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Morningstar | Toyota Avoids Foreign Exchange Headwinds to Start Fiscal 2019

Toyota's first-quarter fiscal 2019 results did not carry any dramatic news and gave us no reason to change our fair value estimate. Total company operating income increased by 18.9% year over year to JPY 682.6 billion while operating margin increased by 120 basis points to 9.3%. Toyota normally has large foreign exchange headwinds but currency had zero impact on earnings this quarter. A slightly stronger yen against the dollar (109 versus 111 in the prior year's quarter) was offset by a weaker yen against the euro (130 versus 122) and weakness with various other unspecified countries. Operating income therefore enjoyed the full JPY 75 billion benefit of various labor and overhead cost reductions as well as a JPY 60 billion tailwind from volume and mix.

The lack of foreign exchange pressure helped the Japan segment increase operating income by 23.8% and operating margin by 150 basis points to 10.2% despite segment unit sales declining 6.3%. Toyota records exports from Japan in the Japan segment. North America experienced the opposite of Japan in that operating income declined by 11.7% and operating margin fell by 50 basis points to 2.8% despite unit volume rising by 3.2%. This decline is indicative of the incentive pressure facing automakers in the fiercely competitive U.S. market. Mix in the U.S. is also an issue because although we think Toyota makes competitive crossovers and pickup trucks, its U.S. light-truck sales mix for calendar 2018 through July of 61.3% slightly trails the industry metric of 68.3%. Light trucks are generally more profitable than cars.

Management maintained its fiscal 2019 guidance for all major line items but it is now assuming a slightly weaker yen against the dollar of 106 for the full fiscal year as opposed to 105 in the last guidance update. For the last nine months of fiscal 2019 management assumes 105, so the yen will have to strengthen against the dollar from its current level of about 111 for this assumption to be correct.

We think Japanese companies tend to be conservative in their guidance and with the Bank of Japan saying on July 31 that it will continue its monetary policy of targeting a yield of about zero on the 10-year Japanese government bond while the U.S. is raising interest rates; we think it's possible management revises its guidance upward on currency tailwinds later in fiscal 2019.