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Morningstar | Toyota Gets Strong Mix Tailwind in Fiscal Second-Quarter Results

We are not changing our fair value estimate after looking at Toyota's fiscal 2019 second-quarter numbers. The company grew diluted EPS 31% year over year and raised fiscal 2019 guidance for revenue, operating income, and net income. The guidance change in our view is coming from less expected sales incentives in the back end of the fiscal year and a weaker yen against the dollar for fiscal 2019 than previously guided at now JPY 110 versus JPY 106. This currency assumption change means an extra JPY 165 billion in operating income relative to previous guidance. Currency headwinds in other nations, most likely Brazil and Argentina, bring the net currency benefit from the guidance change to JPY 125 billion and this tailwind makes up nearly all the expected profit improvement.

For the quarter, total company operating margin increased year over year by 60 basis points to 7.9% while operating income grew 10.9% to JPY 579.2 billion. Foreign exchange hardly mattered in the quarter, and improvements in mix drove nearly all profit growth. This mix improvement likely comes from the United States where consumers continue to flock to light truck models, such as the RAV4 crossover, over cars. For the first 10 months of calendar 2018, Toyota's U.S. sales mix is 62.5% light truck versus 57.9% through October 2017. Toyota North America boss Jim Lentz spoke to reporters on Nov. 6 and said the company may drop some car models from its lineup. We think some Prius models could go away in the U.S. as the Prius V already has, and the Yaris subcompact car could go away, too, with its U.S. volume down 38% in calendar 2018.

We see more upside to guidance possible as the U.S. continues to increase interest rates, which may help the dollar strengthen further against the yen. The current spot rate is JPY 113.38, so more upside to guidance could come after fiscal third quarter.

Despite the currency improvement from prior guidance, Toyota still forecasts a JPY 100 billion currency headwind for fiscal 2019 operating income versus fiscal 2018. That expectation happens because fiscal 2018's average yen to the dollar rate was JPY 111 versus JPY 110 guided for fiscal 2019, but we would not be surprised to see this guidance improve based on the current spot rate weaker than JPY 110.