Toyota (7203) FY17 Outlook – Toyota’s Achilles Heel: North America

An improved sales outlook, thanks to the all-new C-HR and new cost-saving opportunities on the back of TNGA, seem to be working in Toyota’s favour. However, despite these positive developments, we think the hoped-for strong recovery following a weak FY16 set of results (currency losses, quality related expenses, financial services loss provisions) is unlikely: Although we model for FY17 OP growth of 20% YoY to ¥2,420.0bil, this level of earnings and OPM takes us back to figures last seen in FY13.  
The main reason for the somewhat lacklustre performance expected for FY17 lies in the US, where Toyota is facing shrinking passenger car demand, requiring rising incentives. Light truck sales continue to grow and should help Toyota stem total passenger car unit sales losses; however, we would expect strong light trucks to mitigate the worst outcome, rather than effect any strong turnaround. In addition, Toyota’s earnings from financial services should continue to contract, on rising residual losses, loan losses, and higher interest rates. While not included in our forecast (since it is as yet unquantifiable), new trade policies and political pressure from the Trump administration loom large.  
As we outline in this report, we are not drawing a ‘doom and gloom’ scenario for Toyota. We believe that there are several off-setting factors which will prevent the negative factors related to the US market from escalating. At the same time, however, we view the chances of any positive triggers capable of producing a surprise on the upside, as small. Meanwhile, Toyota’s valuation is not particularly attractive: it is trading on an FY17PSAe EV/OP of 14.7x (excluding financial services net debt: 7.7x).  
Toyota has been facing a raft of negative developments over the last three months: The Yen's appreciation of 5% against the US$; Toyota’s higher provisions for residual value losses; very weak Toyota / Lexus car sales in the US, the US interest rate hike, the US review of NATFA and trade deals with Japan; Toyota being directly criticised by President Trump. Since the market level of uncertainty and indecision has risen since Mr Trump came to power, and given that Toyota’s share price has been trading in a tight range over the last six weeks, we are concerned that these negatives may not yet be fully reflected in the share price. Moreover, if, as we expect, we begin to see clear evidence of a weak FY17 profit recovery, we believe investors are likely to lower their weighting in Toyota.