Don't be fooled by
Chairman Hiroshi Okuda's recent comments about raising prices on vehicles sold in the U.S. in order to give ailing American automakers "time and room to catch a breath."
As reported in the Japanese press, Okuda expressed concern about the plight of U.S. car manufacturers generally and
in particular. Price increases could be a step toward "creating a condition where Japanese and U.S. auto makers can compete," he suggested.
The company later disavowed Okuda's generosity, and more importantly, Toyota's
display little altruism toward competitors. At issue is whether Toyota's preeminence in a notoriously challenging industry makes its stock a good investment.
Toyota recorded record sales months in February and March, and it is expected to report $1.64 a share in fiscal fourth-quarter earnings, a 28% increase over the same period last year.
On Wednesday, Toyota announced that it expects to sell 8.3 million vehicles in 2005, exceeding its previous target of 8 million. In 2006, it expects the figure to grow to 8.5 million. In contrast,
and GM have experienced significant erosion in their domestic and global market shares and have repeatedly disappointed Wall Street this year.
From an execution standpoint, Toyota stands unmatched. Its operating margins lead the industry. It leads in the coveted and rapidly emerging Chinese car market. It dominates the hybrid market with the Prius.
Although hybrids accounted for fewer than 1% of the 17 million new vehicles sold in 2004, the market grew about 81% last year, according to new vehicle registration data released by R.L. Polk & Co. The hybrid market has grown by an estimated 960% since 2000.
The results vindicate Toyota's hybrid technology investments in the late 1990s, when U.S. manufacturers feasted on gas-guzzling trucks and SUVs. Those vehicles now appear to be losing luster as oil prices rise. And with its vindication, Toyota looks emboldened.
On Wednesday, the company unveiled plans to build an auto assembly plant in St. Petersburg, making it the first Japanese carmaker to build a manufacturing plant in Russia. It also unveiled plans to invest $455 million in a new plant in Thailand that will produce pickup trucks.
Toyota also plans to expand in the U.S. When a reporter asked Yoshimi Inaba, a Toyota senior executive and former U.S. chief, why the company needs to build a seventh and eighth auto-assembly plant in America, he laughed and boasted: "We may need a ninth or tenth," according to
Such haughtiness is atypical among Japanese executives, but may help explain why Wall Street analysts (a typically boastful bunch) are overwhelmingly bullish on Toyota.
To be sure, the company offers a breath of fresh air compared with the foul winds emanating from Ford and GM. Toyota sports a rare triple-A credit rating, with interest expense at little more than 1% of cash flow from operations; meanwhile, GM and Ford teeter just above the junk heap. Crucially, the company's nonunion workforce leaves it unshackled by the eye-popping health care and pension costs shouldered by the U.S. companies.
But does Toyota's preeminent position make it a good investment?
Even with its shares off more than 10% in 2005, the company doesn't appear to be undervalued, and it faces a host of short- and long-term risks.
Nicest House on Bad Block
Toyota averaged $1,090 per vehicle in incentives in March, a 137% increase from a year ago, according to Edmunds.com. During the same period, incentives offered by U.S. automakers rose only 7%. Toyota's incentives are still only about a third of those offered by Ford and GM, but the big increase suggests the company is feeling pressure.
"These high incentives are a tough thing to reverse once they get started," says Morningstar analyst Phil Guziec. "Toyota would probably welcome a price raise in that respect. It might not gain market share as fast, but it would be generating significant excess profits."
Meanwhile, as Toyota is eating Ford and GM's lunch, it faces lean and mean competition from other Asian manufacturers like
, which just this week took direct aim at Toyota by announcing its intention to be the industry's top-quality producer by 2008,
The Wall Street Journal
"There's very little competitive protection in the auto industry," Guziec says. "When you have a lead in the market, it never takes long for the competition to catch up."
Currency fluctuations present another short-term concern for Toyota shareholders. Using a discounted cash flow valuation model, Guziec pins the fair value of Toyota shares at $71, a slight discount to Thursday's closing price of $71.99. However, a 10% strengthening of the yen vs. the dollar would decrease that fair value estimate by 20%, he estimates, since a stronger yen would presumably decrease Toyota's profits from U.S. exports.
Despite the widening U.S. trade deficit, the dollar has rallied over 3% vs. the yen in 2005; however, many observes believe the greenback's recent rally is unsustainable.
Rising commodity and gas prices are also putting strains on Toyota and on the rest of the auto industry.
George Magliano, director of automotive research with Global Insight, expects sales of about 16.7 million units this year, an increase of about a million units from 2002. "But we've lowered the overall forecast by a couple hundred thousand units because of higher prices of oil, which are going to impact the consumer and take some of the steam out of the light-vehicle market," Magliano says.
Finally, some analysts question whether Toyota's aggressive investment strategy is really in the best long-term interests of its shareholders.
"The big question with Toyota is whether they are growing rapidly and investing in hybrids at the expense of profits and dividends for the shareholders," says Burnham Securities analyst David Healy. "Are they doing growth for growth's sake and market share for market share's sake, or is it for the stockholders? There's a lot of disagreement out there in the investment community as to whether their strategy is right from the point of view of the shareholders." (Healy does not own Toyota shares, and his firm has no investment-banking relationship with the company.)
With more than $17 billion in cash on its balance sheet, Toyota has the ability to improve its dividend yield, currently at 1.3%. However, the company is opting to invest its cash in new technologies, banking on the growth prospects of its business.
"Toyota employs a lot of capital doing what it does, and its returns on invested capital in the automotive business are south of 10%," Guziec says. "They're not superstar returns. Shareholders don't have a lot of ways to get the company to focus on profitability and short-term returns."
Despite all the risks, Healy thinks Toyota's strategy will pay off eventually, especially since he believes hybrids will one day dominate the auto market.
"All this should pay off for investors," Healy says. "But you've got to be a young investor."