Japan is roaring back

Huge profits to fuel more r&d, content

“We have been reducing costs and implementing structural reform, which are showing visible positive results.” --Takuo Sasaki, Toyota managing officer

TOKYO -- Japan is back.

Enjoying a huge windfall from a weakening yen, Japan's automakers are putting a half-decade of travails behind them and entering a golden age of record profits.

Mounting cash hoards mean they can better withstand another downturn, plow more money into new factories, invest more in r&d and make products more attractive by adding content, holding the line on price increases or offering enticing incentives.

"This is a kind of renaissance for Japan's carmakers, after the dark ages of the financial crisis, the tsunami and the exceptionally high yen," said Tatsuo Yoshida, an analyst at Barclays Securities Japan. "They have much more freedom and latitude."

Consider r&d spending, the seed money that yields better products down the road. In the fiscal year that ends March 31, Toyota plans to raise its r&d spending 12 percent from a year earlier to a whopping $8.55 billion. That is more than double General Motors' 2013 net income of $3.77 billion. Even at the much smaller Honda, r&d spending is forecast to rise 13 percent in the current fiscal year to $5.99 billion.

As Japanese automakers report earnings for the October-December quarter, they are issuing buoyant forecasts for the entire fiscal year ending March 31. Four companies -- Toyota, Mazda, Mitsubishi and Subaru parent Fuji Heavy Industries -- are forecasting record net profits, in each case representing a rise of more than 20 percent.

Honda Motor Co. predicted a 58 percent surge in net to ¥580 billion ($5.51 billion), just shy of its record of $5.7 billion. Nissan Motor Corp. was due to release its October-December results and full fiscal year forecast on Monday, Feb. 10.

Japanese automakers say it's too early to detail how they will spend the additional income. But the windfalls will help them afford expansions that are under way, such as new factories in Mexico from Mazda Motor Corp. and Honda, and put them on more solid footing to risk bigger investments in new markets or new technologies, such as costly hydrogen fuel cell vehicles

The carmakers are eclipsing prerecession peaks largely due to the tail wind from a Japanese currency that has lost about 20 percent of its value against the dollar in the past year, following the election of Shinzo Abe as prime minister and his endorsement of a weaker yen, among other economic stimulus policies. But the automakers are also reaping the rewards of years of belt-tightening during the global financial crisis and a four-year stretch during which the yen marched to record highs.

Toyota, for example, reckons its currency windfall will total $8.36 billion this fiscal year, accounting for more than a third of its projected record operating profit of $22.81 billion. At the same time, cost-cutting efforts are chipping in $2.28 billion toward that impending record.

A new dynamic also is at play. When Toyota posted operating profit of $21.57 billion -- its record until now -- in the fiscal year ended March 31, 2008, U.S. demand exceeded 16 million vehicles a year, and the yen-dollar rate was even more favorable than it is today. Now, Toyota is poised to top those profits on much lower U.S. industry volume and an exchange rate that is favorable, but hardly at maximum-gain levels.

Yen's impact

Little wonder, then, that Toyota executives take umbrage at the notion their stellar profits are purely currency plays, an argument made last week by Joe Hinrichs, Ford Motor Co.'s president of the Americas.

"When Toyota came out and said half their profits are due to currency change of the yen, that's a big deal," Hinrichs said at the Economic Club of Chicago. "Morgan Stanley estimated that the recent fall in the yen puts roughly $2,000 per export vehicle into the pockets of Japan's three biggest automakers."

But "that's misleading," Toyota Managing Officer Takuo Sasaki said. "We have been reducing costs and implementing structural reform, which are showing visible positive results."

He noted that Toyota's Global Vision midterm business plan, unveiled in 2011, called for a cost base that can deliver profits at far-less-favorable exchange rates of 85 yen to the dollar, vs. today's rate of roughly 100-105 yen to the dollar. "We are right on track to realize that vision," Sasaki said.

The story is much the same at other companies.

During the lean years, Japan's automakers cut high-cost capacity at home, expanded sourcing of parts from low-cost Asian suppliers, re-engineered vehicles to ride on lower cost architectures and shifted production overseas to reduce the risk of future exchange rate losses. When the yen reversed course, they were primed to score big returns.

Kogai: Reform is bearing fruit.


Case in point: Mazda.

In the depths of the financial crisis, Mazda began to overhaul its global manufacturing footprint and its product. It set up joint manufacturing ventures in Russia and Vietnam, and opened an assembly plant in Mexico last month.

It also developed its Skyactiv line of powertrain, chassis and body technologies, which cost less to manufacture and deliver fatter margins.

Honda did the same with its Earth Dreams powertrain lineup and new global platform strategy. Toyota and Nissan have followed suit with low-cost modular product plans.

Better vehicles are also factoring into the profit surge.

In the first nine months of the year, Mazda reaped a $348.8 million foreign exchange gain. But higher sales and a mix of higher-margin vehicles added $232.8 million to operating profit. Even without the foreign exchange gain, Mazda would have booked a respectable 10 percent gain in operating profit. With it, operating profit soared sixfold.

"We've been working on structural reform for several years, and it's steadily bearing fruit," Mazda CEO Masamichi Kogai said. "It's from here out that we'll see decisive results."

Still, the returns will likely be diminishing. Even if the yen keeps weakening, the currency impact going forward is unlikely to be as dramatic as it has been this year. And, given the vagaries of foreign exchange markets, there is always the risk that the yen could strengthen again and eat away at today's bumper margins.

'Wise investment'

For the time being, the profits are feeding already big cash reserves.

The ever-conservative, cash-hoarding Toyota reported a cushion of $33.93 billion on Dec. 31, including cash and cash equivalents, time deposits and marketable securities. That was up 29 percent from a year earlier.

But even Fuji Heavy, the smallest of Japan's major automakers, had its cash and cash equivalents surge 63 percent to $4.73 billion as of Dec. 31 from a year earlier.

Japan's automakers are plowing some of that money into the future -- pumping up r&d budgets and capital expenditures on items such as new plants and engineering centers.

When reinvesting those profits, a top priority will be strengthening product development, said Toru Hatano, an auto analyst at IHS Automotive in Tokyo. This is especially true as global automakers' r&d budgets are strained by divergent demands to develop electrified, fuel-efficient cars for developed markets and a new fleet of low-cost small cars for emerging markets. The industry's new emphasis on software and semiconductors is also driving budgets higher.

"In the short run, they will focus on r&d," Hatano said. "The needs of r&d are becoming wider and wider. They have to build new facilities and hire new engineers."

Some investors have complained that more of that cash should be paid to shareholders as dividends. That's not what Toyota plans.

"Wise investment is what we have in mind," said Toyota's Sasaki. "We want to develop advanced technology for future growth."

You can reach Hans Greimel at hgreimel@crain.com -- Follow Hans on Twitter: @hansgreimel

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