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Investment thesis and risks
Initiate coverage on JBig3 autos with BUY ratings
We initiate with BUY ratings on Toyota, Honda, and Nissan. Given the recent movements in
the market and macro economic concerns, on an absolute basis we are in an all or nothing
situation where the stocks are likely to rise or fall in tandem. Our view is that the current
share prices have overshot on the downside. From a relative perspective, our top pick in the
space is Toyota. Trading multiples have collapsed and the sector premium has vanished
despite Toyota having the highest percentage of earnings coming from outside North
America in the group and substantial liquid assets standing behind the value of each share.
Global auto demand looks to remain strong
We expect demand from developing economies to drive 3.6% growth in global auto sales in
CY08. Emerging market demand growth is expected to carry the load again this year, with
BRICs markets accounting for 80% of the demand growth, we estimate. For the JBig3 we
project global volume growth of 6.4%, of which we assume almost 90% comes from
outside the traditional core markets of Japan, W. Europe, and North America.
By our definition, US auto sales have been in recession territory since last year. Our view on
the US market is for a further YoY decline to a 15.7m unit market. We believe there is risk
that the annualized rate will run lower than this in 1H CY07, but expect a rebound toward the
end of the year. Within this market, we estimate the Toyota, Honda, and Nissan as a group
take 110bps of market share, which calculates to modest volume growth.
Valuation at discounted levels
We see group P/E levels at or below 9x and PBR at 1x, lows we have touched only briefly in
the past. Clearly the market does not agree with some of our core assumptions. We believe
the market has priced in a bearish scenario of a deep automotive sales recession in the US
market and a continued strengthening in the yen. On our bear-case scenario of a 14.5m unit
US market and ¥100/US$, we still see shares at reasonable P/E levels one-year out in the
10.5-11.5x range.
Earnings growth likely to shift to lower gear on forex, US impact
3Q results for the group should be stable with Nissan likely to post the highest growth rates.
Beyond that, sector earnings growth is expected to be suppressed through 1HFY3/09 on
difficult comps for the ¥/US$ rate. Our forecasts call for lower core profitability in the US on
higher sales expense and lower margins in the finance business, as well as the negative
impact from forex. We see gains from global unit sales growth with a focus on emerging
markets and higher net cost cutting efforts as the negative impact from rising commodity
prices shrinks.
Risks
US market sales level
A major contraction in the US auto market would negatively impact on operating performance.
Risks come in the form of total unit sales, local capacity utilization, sales expense, and
through their finance operations. We detail our US outlook in this note as well as discuss
company specific concerns in this company notes.
Foreign exchange volatility
The JBig3 have transaction related exposure to foreign exchange rate volatility through its
export of vehicles from Japan to global markets. They also face a translational impact when
the results of overseas operations are translated back into Japanese yen for accounting
purposes. The most material exposure is to the US$. When the yen strengthens against the
US$ it generates a negative impact to reported profits of between 1.6%-1.9% of EPS for
every one yen change, we estimate. We detail company specifics in the note.
Material price pressures
Over half of the cost of a typical automobile is parts and material expense. Volatility in core
materials can lead to higher input costs. These costs may or may not be passed on to the
automaker depending on the nature of the contract and exposure to spot market pricing.
Higher commodity prices have been a major impediment to auto makers over the last three
years across a basket of commodities.
Exposure to financial losses at the automotive finance businesses
All of the JBig3 operate substantial automotive financing operating in North America where
the main function is to offer retail loans, leases, and dealer financing. They take annual
provisions against losses that are subject to continuous adjustment by its auditors. Increased
funding costs, a material decline in loan quality, or material deterioration in used car residual
values could impact the profitability of the finance business.
Table of Contents
Investment thesis and risks ............................................................3
Initiate coverage on JBig3 autos with BUY ratings ....................................................................3
Global auto demand looks to remain strong ..............................................................................3
Valuation at discounted levels ....................................................................................................3
Earnings growth likely to shift to lower gear on forex, US impact .............................................3
Risks..........................................................................................................................................4
Earnings and valuations..................................................................5
Earnings outlook........................................................................................................................5
Valuations and share price performance ....................................................................................5
Key variables and risks ...................................................................8
Forex a red light, but cost reductions and volumes green.........................................................8
Foreign exchange headwinds strong, but generally understood ...............................................9
Material price increases expected to moderate helping net cost cutting efforts to accelerate
................................................................................................................................................11
Global volume growth sustainable - FY3/08 providing an example..........................................13
Global auto demand outlook........................................................16
Summary of core macro assumptions .....................................................................................16
Auto growth expected to come from developing markets......................................................16
North American market ................................................................19
US market outlook remains negative .......................................................................................19
Japanese makers set to gain additional market share .............................................................21
What happens if the US falls to 14.5m unit market?................................................................25
US market sales mix and pricing trends...................................................................................25
Exposure to US credit losses ...................................................................................................26
Emerging markets.........................................................................29
Japanese market...........................................................................32
Japan – steady production growth expected, but hard to be overly hopeful on domestic
demand ...................................................................................................................................32
Environmental regulations ...........................................................36
New regulations pose long-term challenges............................................................................36
Companies
Toyota Motor (7203.T)..............................................................................................................40
Honda Motor (7267.T) ..............................................................................................................57
Nissan Motor (7201.T)..............................................................................................................75
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