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  1. Analysis
November 28, 2005

Japan’s carmakers struggle to grow earnings

After a few years of very strong profit growth, Japan’s vehicle manufacturers are struggling to maintian positive earnings momentum in the current fiscal year, despite strong worldwide volume growth and even stronger revenue growth. Toyota Motor, Honda Motor and Nissan Motor - Japan’s big three automakers - reported weak or negative consolidated earnings growth in the first half of the year, while also reporting double-digit revenue growth from their global operations, writes Tony Pugliese.

After a few years of very strong profit growth, Japan’s vehicle manufacturers are struggling to maintian positive earnings momentum in the current fiscal year, despite strong worldwide volume growth and even stronger revenue growth. Toyota Motor, Honda Motor and Nissan Motor – Japan’s big three automakers – reported weak or negative consolidated earnings growth in the first half of the year, while also reporting double-digit revenue growth from their global operations, writes Tony Pugliese.

A significant negative factor for earnings in the current year was the higher asset writedowns due to new accounting procedures and higher pension costs. High raw material prices, particularly of steel, also continue to put pressure on margins and have tended to cancel out any ongoing cost-cutting and continuous efficiency improvement programmes.

But Japanese carmakers also are finding that operating conditions around the world are getting much tougher, particularly in North America and Europe. Yen weakness against the US dollar and other major currencies, as has occurred in the first half of 2005/06, normally represents a significant source of earnings growth once overseas profits are translated into yen.

The weaker yen appears to only partly offset the deteriorating earnings environment in the major overseas markets this year, despite the apparently healthy levels of demand. On the one hand, it is inevitable that as more Japanese vehicle and component manufacturing capacity is built overseas, shifts in currency valuations increasingly will have a more muted impact on global earnings.

This year, however, the positive impact of the weaker yen has been more than offset by increasingly tough conditions in key overseas markets, especially the deteriorating product mix and weakening demand in North America. “In North America, demand for vehicles is shifting from light trucks to more fuel efficient passenger cars,” says Yasuhiro Matsomoto, Credit Research Analyst at BNP Paribas Securities in Tokyo.

“Japanese car manufacturers have had to spend more on incentives to sell their vehicles and light truck inventories are rising,” Matsumoto-san added, “though incentives have not been as high as those paid out by their US counterparts”. Also like the US big three, the Japanese are also having to adjust their production schedules in favour of passenger cars, at the expense of the more profitable light trucks. Rising interest rates in the USA have also impacted magins.

In Europe, the market has responded to high oil prices by downsizing towards smaller, more fuel-efficient cars, says Matsomoto-san, and this has affected margins. He adds that a shift towards diesel cars in these markets has also helped to “lower the profitability of Japanese car companies in Europe” as they lack the economies of scale that European manufacturers enjoy in this segment.

The strengthening Japanese domestic economy has, however, become more supportive for the Japanese carmakers, with vehicle demand becoming more stable. Here the impact of rising fuel prices has been more limited. “Consumers in North America and Europe are more sensitive to fuel prices,” says Matsumoto, adding that “in Japan cars are already fuel efficient,” limiting scope for futher downsizing. “Volumes and product mix have also helped improve the performance” of the Japanese operations.

The outlook for the second half remains little changed, with continuing yen depreciation as the interest rate differentials in Japan and the US increase. But manufacturers remain cautious. New models scheduled for launch in the second half should help strengthen earnings at home, but this will be offset by the challenging conditions in Europe and the USA. Japan’s largest vehicle manufacturers have left their consolidated earnings forecasts largely unchanged since previous guidance earlier in the financial year, with Asia – including Japan, providing most of the cheer.

click table to enlarge

Toyota Motor
Toyota Motor Corporation suffered a slight drop in consolidated net income in the first six month of the fiscal year to Y 570.5 billion. It was the first drop in four years and occurred despite a 10.3% rise in group revenues to Y 9.95 trillion, continued cost-cutting and yen weakness against the dollar and Euro. The company attributes the lower performance primarily on higher business expansion and R&D expenditure, which it says has had a negative impact of Y197.7 billion and a further Y 9.1 billion was attributed to pension fund costs.

Rising raw material costs have also had an impact on the cost of sales, though this was offset be cost cutting efforts and lower marketing expenditure. Operating income fell by 6.6% to Y 809.4 billion and income before taxes, minority interest and equity earnings of affiliated companies was Y 855.9 billion, 6.3% below last year.

Group vehicle sales grew by 266,000 units to a record 3.833 million units, reflecting strong demand and market share gains across most major markets worldwide. Half of the growth came from the North American market, which added 119,000 vehicles to reach a new record of 1.245 million unit sales count in the six month period. Behind this was particularly strong demand for the Avalon, Prius and the launch of the new Tacoma pickup truck in the USA.

In Europe, the Corolla and the newly launched Aygo – produced at a joint-venture with PSA Peugeot Citroën – helped volumes rise by 22,000 to 498,000 units. Sales in Asia rose by 62,000 to 448,000 units, reflecting strong demand for pickups and MPVs following the launch of the IMV programme a year earlier. Sales in other regions, including Africa and Central and South America, increased by 83,000 to 556,000 units.

Sales in Japan fell by 20,000 to 1.086 million units, despite the launch of the Lexus brand in the marketplace, reflecting more than anything a lull in the replacement cycle of mass volume models. The company’s performance at home is expected to strengthen in the second half as production of new models is ramped up.

The company upgraded its previous full-year sales forecasts, announced in August, by 60,000 units which would mean global sales in the current fiscal year would breach the 8 million-unit level for the first time. It also expects that, despite the earlier set-back, last year’s income levels will be exceeded this year based on a Y 110 exchange rate with the US dollar.

Honda Motor
Honda reported a 1.2% rise in first-half consolidated net income across all operations to Y 244.3 billion, which include automobiles, power tools and motorcycles. Revenues for the period rose by 10.5% to Y 4,602.2 billion, flattered by positive currency translation and exceptionally strong sales growth in some of its smaller markets. Revenues from its Japanese operations – including exports – rose by 8.1%. Domestic sales rose by 1.7% to 350,000 units during this period and overseas sales by 8.3% to 1,324,000 units. Growth in North America was particularly strong.

The company’s ongoing cost-cutting progamme and currency translation gains helped to offset the negative impact of the higher R&D costs, accountancy changes and higher cost of sales in North America. Operating income rose by 27% in Japan to T 110.1 billion, offsetting earnings declines in most overseas regional markets.

Nissan Motor
Nissan Motor reported a 3.4% drop in net earnings to Y230.7 billion in the first half of the current fiscal year, despite a 12.1% rise in revenues to Y 4.491 trillion. The company attributed the drop to one-off charges relating to new accounting practices and higher pension contributions. Operating profits rose by 2% to Y 411.5 billion, although at pre-tax and net level, the trend was negative. Nissan Motor still claims a world enviable operating margin of 9.2%.

Sales were boosted by “robust sales in the US and continuous improvement in our European operations,” said CEO Carlos Ghosn. Worldwide sales volumes rose by 8.8% 1.59m units, with US sales rising by 16.6% to 489,000 units and by 6.6% in Europe to 285,000 units. Despite the CEO expecting the business climate in the second half “to remain severe”, Nissan Motor reaffirms its previous full-year guidance of Y 8.176 trillion in net revenues and Y 510 billion in net profits.

Mazda Motor
Mazda Motor’s continued its recovery by reporting consolidated a 66% rise first half net profits to a record Y 31.1 billion yen, reflecting mostly a reduction in pension contributions. Earnings were also boosted by yen depreciation against the US and Australian dollars and the euro, compared with a year earlier, lower manufacturing costs and growth in markets such as Japan and China.
Revenues rose by 2.4% to Y 1.35 trillion – also a record high – with total volumes rising 6.7% to 626,00 units. This growth is largely attributed to the company’s Chinese operations, which saw sales volumes rise by 52% to 67,000 units. Domestic sales rose by 4% to 141,000 units, helped by strong demand for the new Premacy and the launch of the new Roadster. Elsewhere, volumes dropped by 1% in the USA to 138,000 units –which the company attributes to capacity constraints. In Europe, a lack of new model activity helped to drive down volumes by 3% – to 138,000 units.
Mazda Motor has maintained its full year guidance, with ongoing yen depreciation continuing to support earnings in the second half and new model activity helping to improve sales performance.

Suzuki Motor
Suzuki Motor upgraded its full-year net earnings forecasts from Y 48 billon to Y 61 billion, on the back more than anything on strong global demand for its motorcycles, higher sales of small passenger vehicles in key markets and favourable currency trends. First half sales rose by 9.5% to Y 1.27 trillion, helped by strong demand for motorcycles in Asia and Europe, while rising fuel prices has made its smaller passenger cars more atractive in Europe and elswhere. Growth has been strong in key Asian markets such as India, China and Indonesia.

The company now projects revenues to rise by 7.9% to Y 2.57 billion in the current fiscal year, reflecting more than anything the translation of foreign currency into yen. The company said it expects global car sales to rise 9.7 percent from last year to 2.074 million units, lower than its previous forecast of 2.189 million units and motorcycle sales to total 3.485 million units – 20% more than last year but lower than previous forecasts.

Mitsubishi Motors
Mitsubishi Motors reported yet more losses in the first half, though at Y 63.8 billion the net loss was little over half the year-earlier amount. Revenues declined by 7.4% to Y 991.5 billion, though ahead of the company’s earlier guidance of Y 980 billion. Losses were also smaller than it had forecast back in May.

The revenue drop came despite a 2% increase in global vehicle sales to 659,000 units – pointing to severe price erosion, although the smaller losses reflect progress in ongoing restructuring and cost-cutting efforts. The company also benefited from lower asset depreciation charges in the USA and Australia, the non-recurrence of one-off charges relating to previous disposals and recall programmes, lower adverstising and marketing expenditure and lower warranty costs.

Mitsubishi Motors increased vehicle sales in Japan by 12,000 units to 108,000 units. In Europe, volumes rose by 19,000 to 131,000 units thanks to the launch of the Colt in March and brisk sales in Russia, Germany and the UK in particular. Sales in North America fell by 11,000 to 81,000 units, despite the successful launch of the Eclipse in May. Sales in Asia and other world markets dropped by 7,000 to 339,000 units – with North Asia leading the decline.

Mitsubishi has not made substantial revisions to its full-year forecasts, as they comprise a marked performance improvement to reflect the introduction of new models in the second half, including the introduction of the Outlander in Japan and the roll-out of the new Thai-made Triton one ton pickup truck. They also make provision for deterioration in demand in the USA and for the effects of ongoing high oil prices.

At corporate level, continued losses remains a source of frustratation for some of the company’s shareholders, which are becoming increasingly reluctant to support MMC. DaimlerChrysler AG, which earlier this year refused to participate in MMC’s latest recapitalisation programme, this month announced it would dispose of its outstanding shares in Mitsubishi Motors, equivalent to a 12.5% stake.

Tony Pugliese

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