A sell signal just flashed for the Japanese auto makers Toyota Motor (TM), Honda Motor (HMC) and Nissan Motor (NSANY.OB). Data reported Wednesday indicated Japanese exports into Europe were down dramatically, with weakness focused in autos and machinery. Though, the same report indicated stronger exports into the United States. So, after accounting for the changes and factoring in the growth of sales into other emerging markets, we are charged with understanding what the net effect will be to the bottom lines of these firms and whether their individual valuations account for it. That's not a simple task, but we'll take a shot at it.
Japan reported that a collapse in exports into Europe drove its widest ever trade deficit for the month of July. Shipments into Europe dropped by a quarter compared to last year's levels. As a result, the nation's deficit was twice as wide as was expected by economists. The deficit was partly impacted by a significant change in the nation's energy operations since its nuclear disaster last year, with imports of petroleum fuels up significantly to make up for lost nuclear capacity. However, it was also driven by the country's connection to Europe.
Demand for Japanese products fell in every Western European market except for Ireland, with the range of decline reaching from one-fifth in Germany to one-third in Italy, France and the United Kingdom. Exports of autos into Europe were hit especially hard, with those falling 27% and portending trouble for Toyota , Honda and Nissan at their forward earnings dates. However, the Japanese saw increased demand for autos and other goods from their U.S. market. Japanese exports into America rose by 4.7% and were led by autos, which were up 14.7%. Unfortunately, the data also indicate the spreading of softness into emerging growth markets. Japanese exports into Asia were down 9%, though auto exports were 15.2% higher there. Thus, the question is raised, what's the net impact.
Japanese exports were down 8.1% overall, but exports of autos were up 6.4% overall. Still, the marked decline of sales into Europe should impact results if the growth into other markets is not above forecast by more than the shortfall in Europe. Unfortunately, I think that is the likely scenario. Furthermore, the decline of Europe is having repercussions for other markets, and could be dragging on growth of Japanese auto sales elsewhere today or in the near future. Still, it's certain that automakers, including Ford (F) and General Motors (GM), are attempting to mitigate risk in established markets by adding to exposure to emerging markets.
Perhaps the best barometer of the impact of this fresh data is Wednesday's performance of the stocks in question, assuming investors considered the relation before the issuance of this report. You might want to also follow the stocks Thursday and Friday to see if this article shines new light on the issue.
There's a second issue threatening Japanese automakers this year that we would be remiss to dismiss. Government subsidies supporting sales for these manufacturers in their homeland are set to expire at the end of September. The companies still generate a large portion of their total sales in Japan. Post earthquake, and like how "cash for clunkers" helped Ford and GM here at home, Japan's incentive program has aided Toyota, Honda and Nissan. However, its conclusion could also deal them a sort of hangover.
The chart of the last year's performance does not confirm if the stocks have begun incorporating the risks discussed into their valuations.
Volkswagen AG (VLKAY.PK)
Daimler AG (DDAIY.PK)
The P/E ratios of the three Japanese producers would seem to miss incorporation of these risks. However, the three trade at discount to peers, excluding Volkswagen, on a PEG basis. This begs to question whether their five-year growth outlooks are overstated. I reviewed each firm's growth outlook and the Japanese firms sported the greatest expectations. I assume with near certainty this is due to expected emerging market penetration, especially given Volkswagen's play here. It's obvious also that there is cautious optimism at play, given the PEG ratios reflect less than fully valued growth. So risk is incorporated to some degree.
My conclusion is that growth may be overestimated across the board and especially at the high end of the spectrum, because emerging markets are coming under increasing pressures. This is the key cog to high expectations, but it is not a reliable one. Despite results and expectations, recently, datapoint after datapoint out of China is reflecting slowing economic growth. A purchasing managers index just produced by HSBC today showed a contracting manufacturing sector in China. Furthermore, as geopolitical factors begin to play a role, with the potential constriction of the Strait of Hormuz, or at minimum the flow of oil from Iran, will there be a reliable fuel flow to support the burgeoning middle class in China? Even a temporary disruption should impact the extreme growth forecasts at play, and so the PEG ratios do not clearly indicate value. Europe is definitely failing these companies, and the U.S. market is neither without risk. As a result, I would hedge near-term exposure (sell) and look for a clearing of the clouds of valuation before taking stakes again that seek high hope growth for these firms.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.