Toyota's Downbeat Earnings Forecast

Latest records aside, the automaker projects a 29.5% profit drop for the current year, well below analyst expectations

by Ian Rowley

Toyota CEO Katsuake Watanabe Getty Images

It's not often that Toyota Motor (TM) disappoints. Indeed, turbocharged growth has been a feature of Katsuaki Watanabe's presidency at Toyota since he took over from Fujio Cho in 2005. During that time the company has closed within touching distance of General Motors (GM) as the world's biggest automaker. At its annual results announcement in Tokyo on May 8, the company said it had another year of record sales and earnings through March, 2008. Sales increased 9.8% to $252.7 billion, while operating income edged up 1.4% to $21.8 billion and net earnings rose 4.5% to $16.5 billion.

Yet, despite the record-breaking figures, Toyota actually missed its full-year operating profit target by $285 million, after a disappointing final quarter during which operating earnings slipped 31% to $3.81 billion. More important, Watanabe also signaled a projected slowdown in earnings and sales in 2008 that was worse than many Toyota watchers expected. Watanabe said Toyota's sales in the year ending March, 2009 will dip 4.9% to $240 billion, while operating income will drop 29.5% to $15.4 billion. The latter was $3.8 billion below the average result of an earlier survey of 19 analysts by Reuters (TRI).

What explains Toyota's downbeat forecast? Like all of its Japanese rivals (BusinessWeek.com, 4/30/08), Toyota is hurting from the impact of a stronger yen, a slowing U.S. economy, and rising raw materials costs. "How we address these challenges represents a major task for us," Watanabe told reporters.

Factoring in Currency Movement

Of the three, the biggest factor in the short term is the stronger yen. Indeed, even though Toyota has reduced the impact of currency swings by building dozens of plants in local markets, the yen's rapid appreciation still makes a huge impact on profits. For the current year Toyota is basing its forecast on a dollar-yen rate of 100 and euro-yen rate of 155. That compares to 114 and 162, respectively, for the financial year that recently ended. According to Toyota's calculations, currency gyrations will wipe $6.6 billion from its earnings in the current year.

While less painful, rising raw materials also loom large. Yasuhiro Matsumoto, an analyst at Shinsei Securities in Tokyo, reckons rising steel prices, for example, will add around $2.9 billion to Toyota's costs. Yet with competition intense, raising prices of cars is difficult in many markets. In the U.S., Watanabe said Toyota would raise prices by 0.7% but in Japan, where sales for almost all carmakers have long been falling, Toyota has "no plans to raise prices," he said.

Then there's the impact of a slowdown in U.S. sales, which still account for more of Toyota's profits than any other market. Despite Toyota's market share reaching a record 16.3% for the year through March, 2008, North American sales are expected to fall 188,000 in the current financial year, to 2.77 million vehicles. The impact on earnings is made worse by the difficulties of moving larger vehicles at a time when gasoline prices are soaring. For example, in April sales of the remodeled Tundra pickup fell for the first time since its launch in late 2006. Toyota has reduced production at two plants where larger vehicles, including the Tundra, are built.

Typical Toyota Caution?

Amid the doom and gloom there is also the possibility that Toyota is being too cautious. After all, it didn't build its reputation for meeting and beating targets by setting impossible goals. What's more, there are already signs that a year from now Toyota could be once again besting its forecasts. The yen, for example, is currently hovering around 104 to the dollar—significantly above the 100 yen per dollar Toyota is using in its projections. If the Japanese currency stays at that level or weakens further, Toyota can expect a big windfall.

There's also the rapid growth in Asia, the Middle East, Eastern Europe, and other resource-rich emerging markets. Toyota's China business, for example, is expected to increase vehicle sales from 470,000 to 640,000 in the current year, more than offsetting declines in the U.S. Meanwhile, sales in Asia outside Japan and China are expected to rise 144,000 and exceed 1 million for the first time, helping Toyota's global sales reach 9.7 million. "Asia has become one of Toyota's major profit drivers," Toyota Senior Managing Director Takeshi Suzuki noted during a separate presentation.

Toyota's efforts to reduce costs could also end up boosting its bottom line. On May 8, Toyota projected that its cost-cutting efforts will offset increases in raw materials costs by using 20% fewer types of steel in auto production and reducing the amount of resin it uses in cars by 30%. Watanabe added that internal reviews of the way the company is administered or conducts research and development can also save hundreds of millions of dollars.

Rowley is a correspondent in BusinessWeek's Tokyo bureau.