Will Lexus’ Performance Rev Up Toyota’s Dollar Dreams?

A good show in the first half of 2014 is bringing Lexus closer to its past supremacy.

Jul 27, 2014 at 11:19AM

Like all Japanese automakers, Toyota (NYSE:TM) made the most of Prime Minister Shinzo Abe's monetary policy that weakened the yen against all major currencies. Now without the currency tailwind, these automakers have to fend for themselves to sustain their operating performance. Fortunately, Toyota is fundamentally strong with a great stable of cars, market leadership, and advanced technological knowhow.

The company has yet another ace up its sleeve to boost profitability: the premium Lexus brand that's selling very well in the key American market.

Lexus CT 200h Hybrid, Source: Lexus.

Luxury car demand growing in the U.S.
The luxury car segment in the U.S. has remained in the range of 10%-11% of the total auto market between 2008 and 2013, according to IHS Automotive. In 2014, however, Americans have shown a huge appetite for luxury cars. Bloomberg BusinessWeek reported that in the first five months of 2014, Americans bought 66,000 more luxury cars than last year, an increase of 11%. Comparatively, the overall auto market grew 5%. Experts from LMC Automotive and JD Power predict that sales of premium cars will grow further in the coming months. 

The segment is benefiting from growing income levels, a healthy stock market, lower unemployment rates, and a surge in car financing as auto financers are allowing longer loan terms. In a Washington Post article, Experian Automotive said that in the first quarter, average loan terms reached a record high of 66 months accompanied with a 27.6% rise in loans with terms of 73-84 months.

There have also been some changes in the underlying market dynamics. According to Bloomberg industrial analysts, the German luxury car makers have introduced models well within the $40,000 range even at the risk of brand dilution in order to drive volumes. More people can now afford to buy luxury models, giving the segment a big boost.

Within this price range, the American and Asian automakers are quite competitive and become good contenders for market share. The list of 10 best luxury cars below $40,000 for 2014, compiled by Kelley Blue Book, is a mix of European, American, and Asian models.The 2014 Cadillac ATS tops the chart at a starting price of $32,000.The 2014 BMW 3 series comes at $33,000, 2014 Lexus IS and 2014 Mercedes Benz-CLA-Class come just under $37,000, heating up the competition. In its review of the 2014 Lexus IS sedan, Kelley Blue Book analyst wrote, "The new-for-2014 Lexus IS sedan represents the ultimate expression of Lexus design, and, at long last, poses a credible threat to European rivals like the BMW 3 Series, Mercedes-Benz C-Class and Audi A4." 

Lexus regaining lost ground in the U.S.
The U.S. is the world′s largest market for luxury cars and one of Toyota′s biggest regional markets. Lexus has always been a big hit in the U.S., and sales peaked in 2007 at 329,177. After ruling the U.S. luxury market for 11 long years, Lexus was toppled from the top slot by Mercedes-Benz and BMW in 2011 after the Tsunami and earthquake hit production in Japan. Now, however, it seems that Toyota is regaining its grip. Last year, Lexus sold 273,847 units, beating its own target of 270,000. Though the sales figure lags behind its historical highs, the sales trend continuing into this year signals great potential.

Source: Data by goodcarbadcar.com, Chart made by author.

In the first six months of 2014, Lexus has recorded 17% sales growth in the U.S. compared to the year-ago period. The uptick came mainly from the newly launched IS and ES models and the existing RX and GX models. This has helped Lexus to reduce its sales gap with BMW to 18,693 units (down from 21,956 units) and with Mercedes-Benz to 24,428 units (down from 32,958 units) in the first half of 2013.

Source: Bloomberg.

Toyota wants to further reinforce its position in the U.S. by rolling out new models. After the success of Lexus RX crossovers, the company is gearing up for the launch of the NX model that will be smaller than the RX and available in both hybrid and turbocharged versions. There's also the RC F sports coupe that will hit the market by the end of this year. In April, Mark Templin, executive vice-president of Lexus, told Bloomberg, "It's nice to know that people are responding to the new products we've launched. Over the last two years, we've had a string of hits."

Looking for sustainable growth in the U.S.
Toyota's strategy for Lexus is clear. While it rolls out competitively priced products like the NX crossover, which could start in the mid-$30,000 range, Toyota isn't going to dilute Lexus's premium brand image to drive volumes. Lexus chief Jeff Bracken told Automotive News, "We will not head down below $30,000. We have Toyota and Scion to handle that price level for us."

Instead, the company is focusing on sustainable growth. It will customize cars to capture higher market share. In line with its strategy of building close to where it sells, the automaker will also bring Lexus production to the U.S. for the first time. Toyota expects to start producing Lexus ES 350 sedans from its Kentucky facility in 2015. The ES sedans are one of the best-selling premium models in the U.S. The behemoth plans to invest around $360 million to expand the plant's capacity by 50,000 units.

The localization of ES 350 could help Toyota maintain its future margins in case the yen strengthens in the coming years and export becomes costly.

Wrapping up
Regaining Lexus' market share is a priority for Toyota because premium vehicles fetch higher prices than other brands. Even if the company does not attain its peak sales volume in the immediate future, it's making good progress. It makes sense that instead of cutting prices, Toyota's focus is on new models and protecting future margins by localizing its manufacturing base.

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ICRA Online and Eshna Basu have no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.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.

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