In the past 6 months, Toyota (TM) increased 44.24% in price. But this is not the most amazing part of the story: TM 's performance is naturally a clear reflection of the Japanese headquarters (TYO: 7203), the biggest market capitalization in Tokyo Exchange, which experienced an astonishing 74.51% price increase since Abe took power. It is the main mover of the Nikkei 225.
After a 3 months 44.24% increase in stock price, is there further room for growth? In this article we provide a bullish view on the matter, by focusing on both the macroeconomic environment and the fundamentals of the firm. Let us start with the macro first:
1) Toyota and Macroeconomics
My thesis is that Toyota never stopped being a company with excellent products, supply chain management and outstanding value.
However, both the Japanese macroeconomic environment and the U.S. recession hit the biggest auto maker in the world hard, especially after the 2007-2008 crisis, causing the stock to be massively undervalued. But the stock never lost its intrinsic value, even in the worst days of the crisis. Relatively speaking, Toyota did extremely well after Lehman, especially if we consider that it did not receive the kind of government support that its American competitors did.
However, now that the U.S. aggregate demand is recovering and that Abenomics is causing a strong yen depreciation (and monetary-based economic growth), Toyota finds itself in a very comfortable macroeconomic environment. Furthermore, I believe that there is a strong historical correlation between yen depreciation and stock performance.
The following graph shows the 10 year stock price history of Toyota in the Tokyo Stock Exchange. From this long perspective, 5480 yen per share doesn't seem high. But the most important lesson this graph tells us is that there seems to be a strong positive correlation between Japanese depreciation and stock performance: periods associated with strong yen deflation are exactly the same periods when Toyota experiences massive decreases in stock price. For example, the period between 2007 and 2008, when Japanese currency appreciated 15% against the dollar, is the same period when Toyota stock price decreased from 7460 yen to 5020 yen per share.
This relation is not just historical. Let us now focus on right part of the graph: the 6 past months performance.
This period starts basically at the same time Abenomics does. Abe officially took power on December 26th but he was expected to be the next prime minister ever since he defeated Shigeru Ishiba in a run-off vote to win the LDP presidential election on September 26th. His rhetoric favoring quantitative easing and reforms in the Bank of Japan were causing yen depreciation since then.
The following graph shows how Toyota performed under Abenomics so far. You can see how strongly Toyota (both in Tokyo Stock Exchange and New York Stock Exchange) stock price and the USD/JPY correlate.
So far, we understand that yen depreciation and Toyota stock performance have been (and continue being) positively correlated. I will explain more details about the origins of this relation in the next section of the article, but for now it is enough to understand that the statistical relationship is very strong. The more yen depreciation, the higher the odds that Toyota will continue outperforming the markets. Our next question is, will the yen continue depreciating?
From now on
I explained in my previous article "Japanese Economy And Monetary Policy: What To Expect This Week" why I believe that the yen will continue depreciating for the next several weeks. I do not want to repeat the same reasons. Instead, I will mention 3 other sources that also believe Abenomics is just starting:
- Roubini Global Economics: They believe that the combination of expansions in the monetary stimulus program and some regulatory and fiscal reforms scheduled for this year will cause further yen depreciation in Q2, taking the cross rate to around 105 by mid year and higher by year end.
-Robert Khan believes Abenomics is here to stay. This article explains why Abenomics is more than momentum. Abenomics is a change in monetary policy paradigm.
- Paul Krugman believes Abenomics could work.
In a nutshell, it is very probable that the yen will continue depreciating, causing Toyota stock price to further increase. After 5 years, the Japanese macroeconomic environment is finally favorable to Toyota. For decades, many have believed that when Toyota does great, so does Japan. It seems that this year, however, Japan will do great first and Toyota will follow.
2) Why Toyota benefits from a weak yen
But how does Toyota benefit from a weak yen? After all, it is an export driven company. 72% of Toyota's vehicle sales in 2012 were outside Japan (25% coming from North America).
Wouldn't a weak yen have a negative effect on reported revenue?
Toyota benefits from a weak yen due to lower production costs. It might be hard to believe, but Toyota actually exports more than 2 million vehicles from Japan annually. According to an analysis by Deutsche Bank, 27% of the models Toyota sells in the U.S. are imported, compared with 10% of those sold by Honda Motors (HMC). Even Toyota's North American factories will benefit from a weaker yen, since 15% to 35% of the parts employed in Toyota's North American built models come from Japan.
In this way, yen depreciation gives Toyota a significant financial gain on very car it sells. According to Morgan Stanley, the currency boost is approximately $1,500 per car. Detroit is deeply worried about this:
"We're concerned about what the long-term ramifications are"
Joe Hinrichs, Ford motor Co. (F) North American chief
"We did'nt need this, to put it blunty. It's going to make life tougher"
Sergio Marchionne, CEO, Chrysler Group LLC and Fiat SpA
3) The microeconomics of Toyota
Let us finish our article with a brief analysis on the microeconomics of Toyota. I find 4 bullish signals here:
A strong balance sheet: A very small debt, compared with the size of accumulated cash. Toyota's consolidated cash and cash equivalents surpass ¥2.7 trillion (about 16% of the current market capitalization). According to Morningstar, the company also has unused long-term credit lines valued at ¥10.1 (60% of the current market cap).
No "pension liabilities" issue: Unlike the Detroit Three, Toyota has significantly lower pension costs. This is a strong competitive advantage.
Excellent quality and "Just in time" supply chain management: Regardless of the macroeconomic environment, Toyota always strives for continuous improvements (Kaizen). Its superior production system allows the firm to enjoy cost efficiency by:
- Eliminating unnecessary inventory (all parts are "just in time")
- Reducing shipping distances (key suppliers are located near to the main assembly plant).
- Strong collaboration with suppliers to set fair pricing and quality goals.
Toyota is still growing: Having a huge market capitalization of ¥17.5 trillion is no impediment for Toyota to continue growing. Recently, Toyota projected that its global sales would rise 2% to a record next year. It seems the fully recovered from a plunge in production after the Tohoku earthquake (the Aqua model was produced in Iwate, in the north of Japan).
Investment Horizon: 1 year
Strategy: Value, Global Macro