Toyota: An Undervalued Pick In The Automobile Industry

About: Toyota Motor Corporation (TM)
by: Sure Dividend

Toyota shares are well off their 52-week high. Elevated trade tensions is a near-term risk.

However, Toyota is a high-quality company with long-term growth catalysts.

The stock appears to be undervalued today with a secure 3% dividend yield.

Written by Jonathan Weber for Sure Dividend

Toyota Motor Corporation (TM) is the second largest automobile company in the world in terms of production numbers. The company offers a solid and very safe dividend yield, double-digit total returns, and exposure to the electric vehicle segment. The combination of these factors makes Toyota an undervalued and attractive pick in the automobile industry.

With a modest valuation and a 3%+ dividend yield, Toyota is what we deem a cheap dividend stock. While the auto industry is facing short-term challenges from trade tensions, long-term returns to shareholders should be satisfactory.

Company Overview

Toyota, which was founded in 1933 and which is headquartered in Toyota, Japan, was the first automobile company that breached an annual production of 10 million cars. Right now it is the second-largest automobile company in the world in terms of production, right behind Volkswagen (OTCPK:VWAGY).

The company operates the Toyota brand as well as several others, including Lexus, Scion, and Daihatsu. Its main brand Toyota is the most important one by far. Due to its reliability and due to being renowned all around the globe Toyota has repeatedly been ranked the world's most valuable car brand, including in 2018:

Toyota was one of the first movers in the hybrid vehicle market with the Toyota Prius (which was released in 1997), the company has started to offer an all-electric version of the Prius since. Toyota is also active in other environmentally friendly engine technologies, such as hydrogen-powered vehicles.

Recent results and growth outlook

Toyota announced its most recent quarterly results on November 6. The automobile giant was able to grow its H1 (fiscal 2019) revenues by 3.4% year over year, to $130 billion, due to a combination of higher sales volumes (up 1%) and higher average selling prices.

Toyota has, on top of that, been able to grow its operating profit by 15% year over year, to $11.2 billion. This outsized earnings growth (compared to the revenue growth rate) was possible thanks to fixed cost reductions and the positive impact of operating leverage. Toyota's guides for earnings-per-share of $14.35 during the current fiscal year. Toyota presentation

Toyota has not been able to grow its sales in its home market Japan during the first half of the current year, but the company continues to grow its sales at a substantial pace in other Asian markets, where vehicle volumes rose from 740,000 to 810,000 year over year (9%). It is likely that Toyota's growth in these markets will remain at an elevated level, as the market growth rate in many Asian markets is meaningful, and as Toyota offers high-quality, and yet not overly expensive cars that fit the needs for many customers in emerging markets.

Coupled with some price increases (roughly in line with inflation) Toyota should be able to generate a low-to-mid-single-digit revenue growth rate going forward, just as the company did during the last six months.

Toyota is famous for optimizing its production continuously, which is why it is not surprising that shareholders have benefited a lot from cost-cutting efforts in the past. These allow for outsized earnings growth compared to the revenue growth rate the company generates. Toyota has set a goal of lowering its fixed costs further, which should help drive above-average profit growth.

On top of that Toyota is one of just a few automobile companies that repurchase shares regularly. As Toyota pays out just a low portion of its net profits in the form of dividends, there is ample liquidity for share repurchases. Toyota has announced a new $22 billion share repurchase program recently, this is enough to buy back roughly 13% of the company's market capitalization.

We believe that Toyota should be able to grow its earnings-per-share by at least 5%-6% annually going forward, although profits will likely remain cyclical to some extent, which is commonplace for the industry.

Valuation and dividend analysis

Based on management's forecasts for earnings-per-share of $14.35 during the current fiscal year, Toyota is trading at just 8.4 times this year's profits right now (with shares trading at $121). This is an unusually low valuation relative to how Toyota's shares were valued in the past, as shares mostly traded at a low-double-digit price to earnings multiple over the last five years.

We believe that there is potential for Toyota's shares to trade at a minimum of 10 times earnings. If Toyota's multiple rises towards ten over the coming five years, this would add ~3.5% to the company's total returns annually.

Our estimate thus sees share price gains of 9% a year during the coming five years, through a combination of earnings-per-share growth and multiple expansion.

That is not everything yet, though, as Toyota also pays out an above-average dividend: With two dividend payments of $1.76 a year, Toyota pays out $3.52 annually, which equates to a dividend yield of 2.9% right here. Adding this to the forecasted share price gains gets us to a total return estimate of 12% annually, which we deem quite attractive.

Toyota's dividend growth is not overly consistent, and the schedule of just two dividend payments can be a bit confusing to investors who are accustomed to quarterly dividend payments. Toyota's dividend is very safe, though, as the company will pay out just 25% of this year's profits if Toyota hits its goal of generating earnings per share of $14.35 this year. The combination of a dividend yield that is well above the yield that the broad market offers and a very high safety score for Toyota's dividend mean that shares could be a good pick for risk-averse income investors.

Investor Takeaway

Toyota owns the most valuable car brand, the company is highly efficient, and among the biggest players in its industry. Toyota is highly profitable, trades at a very inexpensive valuation, and through its expertise in hybrid models and its plans for hydrogen cars investors could benefit from the growth of the non-gasoline vehicle space.

According to our estimates, Toyota will offer attractive total returns over the coming years, which is why we believe that Toyota is one of the best stocks in the automobile industry.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.