Japan’s vehicle manufacturers are experiencing a sharp slowdown in earnings growth in the current fiscal year due to adverse currency valuations, rising raw material and energy costs and higher interest rates. While the leading Japanese manufacturers generally are fairing much better than their US and European competitors, the earnings environment is getting tougher all round and controlling costs remains a priority. By Tony Pugliese.
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By far the single most important factor in determining Japanese earnings is the ¥:dollar exchange rate, given that the industry depends on the US for the bulk of its profits. Leading Japanese car manufacturers derive as much as 60-70% of thjeir earnings from the US market. But a number of factors are coming together to make the current earnings environment particularly tough and hard to predict.
Sharp rises in raw material prices
Raw material costs have risen sharply in the last six months, mainly as growth in demand from China continues to outpace the rate of capacity expansion. Steel prices have risen by around 20% in recent months, but more recently prices have been bid much higher by companies trying to secure adequate supply. The cost of a supply shortage is much higher. Last December Nissan Motor was forced to cut back production in Japan because of a steel supply shortage. Prices of other raw materials, including resins, have increased by a similar rate.
Merryl Lynch’s Tokyo-based automotive analyst, Christopher Richter, believes that most of the impact of the price rises will be absorbed by the component suppliers. “The average steel content in a car is around one ton, which currently costs around $600. The overal impact of raw material price increases is unlikely to exceed a few hundred dollars per vehicle”.
“Most of the other content of a car is provided by outside suppliers and they have to put forward an extremely good business case to convince car manufacturers to pay more,” Mr Richter adds. Nevertheless, costs do add up and consumers are in no mood to pay a lot more for their cars.
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By GlobalDataHigher energy prices inevitably also add to the cost of production. But the biggest potential impact of high oil prices on earnings is in product downsizing, particularly given that as a rule of thumb, the larger the car the larger the profit margin. Mr Richter points out some degree of downsizing has been taking place in the US market in recent months. The widening range of compact SUVs from Asia is eating into sales of full-size models. But this is hurting US manufacturers more than the Japanese.
Rising interest rates will impact earnings
Rising interest rates will also have a significant impact on earnings, particularly on the financing arms of auto firms. The rate increases are difficult to pass on fully to consumers, particularly in the current environment. The impact of rising interest rates will be broad-based and we are already seeing profit warnings – most recently from General Motors. Also, Japanese companies have been unable to avoid the incentive war in the US market, but on the whole they have managed to limit its impact.
Japan still exports large volumes of cars the the US each year, so it is not only the conversion of dollar-denominated earnings into yen that is affected. Manufacturing cars with a yen-based cost and selling the product for US dollars also hurts. While Japanese vehicle production in the US continues to rise, Japan remains the biggest exporter of cars to this market. In 2004, a total of 1.56m fully built up vehicles were exported to the US from Japan and a further estimated 3.2m Japanese-brand vehicles were made locally.
Mr Richter says that pressure on Japanese companies to cut costs is rising. But he expects Japanese car companies operating profits on average will rise by 7-10% in the 2006 fiscal year provided that the current ¥104:US$1 remains largely unchanged . “A strengthening of the yen to ¥:US$1 would wipe out this growth,” he said.
Third quarter earnings trends
Toyota Motor’s third quarter net profit (to December 31st) rose by 3.5% to ¥296.5bn, but only after a strong sales performace overseas and deep cost-cutting. Operating profits rose by 5.3% to ¥422.9bn on sales on ¥4.64trn. While these figures represent new quarterly highs, the rate of growth is much slower than in previous quarters, due mainly to weakness in the US dollar and higher input costs.
Global sales volumes rose by 8.2% to 1.839m units during the quarter, which ranslates into lower profits per unit even tough US growth was much lower – at 2.6%. Volume growth in Europe was 14.3% and in the other markets combined it was 20.2%. Lower marketing expenditure and cost-cutting offset higher purchasing costs and currency-related rises.
While Toyota has not issued an earnings forecast for the current fiscal year, it is hoping that earnings will exceed last year’s levels. A source said the company is expecting the current strong sales momentum to remain, and this will help offset the negative currency effects and rising raw material costs.
Despite a 7.1% rise in sales to ¥2,134trn, Honda Motor saw operating earnings drop by 6.9% in the third quarter (ending on 31st December) to ¥157.64bn. Net profits fell by just 0.2% – helped by increasingly positive contributions from its subsidiaries in Asia. China in particular has become an important source of earnings for the company. The company cites higher marketing costs for part of the deterioration, while CSFB’s auto analyst Koji Endo points to adverse currency rates, and the weak US dollar in particular, as one of the main reasons for the drop.
The company is upbeat about its earnings prospects for the year ending on March 31st, in view of its strong product range and the potential of ongoing good earnings from its European and Asian operations. It expects full-year net earnings to rise to ¥480bn, from ¥464bn a year earlier as earlier cost-cutting efforts take effect.
Nissan Motor continues to benefit from its turn-around programme under Renault ownership, and earnings growth continued in the October-December quarter despite evidence of tightening margins. Revenue rose by 14.9% to ¥2.092trn and operating profits came it at ¥208bn – which still gives the group a highly enviable 10% operating margin. Net income was ¥134.2bn, up by 6.9%.
The group enjoyed strong high margin sales growth in the US thanks to a young product range and this helped to partly offset some of the negative currency translation and moderate growth in Europe. A shortage of raw material supply, particularly of steel, meant that production had to be cut back in December. The company also cites rising interest rates as contributing to the margin squeeze. Despite this, the company has maintained its full-year forecasts of an operating profit of ¥860bn and net profits of ¥510bn.
Mazda Motor maintained its net profit forecast for the year at ¥37bn and its operating profit forecast at ¥78bn, despite a huge fire at its Ujina 1 plant in Hiroshima in December which destroyed the paintshop facility. Re-building efforts are way ahead of schedule and the estimated lost production resulting from the fire is now estimated to amount to 30,000 vehicles, compared with earlier estimates of 70,000 units. The company now expects to ship 1.1m cars this year, which it expects will generate revenue of ¥2.66trn.
In the third quarter, the company posted net profits of ¥7.8bn and operating profits of ¥20.6bn derived from revnues of ¥685.6bn. There is no year-on-year comparison as quarterly data in the previous year was not released. The operating margin of 3% reflects the small scale of the company. Helping the earnings trend was a focus on growth in Europe, where volumes rose by 14.9% in the first nine months of the fiscal year, while US sales declined – which was blamed mostly on an ageing product range.
Mitsubishi Motors’ financial statements make increasingly grim reading compared with the generally upbeat sentiment of the Japanese automotive sector overall. Last month, the struggling company came out with a new profits warning and a call for yet another cash injection – this time of ¥540bn. There was very little enthusiasm for this latest cash call, which comes on the heels of a ¥496bn recapitalisation in April 2004.
For the full year ending in March 2005, MMC doubled its net loss forecast to ¥472bn, compared with an earlier forecast of ¥240bn. This includes a recurring loss of ¥197bn, on sales of ¥2.02trn in sales revenues. The company is struggling to come up with a viable business plan, other than agreeing to supply vehicles to Nissan and Peugeot in order to boost flagging sales.
DaimlerChrysler has refused to participate in any additional recapitalisation programmes, forcing MMC to use the proceeds of the sale of its Fuso truck business and its stake in the Nedcar car plant joint venture in the Netherlands. Mitsubishi Group companies have agreed to take part in this latest funding call, however. For the moment, MMC expects to return to the black in 2007 – with net earnings of ¥8bn – subject to possible further profit warnings.
