TOYOTA

FINANCIAL

ANALYSIS

CONTENT

2 BACKGROUND

4 SWOT ANALYSIS

5 MACROECONOMIC

EFFECTS

6 FINANCIAL ANALYSIS

10 PEER COMPARISON

16 RISK RETURN ANALYSIS

18 PROFORMA FINANCIAL

STATEMENT

20 VALUATION

Anna Tan An Qi . Lim Seng Wee . Mayank Poddar . Niko

Alfred . Nikhita Kishore

STOCK PRICE:

3120 JPY

(31/03/2009)

STOCK RATING: Neutral

2

BACKGROUND

Business Profile

Toyota Motor Corporation, henceforth known as

“Toyota” or the “Group”, ended FY2009 amidst a global

economic recession with a 21.9% decrease YoY in net

revenue to 20,529.5 billion yen. The drop in revenue was

mainly due to a 15.1% decrease YoY in vehicle unit sales

as global demand for vehicles fell. Expenditure from

marketing activities and other expenses, as well as the

losses from exchange rates resulted in the decrease in

operating income by 2,731.3 billion yen and

consequently an operating loss of 461.0 billion yen.

While global consumer confidence remains low, there

are signs that the recession is bottoming out and sales

figure should see a gradual increase in FY2010.

On-going discussions in Japan and the US on incentives

to scrap old cars may create an additional demand of

about 1 million cars in Japan alone. This could

potentially boost operating profits by 100-200 billion yen.

The Group is committed to a 10% cut in fixed costs

(mainly personnel cost), as a short-term measure to rein

in the losses from sales. However, with the magnitude of

losses, cost-reductions alone will not be sufficient. With

no large restructuring envisaged, any return to

respectable levels of profitability will take time and our

team remains cautious of its outlook for FY2010.

3

BACKGROUND

Key Business

Toyota Motor Corporation’s main operating activities

are in the automobile industry. Toyota is the largest

automobile manufacturer in the world with sales in more

than 170 countries and regions worldwide. Other than

manufacturing, Toyota also has operations in financial

services and others.

Automotive

Toyota is committed to providing quality vehicles at low

cost to major automotive markets in Japan, North

America, Europe and Asia. Toyota is a major player in

the Japan automotive industry, where it owns

approximately 50% of the market.

Impacted by the global recession, unit sales have been

decreasing for 3 consecutive quarters, QoQ. However,

given the signs of a gradually recovering global

economy, sales are expected to increase in 2H FY2010.

However, Toyota’s excess production capacity may see

operating cost eating into any improved sales figures for

FY2010.

The automotive section accounted for 90.4% of Toyota’s

net revenue in FY2009.

Financial

The financial services section of the Group provides

finance to dealers and their customers for the purchase

or lease of Toyota vehicles in 32 countries and regions,

including Japan, Canada, Australia and UK.

This section saw net revenue decrease by 8.1% YoY to

1,377.5 billion yen with an operating loss of 72.0 billion

JPY mainly due to higher provisions for credit losses due

to defaults, despite the increase in financing volume to

9.5 trillion JPY.

Others

The Group also has other operating activities in

intelligent transport systems, information technology and

telecommunication, e-TOYOTA, housing, marine, and

biotechnology and afforestation businesses.

4

Strengths Weaknesses

Strong branding

Research and development investment

Adequate focus on distribution channels

Low cost production system

Unfavorable financial position

Opportunities Threats

Huge, emerging markets i.e. China & India

Rising demand for hybrid cars

Intense competition in the automotive

industry

Transaction risk

Government regulations

Toyota’s main strengths are in its innovation and its strong distribution network. Its emphasis

on R&D has led to the development of the hybrid electric cars and improvements in the

safety testing of its products. These strengths, coupled with the emerging markets in China

and India, as well as the growing awareness on environmental conservation, pose great

growth opportunities for Toyota.

While Toyota’s poor performance in FY2009 is mainly due to the economic downturn,

Toyota must still be wary of other internal contributing factors. Furthermore, Toyota should

expect transactional risks to continue in FY2010 with the fluctuating currency rates due to

the unstable global market.

FY2009 was characterized by massive unemployment, bank failures and bankruptcies as a

result of the sub-prime crisis. This low-down in the global economy has affected Toyota

greatly, as seen in the drastic change in the company’s financial data. Hence, we find it

necessary to explain some of these effects.

SWOT Analysis

5

Macroeconomic

Effects

Exchange rate fluctuations Overall, the Japanese yen strengthened against the US

dollar and the Euro in FY2009. On average, the

Japanese yen appreciated from 115 JPY per 1 USD in

FY2008 to 101 JPY per 1 USD in FY2009, and 162 JPY per 1

EUR from FY2008 to 144 JPY per 1 EUR in FY20091. This was

due to decreases in interest rates that resulted from the

increased money supply, which was meant to ward off

a recession.

Toyota has substantial business outside Japan and the

strengthening of the Japanese yen against the

currencies in these countries has increased the level of

transaction risk – risk that affects operating income and

occurs as a result of the difference between the

currency structure of sales proceeds & assets, and cost & liabilities.

Localization of production would help reduce transaction risk. However, we note that the

local production in Europe (as a percentage of the total sales in Europe) decreased from

64.0% in FY2008 to 60.9% in FY2009. Local production in North America, on the other hand,

increased marginally from 57.2% to 57.4%.

Global inflation Inflation rates in the US, Europe and Japan have also increased, primarily as a result of

the increased money supply, and increasing oil and food prices. This has resulted in a

decrease in overall consumer real income and purchasing power, and has led to a

decrease in demand for luxury and fuel-inefficient vehicles. Toyota has hence been

greatly affected by this, as reflected by the 15% decrease in its consolidated vehicle unit

sales from FY2008 to FY2009 that corresponds to a 21.9% decrease in revenue. The losses

are further exacerbated by the increase in prices of production materials such as steel

and non-ferrous alloys, which includes aluminum.

Consumer confidence Besides the decrease in purchasing power, the negativity in markets has also led to more

conservative consumer behaviour. This is especially true in the US (one of Toyota’s largest

markets by far), as reflected in the drastic drop in the consumer confidence index (with

1985 as a base year) from 65.9 in March 2008 to 26.9 in March 20091. This has translated

into decreased spending and lowered revenues for Toyota.

6

Stable Sales and Profits

5 Year Data Billions JPY (YoY % Change) FY2005 FY2006 FY2007 FY2008 FY2009

Sales 18,551.53 21,036.91 23,948.09 26,289.24 20,529.57

7.27% 13.40% 13.84% 9.78% -21.91%

Gross Income 3681.4 4091.97 4719.9 4768.89 2073.77

19.57% 11.15% 15.35% 1.04% -56.51%

Net Income Attributable to Common Shares 1171.26 1372.18 1644.03 1717.88 -436.94

0.79% 17.15% 19.81% 4.49% -125.43%

Net Cash Flow From Operating Activities 2370.94 2515.48 3238.17 2981.62 1476.91

3.71% 6.10% 28.73% -7.92% -50.47%

Toyota has been reporting increasing sales figures from FY2005 to FY2007 with double-digit

annual increases in gross income during the same period. The slower growth in gross income

in FY2008 is due to the decrease in the growth of sales and the increase in COGS. The

increase in COGS was a result of the increase in depreciation of assets directly involved in

the production of inventory and this is consistent with the excess production capacity

problems that surfaced in FY2008.

Despite the net loss incurred by Toyota in FY2009, we attribute the loss to the slowdown in

sales volume and not to fundamental weakness in Toyota, as can be seen from the strong

positive cash flow from operating activities.

Financial

Analysis

7

Consistent Margins

FY2005 FY2006 FY2007 FY2008 FY2009

EBITDA Margin (%) 14.39 14.69 15.12 14.31 5.04

Net Profit Margin (%) 6.31 6.52 6.86 6.53 -2.13

Operating Margin (%) 9.01 8.93 9.35 8.64 -2.25

Toyota’s earnings and revenue figures give us an idea of the financial position of the

company, but it does not tell us enough about its profitability. Therefore, we look at some

margins to rate the profitability of the company.

The EBITDA, net profit and operating margins for Toyota remained relatively consistent from

FY2005 through FY2008. However, the margins took a deep plunge in FY2009. This is due to

the drastic decrease in sales in FY2009 that led to lower revenues. Furthermore, while COGS

decreased correspondingly with the lower sales volume, operating expenses were still high

due to an increase in SGA expenses. These factors together pulled the margins down.

Stable Current Ratio and Quick Ratio

FY2005 FY2006 FY2007 FY2008 FY2009

Current Ratio 1.15 1.07 1.00 1.09 1.15

Quick Ratio 0.99 0.91 0.85 0.93 1.01

A current ratio of 2.0 signals a company with appropriate liquidity and adequate ability to

finance her current liabilities. However, Toyota’s current ratio has been consistently slightly

above 1.0. This shows that the company has a weak ability to pay for her current liabilities

using her current assets and is thus prone to cash flow problems.

Nonetheless, this figure might be misleading as it includes inventory, which is not easily

converted to cash. This holds especially true for a company like Toyota with a high value

inventory of cars, trucks and others. Hence, the quick ratio would be a better measure of the

company’s liquidity as it discounts inventory.

Toyota’s quick ratios have been hovering closely below 1. It is desirable for the company to

have at least a ratio of 1.5. Thus, we see that Toyota needs to improve on its quick ratio. It

can do so by increasing its current assets (excluding inventory) and funding them through

equity, or reducing its current liabilities.

Furthermore, while Toyota has a good credit history, it would be desirable for Toyota to

improve its liquidity as sources of funding are more limited and less accessible as before,

given the current crisis.

8

Long-term Solvency, Debt financing

FY2005 FY2006 FY2007 FY2008 FY2009

Long Term Debt to Equity Ratio 0.73 0.72 0.70 0.68 0.80

Total Debt to Equity Ratio 1.63 1.66 1.70 1.68 1.83

Total Debt Ratio 0.61 0.61 0.62 0.61 0.64

The total D/E ratio has seen an overall increase from FY2005 to FY2008. This reflects a

greater proportion of debt used in financing assets. However, as the debt financing

position of a company is better reflected by its long-term debts, the long-term D/E ratio

would be a better indication of Toyota’s level of leverage.

There is a gradual decrease in long-term D/E ratio, which may reflect conscientious effort

by Toyota to reduce its debt leverage and to avoid taking too much debt.

In FY2009, despite an absolute decrease in liabilities, there was an increase in the D/E

ratios mainly due to the decrease in equity figures because of the net loss reported in

FY2009. However, Toyota will have to adjust its debt levels back to pre-crisis levels to

maintain its overall debt-risk levels.

Constant Receivables Turnover Ratio

FY2005 FY2006 FY2007 FY2008 FY2009

Receivables Turnover 0.0381 0.0380 0.0383 0.0390 0.0329

Days Sales in Receivables (days) 95.72 96.07 95.35 93.60 110.96

Toyota’s receivables turnover ratio saw an overall increase from 3.81x in FY2005 to 3.90x in

FY2008. This slight increase meant that Toyota had been more efficient in recovering

receivables from its customers and this translated to improved cash flows for Toyota.

The 2.12 day decrease in the DSO from FY2005 to FY2008, as a result of the increase in the

receivables turnover ratio, translated to a decrease in the cash conversion cycle. This in

turn reduced working capital requirements as well as the short term loans required to fund

operations.

The receivables’ turnover ratio, however, dropped drastically in FY2009. This highlights the

extent of the impact of the financial crisis where payments were slower and defaults were

higher, resulting in a negative impact on the Toyota’s cash flows. The higher DSO figures

would also require Toyota to have more free cash to fund its working capital.

9

DuPont Analysis

FY2005 FY2006 FY2007 FY2008 FY2009

Net Profit Margin (%) 6.3 0.065 0.069 0.065 -0.021

Total Asset Turnover Ratio 0.80 0.79 0.78 0.81 0.67

Equity Multiplier 2.67 2.69 2.72 2.74 2.86

Return On Equity (%) 13.60 14.00 14.68 14.49 -3.99

Disregarding FY2009, net profit margins have remained relatively consistent.

Furthermore, Toyota’s total asset turnover ratio has been relatively consistent from FY2005

through FY2009. This reflects continual efforts in leveraging on its assets to generate sales.

Also, the steadily increasing equity multiplier indicates an increased use of debt leverage,

which is consistent with Toyota’s increasing total D/E ratio.

With regards to return on equity, Toyota has managed to grow the returns from 13.60% in

FY2005 to a respectable 14.49% in FY2008. The drop in this figure to a -3.99% in FY2009 is due

to the decrease in earnings.

Increasing Shareholder Value

FY2005 FY2006 FY2007 FY2008 FY2009

Earnings Per Share (JPY) 373.50 435.71 514.10 529.92 -133.70

EPS 1yr Growth (%) - 16.65 17.99 3.07 -125.23

Return On Assets (%) 5.09 5.20 5.40 5.29 1.40

Return On Equity (%) 13.60 14.00 14.68 14.49 -3.99

Book Value Per Share (JPY) 2884.32348 3353.268663

3353.27 3701.21 3661.40 3078.61

Toyota experienced steady YoY growth in their EPS till FY2008. After which, this growth

declined to -125.23%. This can be attributed to the net loss that Toyota experienced due to

the financial crisis.

Toyota’s ROA remained fairly stable till FY2008. This reflects a continual commitment in

ensuring the efficient utilization of assets. The decline in ROA in FY2009 is once again

attributed to the losses suffered by the company in FY2009.

Book value per share is considered to be the accounting value of each share. This figure has

been consistently increasing from FY2005 to FY2008. This is consistent with the increasing ROE

and it directly translates into increased shareholder value. However there was a decline in

this value in FY2009.

10

Peer

Comparison

In this section, we pit Toyota against its closest competitors – Honda Motor Co. Ltd. and

Nissan Motor Co. Ltd., and analyze its relative appeal to investors.

Honda is the world’s largest manufacturing company for motorcycles and internal

combustion engines. It is also among the top automobile manufactures. Like Toyota, Honda

provides other services such as the financing/leasing of its products.

Nissan is among the top 3 Japanese automobile manufacturers in the US. Currently, Nissan

has a strategic alliance with Renault, an automaker in France. Each company holds a

sizeable percentage of the other’s shares.

Toyota Honda Nissan

Employees 198,000 177,249 151,438

Sales (Millions JPY) 20,529,570 10,011,241 8,436,974

Market Value (Millions JPY) 12,239,034.5 5,044,588 1,890,011.2

Toyota and Nissan were founded around the same period while Honda is relatively younger.

However, be it employees, sales or market value, Toyota emerges at the top. Thus, we

conclude that Toyota is the largest and most established company among the three.

11

Liquidity Comparison

Toyota has an average current & quick ratio figure that is in between its peers, which

indicates that its liquidity is moderate as compared to its peers. While a higher liquidity is

desirable, it is in-line with the industry’s standards. While it may not be as liquid as compared

to Nissan, it still has better liquidity than Honda and has a moderate probability of running

into short-term cash flow problems.

The increase in quick ratio in FY2009 will place Toyota in a better liquidity position to ride

through the financial crisis as compared to Honda. However, Nissan still remains the best

choice in terms of liquidity.

2005 2006 2007 2008 2009

Toyota 1.15 1.07 1.00 1.09 1.15

Honda 1.07 1.15 1.21 1.12 1.09

Nissan 1.29 1.24 1.16 1.20 1.32

Average 1.17 1.15 1.13 1.14 1.19

0.000.200.400.600.801.001.201.40

Current Ratio

2005 2006 2007 2008 2009

Toyota 0.99 0.91 0.85 0.93 1.01

Honda 0.84 0.89 0.94 0.86 0.80

Nissan 1.11 1.06 0.98 1.01 1.13

Average 0.98 0.95 0.92 0.94 0.98

0.000.200.400.600.801.001.20

Qu

ick

Ra

tio

Quick Ratio

12

Degree of Financial Leverage

Compared to its peers, Toyota’s Total Debt Ratio is consistently among the lower regions,

comparable to Honda, but much lower as compared to Nissan. The slight fluctuations

between FY2005 to FY2009 are in tandem with its peers, indicating a general change in

accordance with the industry’s movement instead of changes in Toyota’s internal policies.

Toyota’s D/E and Long-term D/E ratios are also similar to the average figures of its peers,

which suggest that the level of debt leverage utilized by Toyota is in-line with the industry’s

standards

The relatively high Total Debt ratios reflect the general approach of the automotive industry

in preferring to use debt to finance its operations over equity. This is also evident in the

generally high D/E ratio of Toyota and its peers. However, Toyota has the lowest average D/E

ratio as compared to its peers, which shows that Toyota is less leveraged and has a lower

debt-risk than its peers.

It can be seen that there is an upward trend in the past three year. This strengthens the point

on the economic crisis effect on increase of company debt.

2005 2006 2007 2008 2009

Toyota 1.63 1.66 1.70 1.68 1.83

Honda 1.83 1.56 1.66 1.74 1.92

Nissan 2.89 2.63 2.40 2.31 2.78

Average 2.12 1.95 1.92 1.91 2.18

0.001.002.003.004.00

Debt/Equity Ratio

2005 2006 2007 2008 2009

Toyota 0.73 0.72 0.70 0.68 0.80

Honda 0.69 0.60 0.70 0.72 0.86

Nissan 1.28 1.05 0.83 0.81 1.27

Average 0.90 0.79 0.75 0.74 0.97

0.000.501.001.50

Longterm Debt/Common Equity

Ratio

2005 2006 2007 2008 2009

Toyota 0.61 0.61 0.62 0.61 0.64

Honda 0.65 0.61 0.62 0.63 0.65

Nissan 0.72 0.71 0.69 0.68 0.71

Average 0.66 0.64 0.64 0.64 0.67

0.500.550.600.650.700.75

Total Debt Ratio

13

Asset Utilization

Toyota’s receivables turnover ratio shows that its collection polices have been consistently

better than Nissan’s but weaker than Honda’s. Since Toyota is the largest of the 3

companies, we conclude that Toyota is aggressive in their sales but less so in the collection

of payment for these sales. These results are also reflected in the days’ receivables.

We notice also that Toyota has the lowest asset turnover ratio amongst the 3 companies. At

first glance, this might be surprising given Toyota’s investment in research and development

that would typically lead to greater efficiency in the usage of assets in production.

However, we have found that this R&D is focused on product quality improvement and not

production efficiency. Furthermore, Toyota’s strategy of selling its products at a low profit

margin implies a larger unit sales volume. This is to counter the smaller profit mark-up and

maintain total sales. However, this would require a higher level of assets, thus causing its asset

turnover to be lowered.

We also observe a noticeable decrease in the asset turnover ratios for all 3 companies in

FY2009. We believe this is due to the decrease in sales and hence earnings, as a result of the

financial crisis. Furthermore, since the bulk of a company’s assets are fixed, the asset level

cannot change as much as the earnings within the year.

The decrease in Toyota’s asset turnover ratio was the largest primarily because of its excess

production capacity problems. This would cause inventory to be unnecessarily large and

thus lower asset turnover values.

2005 2006 2007 2008 2009

Toyota 3.81 3.80 3.83 3.90 3.29

Honda 5.01 4.95 4.74 4.96 4.56

Nissan 2.82 2.52 2.58 2.71 2.45

Average 3.88 3.76 3.72 3.86 3.43

2.002.503.003.504.004.505.005.50

Receivables Turnover

2005 2006 2007 2008 2009

Toyota 95.72 96.07 95.35 93.60 110.96

Honda 72.80 73.80 76.97 73.65 80.00

Nissan 129.64 144.77 141.73 134.60 148.90

Average 99.39 104.88 104.68 100.62 113.29

50.0070.0090.00

110.00130.00150.00

Days Receivables

2005 2006 2007 2008 2009

Toyota 0.80 0.79 0.78 0.81 0.67

Honda 0.98 0.99 0.98 0.97 0.82

Nissan 0.97 0.88 0.88 0.89 0.76

Average 0.92 0.89 0.88 0.89 0.75

0.400.500.600.700.800.901.00

Asset Turnover

14

Decreasing Profitability

Toyota has the lowest gross margin figures as compared to its peers. This may be explained

by its sales strategy to provide affordable vehicles to consumers at a lower price in order to

capture the market share. Due to its low gross margin, Toyota has suffered huge losses during

the financial crisis, as lower sales figures were not able to cover its fixed operating cost.

Honda may be better equipped to weather the financial crisis as its higher gross margin may

ensure that there is sufficient cash inflow despite lower sales to cover other operating costs.

2005 2006 2007 2008 2009

Toyota 0.20 0.19 0.20 0.18 0.10

Honda 0.30 0.29 0.29 0.29 0.26

Nissan 0.26 0.25 0.23 0.22 0.16

Average 0.25 0.25 0.24 0.23 0.17

0.00

0.05

0.10

0.15

0.20

0.25

0.30

Gross Margin

2005 2006 2007 2008 2009

Toyota 0.14 0.15 0.15 0.14 0.05

Honda 0.10 0.11 0.11 0.12 0.08

Nissan 0.15 0.15 0.14 0.14 0.06

Average 0.13 0.14 0.13 0.14 0.06

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

EBITDA Margin

15

Strong Market Value

Looking at FY2005 to FY 2008, we observe that Toyota’s EPS ratios have been the highest

amongst its competitors. This is because it has been enjoying a larger net income. Also, it

does not suffer from share dilution, unlike Nissan, which has a net income that is only slightly

higher than that of Honda’s but double the number of shares Honda has.

However, although Toyota’s historical EPS ratios have been consistently higher than its

competitors, it had the lowest EPS in FY2009. This is because its gross profit and EBITDA

margins were the lowest amongst its competitors in FY2009.

With regards to the market-to-book ratios, Toyota saw a remarkable 43.8% growth from

FY2005 to FY2007. In contrast, both Honda and Nissan’s EPS values decreased during this

period. Toyota was thus generating value for its shareholders during this period.

In FY2008 and FY2009, the market-to-book ratio for all 3 companies fell. This can be attributed

to the increasingly negative market sentiments as the precarious positions of major financial

institutions unveiled towards the end of FY2008.

2005 2006 2007 2008 2009

Toyota 373.50 435.71 514.10 529.92 -133.70

Honda 262.85 326.94 324.95 330.69 75.50

Nissan 125.61 126.42 112.08 118.35 -57.38

Average 253.99 296.36 317.04 326.32 -38.52

-200.00-100.00

0.00100.00200.00300.00400.00500.00600.00

EPS

2005 2006 2007 2008 2009

Toyota 1.39 1.92 2.00 1.36 1.22

Honda 3.03 3.23 1.69 1.17 1.26

Nissan 1.83 1.86 1.48 1.13 0.72

Average 2.08 2.33 1.72 1.22 1.06

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

Market to Book Ratio

16

Risk Return

Analysis

Toyota Honda Nissan

Beta Estimate 2009 1.0208 1.2851 1.1313

Thomson One1 0.94 0.93 1.56

Google Finance3 0.72 0.71 1.70

Financial Times3 0.9542 0.961 1.41

Calculated Volatility (%) 26.41 26.08 25.52

Beta Comparisons

Beta (β) is used to measure the relevant risk of a stock. We plotted the daily rate of returns of

Toyota, Honda and Nissan against the Nikkei 225 index over a one-year period and obtained

a beta estimate of 1.0208 for Toyota through the linear regression model. This means that

Toyota has low systematic risk and its price movement is largely in tandem with the Nikkei 225

index. Hence, we would expect Toyota’s stocks to be more appealing to the average

investors who seek returns similar to the broad index. However, investors with greater risk

appetite might find Honda – with its high beta – a better investment choice, for it has the

potential to generate better returns than Toyota in a bullish market. However, with the

current volatility in the markets due to the financial crisis, Toyota may appear as a better

choice as compared to its peers as a “safer” investment poses less downside risk when the

market is trending downwards.

Our beta estimates are inconsistent with the figures extracted from Thomson One, Google

Finance and Financial Times. According to our estimates, Honda has the highest beta,

followed by Toyota and then Nissan. However, both Thomson One and Google Finance beta

estimates show Nissan with the highest beta, followed by Toyota and then Honda. We

believe the inconsistency is mainly due to the difference in time period of the beta

calculations and that which we extracted from these vendors.

However, comparing the beta from the different sources, Toyota has the lowest average

beta figure. In the current volatile investment climate, Toyota may be the better investment

choice as compared to its peers due to its lower systematic risk. However, any upside will also

be limited due to its lower beta, and one can expect Toyota’s performance to be closely

related to the Nikkei 225 index with little upside surprises.

17

Return Volatility Comparisons

We generated the return volatilty for all 3 companies using their standard deviation and

noticed that the volatility for Toyota is the highest, although it has the lowest beta. This means

that while Toyota is less sensitive to changes in the market, its stock prices and returns

fluctuate more than the other 2 companies. Hence, if we do not expect the market return to

change much, the effects of beta will be discounted and Toyota will be less appealing to

investors due to its greater volatilty. Furthermore, Toyota would attract more long-term risk-

adverse investors than short-term ones. This is becaue the less risk-adverse would favor

Honda for its higher beta and the short-term risk adverse would favor Nissan over Toyota for

its lower volatiltiy. The long-term risk adverse investor would see a closer correlation of

Toyota’s stock returns with that of the market index and would gain more with Toyota’s

stocks than Nissan’s, should the market improve.

Typically, the larger the company, the less volatile it is because it is more likely to be able to

withstand market shocks. However, we see an opposite trend here. Toyota, though the

largest company amongst the 3, has the highest volatility. This show of a lack of investor

confidence in the company’s stock signals an underlying problem with Toyota.

18

Proforma

Financial

Statement

A forecast of the financial position of Toyota has been made for the following 5 years. Since

Toyota is an international business with goods of a relatively high elasticity, it is largely

affected by global market events and sentiments. Hence, we have incorporated the

historical and projected global GDP growth rates (as according to the IMF World Economic

Outlook data) in our forecasts.

The 3 key assumptions we made in our forecasts include:

1) Total revenue growth will follow global GDP growth trends. It will grow at a rate of 3.1%

in 2010, 4.2% in 2011 and 4.4% in 2012 as according to forecasted GDP growth rates.

With the recession forecasted to be over by 2012, it is expected to revert to pre-

recession levels of 13.6% growth per annum

2) Operating cost (operating expenses + depreciation) will remain at 87.3% of annual

sales (as according to historical averages)

3) Depreciation growth rate will remain at 10% of annual sales (as according to historical

averages)

5 Year Data in

Billions JPY FY2009A FY2010F FY2011F FY2012F FY2013F FY2014F

Total Revenue 20,529.570 21,165.987 22,054.958 23,025.376 26,156.827 29,714.156

Operating Cost 19,495.411 18,477.906 19,253.978 20,101.153 22,834.910 25,940.458

Depreciation 1,495.170 1,451.864 1,512.842 1,579.407 1,658.378 1,741.297

EBIT -513.499 1,456.324 1,526.598 1,603.464 1,944.396 2337.685

Continued on the next page

19

We expect FY2010 to see positive earnings because of the projected increase in global GDP

growth rate from -1.059% to 3.102%. We project revenue growth to be largely close to actual

GDP growth rates in the first 3 years after the crisis as the market starts to slowly pick up and

regain consumer confidence. Thereafter, we expect revenue growth to greatly outperform

global GDP growth as the economic recovery goes into full swing. However, we recognize

that revenue growth cannot continually increase exponentially and hence we cap it at

13.6% in 2014, as according to Toyota’s revenue growth before the financial crisis.

Our optimism about the Toyota’s revenue growth is largely due to an expected increase in

demand for Toyota’s vehicles, given the R&D investment, hybrid cars and intended

expansion into more markets. Concurrently, we expect operating costs (and especially

transaction risk) to decrease significantly as the company continues to move production out

of Japan. Depreciation expense would also stay at a low due to the JIT production methods

adopted that would reduce losses due to inventory obsolesces. These factors combined,

would lead Toyota to positive earnings.

Proforma

Financial

Statement

Proforma

Financial

Statement

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egestas. VALUATION

Dividend Growth Model

Due to the global recession, Toyota is expected to report

low growth and moderate positive net income both in

FY2010 and FY2011. As such, we expect dividends to

remain stagnant at 100 JPY in FY2010 and FY2011. From

FY2012 onwards, dividends are expected to grow at the

average historical rate of 7.14% (as according to data

from FY2007 to FY2009). Using the dividend growth model,

and a required return rate of 9.51% (risk free rate = 4.4%;

market risk premium = 5.0%; beta = 1.02), we estimate

Toyota’s target price per share to be 3959 JPY.

Discounted Free Cash Flows Valuation

A discounted cash flow valuation was generated using

the forecasted EBIT for the next 5 years. The forecast was

based on the following assumptions:

1. Revenue assumptions as stated under “Proforma

Financial Statement”

2. The long-run FCF growth rate is assumed to be in-line

with the long term global GDP growth rate of 5%.

3. The WACC is determined to be 8%.

After determining the NPV of the forecasted FCFs, the

target price per share of Toyota was determined to be

3063 JPY.

Forecast of Price based on Book Value per

Share and Price-Book Ratio (P/B)

The book value per share of Toyota is 3208 JPY. Based on

the automotive industry’s average P/B ratio of 0.91, we

estimate the target price per share of Toyota to be 2920

JPY.

21

VALUATION

Analysis

Compared to the stock price at March 31, 2009 of 3120

JPY, the forecasted prices using the discounted FCF and

the P/B ratio methods indicate that Toyota is slightly

overvalued. However, the estimate using the dividend

growth model shows that Toyota is very undervalued.

However, we deem that the dividend growth model is not

a good estimate because of dividend policies i.e. Toyota

is still paying out dividends even though the Group is

making a net loss. Thus, the dividends cash flows may not

be a good indicator of the company’s intrinsic value.

We believe the forecasted values using the discounted

FCF and P/B ratio methods present a better estimate of

the fair value of Toyota for they incorporate the growth

forecast of the entire market and also factor in market

sentiments.

Despite signs of the economic recession nearing its

bottom, consumer purchasing power for automobiles will

take some time to recover. Moreover, the excess

production capacity will continue to keep operating

costs high. However, investors can be hopeful about the

“incentive to scrap” program, which will boost sales

revenue in FY2010, if it goes through.

We recommend a HOLD call on Toyota based on the

adjusted results of Toyota for FY2009 as we foresee a slow

recovery for Toyota from net loss back to profits. Moreover

the economy recession will continue to see luxury items

like automobile to be in low demand even while the

global economy is recovering.