2023-09-25 12:55:41 ET
Summary
- Toyota has been a pioneer of hybrid technology and is a leader in hydrogen-powered engines but, so far, lags in terms of BEVs.
- Recent breakthroughs in solid state battery technology may, however, change that going forward.
- Being relatively technology agnostic may benefit the company going forward, as not all markets are likely to electrify equally fast.
Based on some of my previous articles , one may have already guessed, that I am a fan of motorsports. So, a few weeks ago, I watched this year’s 6 hours of Fuji – which where I live means waking up at 4 am (somewhat crazy, I know, but I am confident that my mind is reasonably sound with regard to investing). The race was won by Toyota Motor Corp. ( TOYOF ; TM ), securing the Japanese manufacturer a fourth consecutive World Endurance Championship.
Watching the race, for some reason, I remembered that, years ago, just having set up a brokerage account, I considered buying Toyota as my first stock. At the time, I ended up buying BMW AG ( BAMXF ) instead – in hindsight, Toyota would have been the better investment. Be that as it may, I was inspired to take a look at Toyota from an investment perspective once more.
The world’s largest car manufacturer, who famously pioneered hybrid technology, has been criticized for its rather limited footprint in the electric vehicles category compared to the likes of Volkswagen AG ( VLKAF ; VWAGY ; VWAPY ; VLKPF ) or Hyundai Motor Company ( HYMTF ), let alone Tesla, Inc. ( TSLA ). I am, however, not convinced that not fully committing to BEV technology (yet) is necessarily a bad decision. Being relatively technology agnostic compared to rivals, many of whom have more or less exclusively committed to BEVs going forward, could benefit the company going forward. At the same time, breakthroughs in battery technology could firmly establish Toyota in the BEV market, too. Below, I will explain why I think that Toyota is well positioned for the future. I will also take a look at valuation, and why despite being a high quality investment, I am in no particular hurry to buy the stock at the current price.
Kindly note that, following, I will not distinguish between cars and SUVs. Unless otherwise stated, the term “car” comprises SUVs, too.
Hydrogen Leadership
Among all relevant vehicle manufacturers, Toyota is probably the leader in the field of hydrogen powered engines. In fact, the Toyota Mirai is currently the only commercially available hydrogen car sold in remotely relevant quantities. I am rather confident, that medium to long term, there will be ample supply of hydrogen. Not least due to massive government subsidies such as the American IRA and the EU’s “ hydrogen accelerator ”. In fact, without a successful implementation of hydrogen production and infrastructure, one might argue that we could call off the whole electrification of transportation and just continue burning fossil fuels. After all, there is no other carbon neutral alternative for vital industries such as steel (which otherwise must continue to rely on metallurgical coal). It is worth remembering, that transportation is not the only source of carbon emissions.
With regard to heavy duty vehicles in particular, leadership in hydrogen vehicles offers the opportunity, I believe, to gain significant market share at the expense of the likes of Traton SE ( TRATF ; TRATY ) as, I have previously discussed in more detail. Furthermore, Toyota’s partnership with Daimler Truck Holding AG’s ( DTHGF ; DTRUY ) Mitsubishi Fuso division in procurement, production and development means further economies of scale. Notably, a merger of Mitsubishi Fuso and Toyota’s separately listed truck division, Hino Motors KK ( HINOF ; HINOY ) is currently being considered .
Continued Plan For ICE
While, naturally, the stock market is inherently oriented towards the future, one should not entirely disregard the present either. And, for the time being, the present of road transportation is dominated by the ICE. Remember: Toyota has become the largest vehicle manufacturer with almost no pure BEVs.
Notably, Toyota has not fully committed to phase out ICE technology so far. Instead, the company intends to base its lineup on each market's respective demand. Given Toyota’s relatively strong position in emerging markets, most importantly the world’s most populous country, India, this strikes me as a rather prudent approach. I believe it to be rather likely, that certain developing markets will take considerably longer to electrify their respective overall fleets than developed nations. India, in particular, is interesting in that regard given its projected growth in the face of a rapidly expanding middle class and the country’s frequent power outages, which could lead to consumer reluctance to rely even more on electricity. Being the one manufacturer continuing to further develop and improve its ICE lineup, certainly offers some potential advantages under such a scenario. Especially, given that hybrid technology also provides access to many of the advantages of electric mobility.
Even in developed markets, there could still be ICE demand going forward (at least as long as there are not too many political roadblocks). I suppose that there will always be a certain share of customers who, if given the choice, will prefer gasoline to electricity (even if for no other reason as to not appear “woke”). This – admittedly somewhat irrational – factor of political beliefs and the desire to express those via consumption behavior is also, why I would expect a significant number of American states to not ban ICE vehicles anytime soon. The end of the technology in the EU is not set in stone, either - provided there will be synthetic fuels in sufficient quantity, following last minute amendments to relevant legislation pushed through by a coalition of countries including Germany, Italy and Hungary.
Potentially A Serious Future BEV Contender
A field in which Toyota has long been notably absent, despite being a pioneer of hybrid and hydrogen vehicles, is that of BEVs. In fact, to date, the Toyota bz4x (and the technologically identical Lexus RZ) is the only commercially available BEV in the portfolio of the world’s largest car manufacturer by volume.
However, the company looks set to make a big move here going forward. Toyota claims to have made substantial breakthrough with the development of solid-state battery technology. The technology, which the company expects to be ready for commercial use 2027 or 2028, promises to enable significantly farther range (1000+ km per charge, according to Toyota) as well as to materially reduce charging times compared to conventional cells.
Being among the last legacy manufacturers to seriously push into the BEV space does not necessarily have to be a bad sign. Just think of Apple Inc. ( AAPL ): while seldom the first mover with regard to innovations, its devices tend to introduce new features in a fairly thought out and smoothly running manner.
Strong Margins
For a manufacturer in the volume segment, Toyota is relatively profitable (let alone in absolute terms, which should come as no surprise given its status as the largest player in its sector globally). The company consistently generates operating margin of around 8 percent (7.9 percent as of the latest quarter ). The company mainly achieves this by being fiendishly efficient. Toyota is famous for pioneering the just-in-time approach to vehicle assembly. Collaborations, including shared platforms, with carmakers such as Suzuki Motor Corp. ( SZKMF ; SZKMY ), Subaru Corp. ( FUJHF ; FUJHY ) and BMW AG (BAMXF;BMWYY;BYMOF) create further economies of scale.
Furthermore, the company seems to increasingly put the focus on premium products, which tend to generate higher profit margins. Notably, the newly appointed CEO, Koji Sato, formerly headed the higher priced Lexus division. Lexus will play an important role with regard to increasing electrification. This makes a great deal of sense from my point of view, given that EVs, for the time being, tend to come at higher price points than comparable ICE vehicles – which matters less in the premium segment, due to customers typically being less price sensitive.
Toyota plans to enter the hard luxury category, too, by expanding and globally roll out its Century model family (probably best known as the official state car used by the Japanese Emperor or Tenno for official functions) – which to date has been domestic market only. As can be seen at around minute 19:25 of the IAA presentation of the new Century SUV, the plans seem to include an SUV convertible, which would be a standalone offering in this class. Given the BoJ’s more dovish policy compared to other important central banks such as the Fed, the ECB or the BoE, a potentially weaker Yen could have an especially positive effects on the profitability of exported luxury vehicles assembled in Japan.
Do Not Let Nominal Debt Scare You
On paper, Toyota is one of the most indebted companies in the world, at least in absolute terms. The company reports debt of ¥45 trillion in its most recent 20F filing. That is more than $300 billion, certainly a staggering figure. Factoring in liquidity of about ¥ 7.5 trillion (about $50 billion), this still comes down to a nominal net debt figure in the range of $250 billion. However, it should be kept in mind that much of the debt stems from the financial services segment (as is by no means unusual for carmakers). Also, Toyota generates similarly impressive absolute net profits. On average, net profits (in USD) for the last 10 fiscal years as per Seeking Alpha data were in the range of $20 billion annually. So, despite massive absolute debt, I believe that Toyota is financially stable. That is underscored by the company’s strong credit ratings : Standard and Poor’s rates Toyota A+ while Moody’s assigns an A1 rating.
Potential Beneficiary Of UAW Strikes
In the short to medium term, the current strike against Toyota’s Detroit based competitors Ford Motor Company ( F ) and General Motors ( GM ) as well Stellantis N.V.’s ( STLA ) American subsidiaries could benefit the company, as it has the advantage of its American plants being largely union-free. Depending on how long labor disputes last, Toyota could potentially increase its relative market share in the US. A recent article by Doron Levin explores this topic in more detail.
Risks and Downsides
Despite the many positive factors discussed above, there are, of course, also some risks to be considered. First of all, the shift towards green mobility does not come cheap. Toyota expects investments to the tune of $36 billion through 2030 in order to further electrify its lineup. While the company is taking advantage of certain government subsidies such as a ¥ 120 trillion (currently around $820 million) grant by Japan’s Ministry of Economy, Trade and Industry, this is, obviously, a significant sum. If hydrogen and/or the solid-state battery technology do not work out, Toyota could be disproportionately affected, given its relatively weak market position in “current-gen” BEVs (under the assumption that ICE technology will be phased out in the long run).
Long term, possible UAW successes could also result in headwinds for Toyota’s American production, as it might lead to skilled labor being lured away by more attractive union wages at competitors and/or unionization attempts at Toyota plants.
For non-Japanese domiciled shareholders, there is also the currency risk to be considered. Toyota’s dividend is calculated and paid in Yen, so forex rates may negatively impact the value of any distribution. Moreover, there are clearly more attractive investments within the sector, if one invests with a focus on dividends in particular. Lastly, the automobile sector is a fairly cyclical one, and Toyota as the biggest player is not insulated against macroeconomic risks.
Valuation
Based on the company’s earnings guidance of around¥ 190 per share, the current share price of ¥2,788 translates to a forward P/E ratio of around 14.66. While I do not consider this to be unjustified, given the aforementioned strength of Toyota’s business, the company is not particularly cheap at this valuation. Therefore, I see the stock as a hold for the time being. I will, however, keep in on my radar and would consider buying it after a future correction. In the range of ¥2,400 per share, translating to around $16.3 per share (=$163 per ADR, as these represent ten shares each), or lower I would consider Toyota a buy.
Conclusion
All in all, Toyota, while an excellent business, is currently fairly valued (if not slightly overvalued), in my opinion. Hence, I am not in a particular hurry to invest at the moment. Nonetheless, I am keeping an eye on the company as a potential buy at the right price.
For further details see:
Toyota Motor: Quality At A Price