Investment thesis

My previous bearish thesis about Toyota Motor Corporation (OTCPK:TOYOF) aged somewhat well because the stock significantly lagged behind the S&P 500 since September 2023. On the other hand, the stock delivered a modest 5.6% return to shareholders, which is definitely not bad.

The stock’s return could have been even better if there was no scandal around the company cheating on safety certificates, which is a big red flag in my opinion. This situation significantly undermines trust in Toyota’s cars and certainly unveils internal control deficiencies. The company’s solid FY 2024 performance looks like a temporary spike as Toyota continues lagging in the secular shift to electric vehicles [EVs] and its long-term expansion to electric goals does not look ambitious enough for the company which dominated the internal combustion engines [ICE] era for decades. The company’s market share in calendar 2024 is likely to deteriorate as its sales volumes are projected to decline, while the broader global industry is expected to demonstrate growth. The company’s flagship Toyota Corolla model lost its number one spot among the world’s best-sellers to Tesla’s Model Y, which is quite symbolic and underscores Toyota’s lag in shift to EVs. Moreover, the stock is slightly overvalued. All in all, I reiterate my “Sell” rating for TOYOF.

Recent developments

The latest quarterly earnings were released on May 8th, when Toyota delivered about flat revenue in fiscal Q4. Despite flat revenue, TOYOF showed a YoY EPS expansion from $3.07 to $4.99.

For the full fiscal year, Toyota delivered a 21% revenue increase with the net income approximately doubling. The bottom-line strength was powered with solid operating leverage. The operating margin improved from 7% to almost 12%, which is a solid achievement, in my opinion.

Strong operating leverage helped in generating better cash flows, which was beneficial for the company’s balance sheet. The company ended fiscal year 2024 with 9.4 trillion Japanese Yen in cash [approximately $61 billion]. The balance sheet is robust, and it is also backed by Toyota’s rock-solid credit ratings.

Despite strong performance in Q4 and FY 2024, I am still quite pessimistic about the company’s future prospects amid the secular shift to EVs. The company plans to sell 3.5 million battery EVs by 2030. This might look impressive without context, but to me, it looks like Toyota plans to be an EV laggard. Of course, Tesla (TSLA) recently omitted its bold goal to sell 20 million EVs annually by 2030, but this company already sold around 2 million vehicles in 2023. There are still six more years before 2030, and it looks like Tesla is way ahead of Toyota’s plans.

Furthermore, Toyota’s 3.5 million goal means that it plans its electric sales to comprise around 30% of its total volume. At the same time, the world’s second-largest automotive player in terms of volumes, Volkswagen (OTCPK:VWAGY), has far more ambitious tasks to achieve 55% electric sales in North America and 80% in Europe. I am emphasizing the year 2030 because there a ban from the EU on internal combustion engines will become effective in 2035. That said, the decade after 2030 will be crucial and will highly likely change powers in the automotive industry.

My cautious stance about Toyota is also backed by the management’s soft expectations for FY 2025. For the fiscal year 2025, TOYOF expects consolidated vehicle sales to be 9.5 million units. This will be lower than 11.09 million units sold in FY 2024. The decrease is shallow in relative terms, but for me, context is crucial. According to S&P Global Mobility, global new light vehicles sales will see a 2.8% increase in calendar 2024. Comparing calendar 2024 and Toyota’s fiscal year 2025 is reasonable, since three out of four quarters of these periods overlap. That said, Toyota’s global market share is poised to deteriorate in calendar 2024.

Another important point proving that Toyota is losing its dominance in the automotive industry due to the secular EV trend is recent information that after two decades as the world’s best-selling car, Toyota Corolla lost its first spot to Tesla Model Y.

Apart from external pressures amid industry evolvements, it seems like there are problems within the company as well. Akio Toyoda, the company’s leader, was recently re-elected with record-low support level from shareholders. The reason for deteriorated support for the chairman is the recent “safety scandal” when it was revealed that the company cheated on certification tests for its seven vehicle models. The stock reacted to this information with a pullback, and I completely agree with the market’s reaction. Cheating on safety certificates indicates significant deficiencies in the company’s internal controls, which undermines trust in reliability of Toyota’s cars.

Valuation update

TOYOF delivered a 23.7% rally over the last twelve months, slightly behind the broader U.S. stock market. At the same time, TOYOF is substantially outperforming the iShares MSCI Japan ETF (EWJ) that showed a 6.8% increase over the last twelve months.

Toyota’s stock looks overvalued compared to prominent German players like Volkswagen (VWAGY), BMW (OTCPK:BMWYY), and Mercedes-Benz (OTCPK:MBGAF). On the other hand, the discount on European stocks might be fair given the biggest war on the continent since WWII, which started more than two years ago.

To cross-check ratios peer analysis, the DCF simulation looks reliable. My revenue CAGR projection for the next decade is 3%, which is a mix of consensus estimates [available up to FY 2028] and my professional judgment based on all the fundamental risks and uncertainties. Toyota’s TTM FCF margin is 4.3%, and it is difficult to expect expansion here because of the rapidly intensifying competition from EV companies.

Moreover, the company rarely demonstrated strong FCF expansion trends in the past. In my initial coverage of Toyota, I have shared the above table, where readers can see that the company’s FCF margin is extremely volatile and was only once below 5% over the last decade. I am using a 10% WACC, which is recommended by FinBox.

My DCF simulation suggests that TOYOF is approximately fairly valued with a slight overvaluation. I would like to emphasize that the model incorporates optimistic assumptions. For example, the next decade’s revenue growth assumption is 3%. This level is approximately in line with the past decade, but there was much less competition from emerging EV companies. The assumed stability in FCF margin is also optimistic. To sum up, I cannot conclude that TOYOF is attractively valued.

Risks to my bearish thesis

Despite all fundamental risks and uncertainties, Toyota remains Toyota. I mean it is still the number one automotive company in the world by volume with several models like Camry, Corolla, and Rav4 consistently among the bestselling names. The brand has a huge loyal fan base and Toyota’s cars are perceived as one of the most reliable and long-lasting ones. This brand strength and perceived durability might be a significant asset in the transition to EVs when the company starts to expand in this field more aggressively.

From the corporate experience perspective, we should also not forget the company’s vibrant history tracing back to the 1930s. Over almost a century, Toyota faced lots of various disruptions, including technological ones. Nonetheless, the company became the dominating power in the global automotive industry and is still number one in terms of the car volumes sold. My expectations about the secular shift to EV might be too aggressive, and ICE vehicles might remain the majority for longer.

Bottom line

To conclude, TOYOF is still a “Sell”. The company’s goals do not look very ambitious in the EV race, especially considering the rapid adoption of them across the developed world. Toyota will likely lose some portion of its market share in calendar 2024, which is another red flag. As the recent safety scandal shows, Toyota’s challenges span beyond secular headwinds, since there are likely problems in the company’s internal controls. The valuation does not look attractive as well.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.