Toyota: Maybe the Worst Is Behind Us

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We were shocked, shocked to find losses in this establishment: Toyota (NYSE: TM  ) on Tuesday reported an operating loss of 108 billion yen ($1.4 billion) for the quarter ended June 30, down from a profit of almost 212 billion yen ($2.7 billion) a year ago.

As anyone who has tried to shop for a Prius in the past few months knows, it's no secret that Toyota has been struggling with major supply disruptions in the wake of the March earthquake and tsunami in Japan. Add in the recent surge of the yen versus other major currencies, and for Toyota to post its first operating loss in two years is absolutely no surprise.

But following on the grim outlook put forth by management back in June, today's report contained several rays of sunshine.

A solid beating of grim expectations
All things considered, it was a pretty decent quarter for the Japanese auto giant. Analysts had expected a 78 billion yen loss, which Toyota beat handily. And in fact, on a net basis, the company actually eked out a small profit of about $15 million -- thanks in part to a 43 billion yen tax refund.

Better news for shareholders, though, was a boost in management's outlook for the rest of the fiscal year. (Toyota's fiscal year runs through March 31.) Management now forecasts that the company will earn 390 billion yen ($5.1 billion) for the year, an almost 40% boost from the worst-case 280 billion yen it was forecasting as recently as June.

In raising its outlook, Toyota joins fellow tsunami casualty Honda (NYSE: HMC  ) , which bumped its own profit forecast by 18% on Monday. The story, in a nutshell, is the obvious one: Suppliers hurt by the March disaster are recovering more quickly than expected.

The upshot is that Toyota should be back up to full production capacity within weeks. That's good news. But big challenges remain.

Gathering strength in a tough market
While Toyota (and Honda) have struggled with short parts supplies and limited production capabilities, rivals like Hyundai (OTC BB: HYMTF.PK), Ford (NYSE: F  ) , General Motors (NYSE: GM  ) , and Volkswagen (OTC BB: VLKAY.PK) have moved to eat their collective lunches.

Hyundai in particular has made the most of this particular moment, posting a second-quarter profit gain of 37% and adding significant market share in the United States. Hyundai's compact Elantra and midsize Sonata are top-notch products that arrived at just the right moment, winning comparison tests and consideration from import-focused buyers disappointed by what they're finding (or not finding) on Toyota and Honda dealer lots.

Ford and GM have won some of that business as well, and Volkswagen has continued to press its advantage in emerging markets. But Toyota is determined to make up as much lost ground as it can: The company said it will hire 4,000 extra workers in anticipation of a "production recovery phase" starting in September, and Toyota's Senior Managing Officer Takahiko Ijichi said that the company would boost incentive spending in the United States in a focused effort to regain lost market share.

The bigger problem on the horizon
Regaining market share is one thing, but boosting profits may be a more elusive goal, despite the more optimistic forecasts heard on Tuesday. Toyota books its earnings in yen, and the yen is currently near record highs versus the dollar. That means that sales made in dollars are worth less than they were last year. The yen's appreciation over the past year has cost the company nearly $4,000 per car in profits, Ijichi said.

That's a big hit, and the company's already-squeezed margins are going to get squeezed further by that incentives campaign. GM veterans can tell you all about the "joys" of trying to compete with global competitors when handicapped by a fixed-cost disadvantage and a reliance on incentives. It's hard to make money in that situation without, as auto executives say, taking cost out of the products.

That, in turn, can lead to cars that feel cheap and don't stand up well to comparisons with class leaders, and over time that will lead to market-share losses. (Sounding familiar yet?) Think about this: On Monday, news broke that Consumer Reports had dropped the new Honda Civic from its "Recommended" list, because it no longer compared well with the best products from companies like Hyundai and Ford. Honda, said the respected consumer advocate, seemed to go backwards while others moved ahead.

For Toyota, keeping its vaunted products from following suit could be quite a challenge.

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Fool contributor John Rosevear owns shares of Ford and General Motors. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of Ford and General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 03, 2011, at 10:58 AM, baldheadeddork wrote:

    Toyota has shown irrational exuberance from the beginning of this. I wouldn't bet a lot of money on whatever they see in their crystal ball.

    The debt ceiling clusterfook is going to keep the dollar weak against the yen for the foreseeable future. The Japanese market was tumbling even before the tsunami, and their profitability this year has overwhelmingly come from a lowering of their write-down reserves for Toyota Finance. What profits they've picked up from building cars has been achieved through cost cutting. I'm not going to short TM because the market has always been awful about identifying strengths and weaknesses in the auto industry, but Toyota is badly damaged company with a mountain of challenges ahead of it.

    One of the biggest challenges is just a few weeks away. The "all new" Camry is coming soon, and I don't think its hyperbole to call it the most important car Toyota has ever made. The midsize class is insanely strong and Toyota needs a home run just to stay in the game. If it redefines the class the way the Camry has done at least twice before, the outlook for the company as a whole will improve sharply. But if it's another quarter-assed refresh a'la the "all new" 2011 Corolla or if they misread the market they way they have with the Tundra, then their problems are just beginning.

  • Report this Comment On August 03, 2011, at 3:08 PM, Jason87467 wrote:

    The new CAFE will not look at the whole fleet of cars and trucks averaged together like it has for decade. Now trucks will have it's own ratings which of course will be higher and subject for reviews.

    For decades Japan, and others have had a huge advantage over the domestic because of this. Back then, GM, Ford and Chrysler sold many large trucks while Japan already made fuel efficient small cars and few trucks. Add to another advantage, Japan also had another huge advantage with the fact that it and others, did not have one single retiree to pay pension to, while Detroit had to pay over 1 million retirees.

    With these reasons, it's really easy to see how the domestic could not compete, and then came the mediocre vehicles from Detroit.

    I see the tide changing though, and I see Japan and the other competition worried that now things are closer to a level playing field.

  • Report this Comment On August 04, 2011, at 11:47 AM, TMFMarlowe wrote:

    @baldheadeddork: Your point about the Camry is dead-on (at least as far as North America goes), and worth amplifying. They can't phone this one in and trust the Toyota name (and Consumer Reports) to keep it moving; the Sonata and Fusion are just too good.

    Look for an article from me on Monday (hopefully) that digs into that and Toyota's prospects for the next couple of quarters.

    BTW, speaking of strong entries from Ford, my wife just (like, an hour ago) bought a 2012 Focus. I'll have an article on that sometime in the next few days too.

    Thanks for reading.

    John Rosevear

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