Toyota Motors (TM) could shed another 7% to 15% if you believe this hit to its reputation could bring it down to earth, or to a forward P/E ratio comparable to peers Honda Motors (NYSE: HMC) and Ford (NYSE: F).
Toyota Motors said late Wednesday that it was expanding its vehicle recall to include another 1.1 million cars and trucks. This is in addition to the 2.3 million vehicles Toyota recalled last week. The reason for recall is the same across models and years of production, a faulty accelerator pedal that is at risk of sticking. Toyota is now recalling vehicles in the US, Canada and Europe. The additional models and years are:
- Corolla, Venza & Matrix (2009 - 2010)
- Highlander (2008 - 2010)
- Pontiac Vibe (2009 - 2010)
Including last year's recall, which was reported by the company as a problem with floor mats, Toyota has now called back a total of 5.9 million cars and trucks. The catalyst behind the discovery of the sticky accelerator seems to be an investigation by the U.S. National Highway Traffic Safety Administration, which was tied to a deadly accident.
Toyota has built its name on quality, and has become the auto industry's global production leader thanks to that record and the troubles of its American rivals. With its reputation now damaged so badly in the US by this matter, and with the rise of low cost producing rivals overseas like Tata Motors (NYSE: TTM), global market share loss seems likely. This might be a classic reversion to the mean scenario, and so I would not be a buyer of TM weakness here, despite the significant price shedding of the past few days.
Considering how poorly the company has managed public relations to this point (just hired a PR firm), and how important honesty is to the American consumer (the appearance here is something less than that), expect this to benefit the Americans. Ford shares gained 3.2% on Wednesday, and were up another 0.87% in the after market (7:59 PM) - partly on this and partly on its own good news this quarter.
Both General Motors and Ford have jumped at the opportunity to take back some recently lost market share. GM said that from now through February, dealers will offer owners and leasees of Toyota vehicles three incentives to buy its cars:
- A waiver of three payments up to a total of $1,000 for lease customers
- Zero percent interest for up to 60 months for financing customers
- A $1,000 purchase bonus for cash buyers.
Ford is offering Toyota customers $1,000 if they trade in their used or leased vehicles. Ford extends this offer to folks who turn in Toyota, Lexus, Scion, Honda or Acura vehicles with model-years between 1995 and 2010. The offer can be applied to all Ford vehicles, except its gas-electric hybrid models, its F-150 Raptor pick-up truck, the new Taurus SE sedan, the Edge SUV all-wheel drive, and its Shelby GT500 and KR sports cars (according to a report published Wednesday by The Wall Street Journal).
Back of the Envelope Valuation
Toyota's shares dropped 8.1% on Wednesday, and were off another half point in after-hours trading (7:54 PM). Since posting a recent short-term high on the 19th of January, the shares are off 13%. If this hit to Toyota's image, which was pretty solid before the scandal and apparent cover up broke, were to bring its P/E ratio even with Ford's on forward EPS estimates, then Toyota should trade at $68.44. (Note: we have not accounted for the difference in fiscal year. Ford's fiscal year ends in December, so we used its FY 2010 (Dec) consensus EPS estimate of $0.54 (found at Yahoo Finance), and then applied the related P/E ratio of 21.389 (based on a closing price of $11.55) to Toyota's FY 2011 (March) consensus estimate of $3.20; theoretically this difference would serve to overstate Toyota's price target though, given no seasonal factor plays a role quarterly results.)
Keep in mind that this is a very rough estimate, using the unstable figures of two companies in quite different situations. However, if we use Honda Motors, which like Toyota has a March fiscal year, and take its relative forward FY 2011 P/E ratio of 20.83, and apply it to Toyota's $3.20 forward EPS estimate, the target becomes $66.66 (not much different). The average of the two price forecasts is $67.55, and so we might say roughly that Toyota could sink another 15.3% if it were to revert toward and reach the relative valuation mean of these two rivals. Also note that both Ford and Honda are reporting earnings now and may revise forecasts.
Keep in mind that both Ford and Honda stock prices have already closed some of the valuation gap between them and Toyota. So, if both valuations are converging, due to a limited global market size and near zero sum market share trade-off in the developed markets they mostly compete in (though sales recovering), we might cut the forward loss potential in half, to 7.7% or so, or toward a price target of approximately $73.66 ((Target mean + TM Price) / 2). This assumes the valuations will meet before effective reconsideration takes place ("valuations" are rising F & HMC to falling TM).
Now this implies that the global marketplace is even and fair, but we know Toyota enjoys strong advantage at home. However, we might also argue that President Obama is igniting a nationalistic attitude in the US, which serves to improve American-made demand at home (another significant marketplace). In any event, the case seems to build against Toyota.
"I would sell Toyota toward a price target of $74 to $68."
I would not be buying TM now, but selling toward a price target of $74 to $68. A pair trade, including the purchase of Ford or Honda against the sale of Toyota seems to also work, while weeding out macroeconomic noise. However, you run risk related to the near-term EPS reports of Ford and Honda - although both have posted good news lately, you still run a special risk with the pair trade.
When I was an equity analyst, I would base my idea only on this information, but I would further research other rival firm valuations, and consider various valuation methodologies before moving forward with a formal recommendation. For an investor, it also makes sense to give more consideration to these issues before putting money on the unfinished theory.
Your biggest risk against the sale of TM seems to be that Toyota works a PR miracle, but its actions to this point do not indicate to me it would occur anytime soon. A second risk would be an early upgrade of TM by a stubborn or ambitious Street analyst with a name. That potential action also still seems too far off to me, but seller beware.
Author's Disclosure: No Positions