As the yen and the euro continue to strengthen against the US dollar, and as the incentive war continues to escalate in the US market, car companies worldwide are becoming increasingly uncertain about their short-term earnings prospects. For most major Japanese car manufacturers, the USA has become the biggest source of earnings. But how badly will they be hit by dollar weakness and how well placed are they? Tony Pugliese reviews the companies' earnings prospects.

The implications of any change in US government policy with regard to its currency are very significant. As the US attempts to reflate its economy, exporters elsewhere will inevitably suffer. But the Japanese vehicle industry is positioned better than most to face up to these challenges.

While the Japanese car industry issued very strong financial statements for the year just ended, the outlook for this year and next is far from rosy. Companies such as Toyota are expecting earnings to drop in fiscal 2003/04, after a three-year run of record profits. Others are tentatively forecasting only modest gains. For companies such as Nissan, Mazda and Mitsubishi, which are in the midst of their individual restructuring programmes, earnings have additional momentum. But forecasts are being scaled back nevertheless.

Most Japanese carmakers are focusing their attention on Europe, and on the strong euro, to offset the weakening outlook for earnings growth in the USA. While the demand outlook in Europe is also not encouraging, Japanese car companies are targeting significant market share gains in this region as the single currency continues to outperform. The profitability of production facilities across Europe is rapidly increasing and output is being ramped up. As is the case in the USA, pressure on European carmakers will increase.

In the USA, the Japanese are unlikely to be dragged into a full-blown incentives war with the indigenous manufacturers. Offers may have to be improved, earnings will come under some pressure as result - and also as the dollar weakens. But their superior quality image and typically strong new product programmes put them in a relatively strong position in the long term.

After setting records, Toyota is cautious on fiscal '03 outlook
Toyota Motor reported its third successive record year for earnings in 2002-03, with consolidated net profit up 53.4% to Y944.6bn. Net sales rose by 6.5% to Y16.03trn, and operating income by 21.4% to Y1.36bn.The company's performance all round has been strong, with US sales rising by 202,000 units to just under 2m, and currency translation flattered by the weak yen. Models such as the Corolla, Highlander and the Lexus ES3000 helped drive volumes. Despite weak market conditions at home, Toyota's sales were stable and market share rose. New models such as the iST, Wish, Alphard and more recently the bB have helped its domestic performance. Most of its markets in Asia grew last year, particularly China and Thailand. Globally, Toyota's consolidated vehicle sales exceeded 6m vehicles last year for the first time.

Nevertheless, the company is cautious about the earnings prospects for the new fiscal year, ending in March 2004, mostly due to the adverse and volatile and foreign exchange markets. It is more confident of its ability to sell vehicles, forecasting a 5% rise in group volumes despite growing signs of weakness in some major regional markets. The demand outlook in Japan remains uncertain, though most analysts are expecting growth, albeit skewered towards smaller cars. Growth segments such as MPVs of various sizes are becoming increasingly overcrowded, and pricing pressure is rising.

Toyota hopes to strengthen its product appeal and protect its pricing power with an intensive new product strategy involving 11 new and revised model launches in the next 12 months, including the new Raum and bB van. Already in 2003, Toyota is showing signs of outperformance in Japan and in other important markets. The company is also planning a volume offensive in Europe, by adding third shifts at its UK and French plants, but this is not expected to feed trough until the 2005 fiscal year. In the meantime, exports from Japan are likely o be stepped up. The recent rise in the euro has made Europe a priority regional market for earnings growth, targeting 790,000 sales in 2003. The Avensis is expected to provide much of the momentum, as is the newly launched diesel-powered Yaris.

Toyota is hoping that a strong performance in Europe will help offset in part the increasingly gloomy earnings outlook in the USA. Here, pricing competition is expected to intensify and Toyota is expecting to be caught up to a moderate extent in the incentives war. Despite its size, Toyota does appear to respond better than most to short-term market developments, including currency movements, to maximise earnings. More focus will have to be placed on cost cutting and progressing synergies with Hino and Daihatsu, which are now beginning to bear fruit. But for the current fiscal year, Toyota is assuming a year-on-year drop in net income to Y440bn, and growth at consolidated level is also unlikely given its dependence on the US for earnings.

For fiscal '03, Honda expects modest earnings growth
Honda Motor's consolidated net profits for the fiscal year ending in March 2003 rose by 18% to Y426.7bn, just short of its Y430bn target but a good level nevertheless - translating into a group net margin of 5.4%. Operating margin was 7.5%, up there among the top three in Japan, on sales just shy of Y8trn. Sales in the all-important North America market grew by 11% Y4.926trn from 1.5m car and truck sales, but strong growth also came in Europe, where revenues rose by 25% to Y420.3bn.

For the current fiscal year, Honda is expecting only modest earnings growth, with consolidated net profits of Y440bn on the back of Y8.3trn in group revenues and operating profits of Y660bn. Honda has ridden on a strong wave of well targeted (but narrow range) of products, a conservative production plan and tight cost control. But weakness among many of its Japanese competitors also helped Honda's recent run of growth, and there is evidence that Nissan and Mazda at least are turning their businesses around. Although Honda has positioned itself well in many important markets, and improved economies of scale significantly, it will have to fight hard to keep the upper hand. It is well positioned in key growth markets, however, including China.

In the short term, China will remain Honda's strongest prospect for revenue growth, though exchange rates will make Europe one of the brightest prospects for earnings growth. This is likely to be offset but the increasingly tough trading environment in the US, and intensifying competition in Japan as Nissan and Toyota intensify new product activity, Honda has set itself tough targets for the current fiscal year which may be revised down later.

Nissan delivers on promises
Nissan Motor has clearly begun to deliver on its promises, with the management team under Carlos Gosn announcing results for the fiscal year just ended the envy of its larger global competitors. It is hard to believe that only four years ago, the company was close to being crushed by debt. Net earnings rose by 33% to Y495.2bn, for a net margin of 5.4%. Operating margin was 10.8%, among the highest in the industry, on sales that rose 10.2% to Y6,828.6bn. Furthermore, debt has been totally eliminated from its automotive operations, compared with Y431.7bn at the beginning of the fiscal year.

Nissan Motor is clearly moving into the second phase of its recovery plan, from cost-containment to a more positive, product-based expansionistic strategy. The company has begun making good products that people want to by, such as the strong selling Xtrail compact SUV. Weak and untargeted product development was the main reason for its troubled 1990s. The company has since fully recovered its financial health, and in combination with Renault of France it has a significant and growing global footprint. Despite the uncertain global economic environment, Nissan Motor is anticipating that its recovery will go uninterrupted, with revenue growing by 9.1% to Y7.45trn in the current fiscal year and an operating margin of 11% based. Net profit is forecast at similar levels to the current year, indicating that substantial expansion activity is expected to take place.

Although Nissan will be affected by currency exchange factors, such as the weak US dollar, the company is in the process of leveraging the cost benefits of the Renault merger, and profitable growth is expected to continue as new models come onto the market. In the near term, significant growth is expected to come from China, follow the acquisition of 50% stake in the Dong Feng, and the company also expects to claw back lost market share in Japan and North America. New products based on shared platforms with Renault have begun to provide profitable growth in Europe recently, but the demand outlook overall in not encouraging at present. Further ahead, growth is also likely to come from expansion in the US and from its newly announced global joint venture with Nissan Diesel in light trucks, in which Nissan Motor will take an 85% stake, but not for a few years.

MMC in recovery mode
Mitsubishi Motors is beginning to recover from the recall scandal and weak new product development of the recent past. It has also been slow in defining its long-term strategic direction in relation to majority shareholder DaimlerChrysler. This has meant that the company has been drifting for longer than should have been necessary. But life finally seems to be getting better for the carmaker, and management is increasingly upbeat about future prospects. The company reported net profits of Y37.4bn for the fiscal year just ended, the best result in a long time, and further moderate progress to Y40bn is expected in the current year, as its cost-cutting programme gathers momentum. Consolidated revenues are expected to fall to Y2.9trn to reflect the spinning off of its truck division.

Spinning off the Fuso truck division is a positive development which will certainly help it focus on its core and most promising operations, with a strategy centered around component and cost sharing with Chrysler and to a lesser extent Hyundai. Reducing the number of platforms, and platform sharing, will be key to earnings growth in the future. The company has said it will have 7 platforms each spawning 1.5-2.0m vehicle sales per year in combination with DaimlerChrysler.

Mitsubishi expects sales in Japan to grow this year, to 400,000 units - a rise of 13%, helped by the launch of the new Grandis MPV. If it succeeds, this will merely return it to 2001 levels, after the 12% drop in volumes in the fiscal year just ended. But this growth target does look a bit ambitious, given current market conditions and the strength of its competitors. Monthly sales of the new Colt small car have disappointed and recent data suggest declining sales. A new showroom refurbishment operation over the next two years is designed to help shed its poor quality image acquired as a result of the complaints cover-up, and 14 new models are scheduled to be launched by 2008. It remains to be seen whether it will manage to break even in Japan by 2005 as planned.

Mitsubishi is looking to Europe for an earlier return to profitability, by sometime in 2004 and with the help of the strong euro. In North America, it is banking on the new Galant to continue its recovery momentum, but earnings will be under pressure as market conditions get tough and because of the weak dollar.

From bad to worse for Isuzu
For Isuzu Motors, life has gone from bad to worse. The company appears to be imploding - crushed by a mountain of debt to the tune of Y560bn - around 40% of annual revenue. It opened its books on yet another negative year, with a net loss of Y144.3bn, inevitable given the borrowing costs and restructuring costs. Revenues came in at Y1.35bn. Its world continues to shrink, however, as it is squeezed out of what were once core markets and key market segments. Assets are being either sold off or written down. Nissan Diesel walked away from a preliminary agreement for a light truck joint venture, choosing instead to partner with Nissan Motor. This means that Isuzu will have yet another competitor to contend with, and a cost-sharing avenue cut off. In Japan its share of the truck market is a mere 5%.

The company's main focus is now Asia, where even today it derives the bulk of its sales. China in particular is its biggest single market, and by far its best opportunity for future growth along with Thailand. Its exposure to the vast Chinese market is being increased, with a heavy truck joint venture being launched with GM and Shanghai Automotive Industry Corporation. The plan is for the bulk of output to come from low-cost countries such as China and South-East Asia, as it ceases production in the higher cost production bases in North America and closes facilities in Japan. Its exposure to the US market is being reduced, with the model range being cut back further. It simply could not afford to keep up with its more powerful rivals, once discounting and other incentives became widespread. Expansion is earmarked for the Thai plant, where a new SUV will be produced based on its pickup platform for sale in North America as well as Japan and the rest of Asia.

It is clear that strategic and financial investors are treading with caution when it comes to Isuzu. It badly needs to be recapitalised, yet its shareholders appear only to be propping it up. It remains to be seen whether its strategy of focusing on Asia will work, and for how long. Potentially, Asia could provide sufficient volumes to sustain sales and future product development. It is evident that this is a survival plan, and although additional selling support could be available through the GM network, the company looks like becoming very heavily dependent on a region with a history of bursting bubbles.

Mazda's gradual recovery continues
Mazda Motor's gradual recovery as part of the Ford group continues, with net income rising to Y24.1bn, from Y8.8bn a year earlier. Consolidated revenues grew 12.9% to Y2.36trn, as product and capacity sharing with Ford in Europe gathered momentum which helped operating profits rise by 77.4% to Y 50.66bn. The company had a good year in Japan, with new products drove sales forward and recent cuts in production capacity helped it to grow profitably. Its performance in the US was not so good, however, with inventory build up of older models and sluggish Mazda 6 sales.

For the current year, Mazda again has set itself moderate targets given the phase of its recovery cycle, with the US likely to continue to act as a drag on momentum. Europe and Japan are expected to provide the bulk of the profits. The new Atenza is expected to continue to sell well and the new Mazda 2 and Demio models shold help secure further growth. Both markets will be priorities for market share expansion this year and next. For the US, inventory adjustment and will be a priority.

Overall, the company expects consolidated sales to rise moderately in the current financial year to Y2.5trn and net earnings by 24% to Y30bn. These levels seem well within reach provided Mazda rectifies some of the problems in the USA. As part of its strategy to contain costs to reflect its size, Mazda is exiting the large car segment by discontinuing production of the Millenia model later this year. Globally, it sold only 1,500 units of the model last year. Mazda's range will encompass the 6 model and below, with particular emphasis on sports and RV models.