its sales grow by 1.6% to around 10.3 million units. Its revenue declined by 2.8% to around $165.4 billion with net income declining by 21%. Moreover, the company guided that net income for the next fiscal year will also decline by 18%, which could make the 2017-2018 period the company’s worst in 20 years. The main reasons for the decline in the company’s profitability are 1) the decline of the passenger car market in the U.S., 2) the slow down in the Japanese car market and 3) unfavorable fluctuations in the currency exchange rate.

Toyota has traditionally dominated the passenger car market in the U.S. with Camry and Corolla. But this market segment has now declined for three years in a row now and this has affected the company’s profitability in this segment. Although Toyota has made headway in the SUV segment with RAV4, Highlander, and 4Runner, these gains aren’t enough to offset the decline in the passenger car segment.

Currently, the company is expecting its capital expenditure to go up as it retools its factories for the new Toyota Global Vehicle Architecture Platform. This platform will allow Toyota’s cars to become much more modular. The Japanese auto maker has already been successful with the latest version of the Prius, Camry, and Lexus LC in using this production methodology. Modular manufacturing and design also makes vehicles much more amenable to electrification, one of the biggest factors haunting Toyota’s future prospects currently. For a number of years the company has dithered on the question of electric vehicles, instead preferring hybrid technologies or fuel-cell vehicles. However, now the company is going full pelt into electric vehicles, having started a new EV Business Planning Department which will be headed by company President Akio Toyoda himself. Additionally, the company is investing $1 billion in a U.S. based research institute for Artificial Intelligence to keep up with the latest innovations in ride sharing and autonomous driving capabilities.

Innovating in the manufacturing process, developing self-driving capabilities, and figuring out a way to ward off self-driving companies like Uber are the three most important things for an auto company today and Toyota is alert on all three fronts. The trouble here is that increased investment in these areas will not have immediate returns and their success is still uncertain. This is why Toyota’s profitability going forward is likely to be lower.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Toyota Motor

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