Toyota Back on Track Toward Record Profits, But Still Work to Do, Analysts Say

TOYOTA CITY, Japan – It all began here, at Toyota’s Honsha plant.

Sandwiched between the automaker’s main tech center and its former headquarters building, the plant was the real-world proving ground of Taichi Ohno, cofounder of the Toyota Production System with former Toyota Chairman Eiji Toyoda.

Many well-known Japanese business concepts later exported around the world either originated or were refined inside the plant’s 4,700-sq.-ft. (440-sq.-m) walls: kaizen (continuous improvement), muda and mura (eliminating waste and unevenness), kanban (signboards for just-in-time parts supply) and genchi gembutsu (go to the spot and see to take corrective action).

Ohno was the operation’s general manager from 1964 to 1968.

The plant opened in 1938. Leveled by Allied bombing during the World War II, it reopened in 1947, built up from its foundation, with the launch of the Toyopet SA, Toyota’s first postwar car.

The Honsha facility, still a major production and development center for forgings and chassis parts, came back into the spotlight in recent years as the automaker looked at its roots to find solutions to problems ranging from massive recalls to a bloated cost structure – and its first red ink in nearly 70 years in fiscal 2008.

Of course, Toyota is profitable again and on track to report record earnings in the fiscal year ending next March. Given that the dollar and euro continue to rise against the yen, most analysts expect earnings to grow beyond their earlier forecasts of ¥2.3 trillion ($21.5 billion), up from last year’s ¥2.29 trillion ($21.4 billion) record.

Sales still lag but are coming back strong, as they are projected to approach peak levels of ¥26.29 trillion ($245.9 billion).

So what is different from then and now?

Toyota now can be profitable at $1:¥85 and €1:¥110, or even $1:¥80 and €1:¥100, meaning it has cut costs and expanded operations outside Japan sufficiently to reach its “global vision” profit targets announced in February 2011.

Looking Backward, Forward

Toyota’s fall from grace can be traced back to Sept. 15, 2008, the day Lehman Brothers Holdings filed for bankruptcy. The automaker’s business immediately went into a tailspin, resulting in its first deficit since the 1930s.

Sales crashed to 7.1 million units the following fiscal year from 8.7 million in fiscal 2007, and the hyper-strong yen wiped out profit margins on exports.

The automaker began its recovery by cutting expenditures on travel, facilities and management bonuses. It delayed the introduction of new models and froze hiring.

The cuts had an almost immediate positive effect. After running up losses of ¥7.4 billion ($68 million) over the next nine months through June 2009, the automaker eked out a tiny operating profit in the second quarter of fiscal 2008 (July to September), only to be hit with a series of massive recalls between 2009 and 2011.

Not only was Toyota quality questioned, its safety record was hit hard by recalls related to sudden-acceleration claims and braking problems that were linked to nearly 90 fatalities in the U.S.

At a hastily organized news conference in early 2010, Toyota President and CEO Akio Toyoda admitted the company had expanded too rapidly.

By spring, Toyota would undertake a series of countermeasures to improve quality, the long-term effects of which remain uncertain.

With earnings on the rebound again in early 2011, a massive 9.0-magnitude earthquake and tsunami struck off the northeastern coast of Japan on March 11, bringing domestic vehicle production to a virtual halt for the better part of two months. That resulted in more red ink, though only for several months, as breaks in the automaker’s supply chain were repaired more quickly than analysts predicted.

Ironically, two days before the earthquake and tsunami, CEO Toyoda outlined the automaker’s global vision restructuring plan through which he hoped to build a foundation for sustainable profits even if production and sales were to fall below 7 million vehicles. The automaker’s breakeven target was 6 million units.

“We must be prepared to generate profits under any circumstance,” he said.

Toyoda’s fiscal-2015 target calls for a 5% operating profit margin at $1:¥85 and €1:¥110 rates, production levels of 7.5 million vehicles, including subsidiaries Daihatsu and Hino, and profits of ¥1 trillion ($9.3 billion).

Toyota’s current operating profit margin is 9.0%, and a paper-and-pencil calculation indicates the automaker would be profitable even if production and sales levels were to fall back to 7 million.

Also part of its restructuring was to expand overseas production. The automaker now produces more than half of all vehicles outside Japan – 61% in fiscal 2013 compared with 51% five years earlier. By 2020, analysts expect Toyota’s overseas production share to increase to 75%.

This is a powerful strategic weapon, as it provides Toyota a buffer against sudden exchange-rate fluctuations.

Meanwhile, Japanese automakers hold the dominant position in Southeast Asia, where Toyota has been the leading brand for decades. In China, its sales share is still relatively small at 5%, although volumes are approaching 1 million units. Several years ago, Toyota began producing hybrids in China and reportedly will add two models in 2015, a Corolla and Levin, raising its total to four.

In North America, Toyota has capacity to assemble upwards of 1.2 million vehicles, everything from compact sedans and SUVs to pickup trucks. It now ranks among the top three automakers in the U.S., having passed Chrysler Group in sales in 2006.

Even in Japan, the automaker now is profitable, having restructured around three regional production centers: Aichi (Central Japan) for Lexus sedans and bread-and-butter models such as the RAV4 and Crown, Tohoku (Northeastern Japan) for small cars such as the Aqua and Corolla, and Kyushu (Southern Japan) for midsize CUVs and some Lexus cars.

Gasoline-electric hybrids will play a key role in Toyota’s model strategy. Analysts estimate more than 25% of Toyota’s global vehicle sales in 2020 will be hybrids, thus some 3 million units based on projected sales of 12 million. The forecast excludes affiliated brands Daihatsu and Hino.

Since launching the Prius in December 1997, Toyota has sold 7 million hybrids, including nearly 1.3 million in 2013. With the domestic launch of the Lexus RS 300h this autumn, the automaker will have 29 hybrids on the market, including nine Lexus models.

Even with the emergence of new competitors in North America, Europe and Asia, Toyota’s global hybrid share stands at more than 60%.

More importantly, Goldman Sachs Global Investment Research reports profit margins for hybrids is now in line with the automaker’s per-vehicle average, meaning Toyota is making money.

Not everything is rosy, however.

The plug-in hybrid version of the Prius, which can run solely on its battery for short distances, has fallen substantially shy of the automaker’s sales target. Through June, global deliveries totaled just 11,750 units, after averaging only 24,330 in its first two years on the market. When Toyota launched the model in January 2012, it projected annual volumes of 60,000 units.

Critics argue the car lacks sufficient range in pure-electric mode – about 11 miles (18 km), which is well below the Chevrolet Volt’s roughly 35-mile (56-km) range.

Meanwhile, the aut maker’s Lexus division, which accounts for only 5% of unit sales, represents more than 25% of profits. In 2013, Toyota sold more than 520,000 Lexus vehicles globally. Goldman Sachs expects the brand’s sales to approach 700,000 units in fiscal 2015.

Although still far behind BMW, Mercedes and Audi, Lexus is comfortably ahead of Nissan’s Infiniti and Honda’s Acura brands.

Still Work to Do

Until 2008, Toyota was the world’s top auto automaker by any measure – production, sales, quality, supply base and market cap. It no longer is, at least not in all categories.

“Toyota has the best balance sheet and strongest supplier base in the industry,” says Koji Endo, managing director of Advanced Research Japan. “It remains the industry leader in technology, particularly in hybrids. But questions linger about its engineering capability and leadership at the top. Basically, it is too soon to tell.”

The seemingly endless procession of recalls is problematic. Another recent one involves nearly 1.7 million cars, raising Toyota’s 5-year total to upwards of 20 million worldwide since November 2009 when the sudden-acceleration-related floormat problem surfaced in the U.S.

Independent industry rating organizations provide no special insight.

In J.D. Power’s 2014 Initial Quality Study, Lexus came in third behind Porsche and Jaguar. But only one Lexus or Toyota model ranked highest in its segment, the compact Lexus ES, meaning there were 20 non-Toyota winners.

Yet, Toyota assembly plants came in one, two and three globally in the study.

It also is too soon to determine the impact of the automaker’s new flexible vehicle platform. By adopting TNGA (Toyota New Global Architecture), Toyota reportedly hopes to reduce development and key component costs by 25% and 50%, respectively.

The first model to employ the architecture will be the new Prius whose launch apparently has been delayed six months until fall 2015.

It also is too soon to determine the effect of management’s March 2013 decision to reorganize the automaker’s business around four large groups: Lexus; Toyota in North America, Europe and Japan; Toyota in China, Asia, the Middle East and elsewhere in the world; and engines and transmissions.

It probably will be positive, much like Toyota’s IMV-platform strategy for emerging markets in Asia that dates back to the middle of the last decade. But again, it’s too soon to tell.

Less clear is how Toyota’s commitment to improving the styling and design of its cars will play in an increasingly competitive marketplace worldwide.

But achieving its cost- and labor-saving targets in its manufacturing plants is another matter. Toyota, more so than many of its competitors, has a proven track record extending over decades.

Toyota is expanding laser welding and servo presses, resulting in 50% and 40% reductions in processes and floor space requirements, respectively.

By switching to jigs in place of exclusive-use equipment, setup time during model changes can be cut 90%, while use of compact die-cast stamping dies will trim time requirements by 70%.

There is little doubt the automaker will meet these targets.

The historic Honsha plant, although no longer producing cars, still is a major production center for forgings and 4-wheel-drive transfer cases.

It also has become a phase-in plant for new technologies, in particular environmental technologies, such as in-wheel motors, lithium-ion battery assemblies and fuel-cell stacks.

The Li-ion battery pack for Toyota’s plug-in Prius is assembled here. Most likely, the stack for the FCV will be produced here along with other future components.

Against this backdrop, it also is a basic skills learning center. Some 20 workers from Toyota plants around Japan come to the Honsha plant to attend monthly workshops on the Toyota Production System, keeping the spirit of Taichi Ohno alive.