The latest developments in the automotive industry continue to be disastrous. As most are now aware, American auto makers will receive a bailout even though Congress was unable to reach agreement on the matter. However, it is not just American automakers that are dealing with the fallout of collapsing worldwide demand. U.S. sales data for the auto industry were released yesterday with cumulative sales plunging 36% in December. The results were abysmal across the board: General Motors (GM) down 31%, Ford (F) down 32%, Honda (HMC) down 35% and Toyota (TM) off 37%. These figures are compared to sales from a year ago and in that time the deterioration in both consumer spending and confidence has been drastic. For the entire year, Toyota’s sales slumped 16%.
Now, Toyota is expecting its first operating loss in its 70 year history. This is certainly not an easy operating environment for automakers, including the world’s largest. As Toyota’s newly-resigned President Katsuaki Watanabe said, “It’s a kind of emergency that we’ve never experienced before. The environment surrounding us is extremely harsh.”
In response to weakening demand in Toyota’s hugely important U.S. market—as well as other markets such as Asia—the company is being forced to tighten its belt. Today, TM came forward with a plan to shut down production for 11 days in February and March for all of its factories in Japan. This is in addition to the three day suspension of operations in January already announced. Clearly, we underestimated the impact that the dramatic dive in demand would have on Toyota–especially in the Asian markets–when we wrote in our July piece that TM would stand to benefit from weakened competitors and gain market share worldwide (Kicking the Tires of Toyota Motors). At that time, gas prices were sky high and we believed that Toyota might have a leg up with its largely fuel efficient line-up.
An interesting piece in the Wall Street Journal by Paul Ingrassia illuminates some of the difficulties facing Toyota. One of the biggest problems facing TM is that they underwent an aggressive expansion a few years back. In retrospect, the timing of this massive expansion was dreadful. Ingrassia points to greater quality control problems as a symptom of a company expanding too fast and losing focus on its products. We agree with Ingrassia that Toyota now faces a period of substantially scaling back its operations and some plants may be shuttered as others will simply ratchet down production.
Although the company and the industry as a whole (see industry 52-week chart) have fallen on hard times, there is little doubt that Toyota will manage through this slowdown. People will resume buying cars again once the economy improves and Toyota will remain a leader in many classes. Toyota seems to us one of the best run companies in the auto industry and will continue to be one of the strongest global competitors.
As for our Ockham valuation, we continue to rate TM as undervalued because based on historical norms the stock is undeniably cheap. Even as sales have slackened, Toyota’s price-to-sales is currently .40x versus its historically normal range of price-to-sales of .58x to .90x. Likewise, now that TM’s price is $66.37 and its price-to-cash earnings ratio is 3.03 (as of last reporting), we are very positive on its outlook from the cash earnings perspective. In fact, TM is now trading a full 51% below its average historical price-to-cash earnings ratio at these profit per share levels. Of course, we are concerned about the company’s impending slip into negative earnings, but if we are near the bottom in car sales, the stock could rebound nicely in the year ahead.