Toyota: Pragmatic Approach Towards Electrification, Compelling Risk-Reward Proposition
Summary
- Although Toyota faced supply chain challenges in Q2 FY23, it remains optimistic about reaching higher production targets in the coming quarters.
- Toyota stands apart from its rivals thanks to its robust vehicle deliveries and market dominance.
- The company targets to launch 30 new all-electric models and to sell 3.5 million electric vehicles worldwide by 2030.
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Investment Thesis
Toyota's (NYSE:TM) excellent brand image and vehicle portfolio have contributed to the company's success over the years. The company has a significant presence in important markets such as North America, Japan, and Asia. Its excellent vehicle deliveries and growing worldwide market share set it apart from its competition. Even though the popularity of electric vehicles is growing, the transition from ICE to EV will take some time. Toyota understands this and thus it is not rushing into electrification quickly. Its strategy to convert old cars into all-electric will help the company save costs going forward. Moreover, this strategy will not only help the company to improve its margins but will also help it to retain its existing customers. Its strong delivery numbers and reasonable valuation hint at a good upside potential for the company’s stock. The company has also rewarded dividend investors well in the past and it offers a healthy yield of 2.7%.
About the Company
Japanese automaker Toyota was incorporated in 1937. The company is involved in the manufacturing and selling of automotive vehicles. It also conducts business in finance and other industries. The company sells its vehicles in around 200 countries and regions. Its main markets are Japan, North America, Europe, and Asia.
Industry Trend
The automobile industry is facing uncertainty due to the conflict between Russia and Ukraine, the Covid-19 surge in China, and the scarcity of semiconductors. Automakers were forced to raise prices due to rising raw material costs, which impacted demand. Further, semiconductor supply constraints impacted sales in 2022. The automotive industry may face headwinds in 2023 too due to the inflationary situation and global geopolitical tensions.
Market expectations from auto stocks in 2022 were low. The S&P 500 Index fell by 19.4% over the year. Most of the auto stocks fell too. Risky and overvalued EV stocks fell harder compared to stocks of legacy automakers.
Toyota's stock price dropped by 26.3% in 2022. Compared to its competitors, the decline in its stock price was less abrupt. In the year, the stock prices of General Motors (GM), Ford (F), and Volkswagen (OTCPK:VWAGY) all decreased by over 40%.
How Toyota Stands Out
Toyota stands apart from its rivals thanks to its robust vehicle deliveries and market dominance. The market share of Toyota globally has been rising in the past. Volkswagen's market share grew too, although it declined after 2019. On the other hand, the market shares of General Motors and Ford globally are still declining because of the poor performance of their flagship brands.
Company reports, author’s calculations
Note - Cuba, Iran, North Korea, Sudan and Syria are subject to broad economic sanctions. Accordingly, these countries are excluded from industry sales data and corresponding calculations of worldwide sales.
Toyota continues to hold a strong presence in North America, Japan, and Europe. In Europe, the company outperforms all German brands in vehicle sales except Volkswagen. Volkswagen continues to be the market leader in Europe with the highest market share.
In North America, the company competes neck-to-neck with General Motors and Ford. Sales of General Motors and Ford declined by 12% and 7% respectively in 2022. Similarly, Volkswagen vehicle sales also declined by 7%. Toyota’s delivery numbers for Q3 FY23 are yet to be out. Toyota’s YTD deliveries for 2022 stood at 1,834,000 units, down by 4% compared to the same period last year. In Japan, Toyota enjoys a market share of more than 50%. Vehicle sales of Nissan and Honda combined are half of Toyota’s annual vehicle sales. In Asia and other markets, the company continues to maintain a strong presence.
Toyota
Electric Vehicles
Sales of electric vehicles have soared since the Covid-19 outbreak. EVs have gained popularity during this period as people are realizing the importance of sustainability. China, Korea, and many European countries are transitioning to EVs faster than other markets. According to 2023 Deloitte’s Global Automotive Consumer Study report, consumer preference to drive Gasoline/diesel (ICE vehicles) is lowest in Japan, followed by Korea and China. This is because customers prefer to drive Hybrid Electric Vehicles or Battery Electric Vehicles in those countries.
Hybrid technology continues to outperform Battery Electric Vehicles in most parts of the world except China. Although the preference for HEV is high in Japan, US, and India, the transition to going all-electric is slower.
Deloitte’s Global Automotive Consumer Study report
Toyota targets to launch 30 new all-electric models by 2030. It also aims to sell 3.5 million electric vehicles worldwide by 2030. Toyota’s Hybrid Electric Vehicle is quite popular in Japan. Over 36% of consumers prefer to drive Hybrid Electric Vehicles in Japan. The rate for HEV preference is the highest in Japan compared to other markets.
Toyota’s competitors are moving into EVs at a faster pace. However, Toyota’s strategy to go electric is somewhat different. It doesn’t plan to produce new electric cars directly, but to use a conversion strategy that involves transforming older vehicles on road into electric vehicle models.
Toyota’s Strong Financial Performance
Toyota Toyota
Over the years, the company has reported strong revenue and margins. In FY22, Toyota’s total revenue grew by 15% to 31,379,507 million yen. Revenue from vehicle sales stood at 29,073,428 million yen, up by 16% compared to last year. Its vehicle margin also improved by 2%. This was due to an increase in deliveries during the period. Operating profit increased by 797,948 million yen during the year mainly due to marketing efforts and the effect of change in exchange rates. This resulted in the operating margin improving by 200 bps.
Toyota
Sales revenues in Japan improved by 7.0%, to 15,991,400 million yen, and operating income improved by 23.9%, to 1,423,400 million yen in FY2022 compared with FY2021.
Sales in North America also improved by 17.6% to 1,116,600 million yen in FY22. Its operating profit also increased by 41%. The company’s sales in Europe also improved by 23.4% to 3,867,800 million yen in FY22. Its operating profit also improved by 55,000 million yen in FY22 compared to FY21.
Sales revenue in Asia and other countries improved by 29.4% and 56.3% respectively. Its operating income also improved by 220,800 million yen and 165,900 million yen during FY22 compared to FY21.
Financial Result for First half of FY2023
Toyota
Toyota’s total revenue increased by 14% to 17,709,349 million yen in H1 2023 compared to H1 2022. However, the rising material cost pulled gross profit and operating income down by 9% and 35%, respectively. This resulted in operating margins falling from 11% to 6% in H1 2023 compared to H1 2022. The company declared an interim dividend of 25 yen per share, 1 yen higher compared to last year.
Premium Valuation Among Legacy Auto Makers
Toyota’s Price to Earnings Ratio has historically been higher than its traditional peers. The company has consistently posted strong earnings, which makes its valuation justifiable. Several other automakers have not been able to maintain strong earnings growth in the past and thus are trading at lower PE multiples.
As the chart above shows, despite a higher PE, Toyota's PE is less than its 3-year average PE. Toyota's strong performance, as discussed above, indicates that the company will be able to maintain its stronger earnings growth. In the long term, investors can expect a steady price increase, in-line with the company's earnings growth. Additionally, the returns will include dividend payments, currently yielding 2.7%.
Based on EV-to-EBITDA ratio too, Toyota stock trades at a peer-leading valuation, but it is slightly lower than its own 5-year average ratio.
Overall, there is a scope for some multiple expansion, in addition to earnings growth, to boost the stock price going forward.
Seeking Alpha’s proprietary Quant Ratings rate Toyota Motors as “hold.” The stock is rated high on profitability, but low on revisions factor.
Payout Ratio
Toyota distributed over 27.89% of its net profit earned as dividends to its investors. Its Payout ratio is the highest among its peers. The stock offers a yield of 2.7%. This makes it attractive among dividend investors.
Outlook
Toyota anticipates that 2023 will be more difficult due to supply-side restrictions. The management earlier had to reduce its expectation for vehicle production by 5,00,000 units to 9.2 million units due to semiconductor supply constraints. However, recently, the management said that it may build up to 10.6 million cars in 2023.
Based on current macroeconomic projections, the company had also understated its prediction for vehicle sales by 50,000 vehicles. It expects North America and Japanese vehicle sales to be similar to last year while its vehicle sales in Asia, South America, Africa, Oceania, and the Middle East to grow strongly.
Conclusion
In the automotive business, strong delivery numbers matter, and Toyota is able to deliver the same. The stock has corrected by 26% in 2022 despite strong financial performance. The fall has made its valuation attractive for long-term value investors. Although the new year poses challenges, the stock has the potential to rebound based on the company’s current business strategies.
Obviously, unlike growth stocks, we don't expect astronomical returns from Toyota stock. However, the stock offers a compelling risk-reward proposition, given its long history and potential for stable growth in the years to come.
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This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.