Lexus to Super-size Price and Image

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The Wall Street Journal has a nice Page One piece on Lexus, about how it is respected for its quality, but not a top choice, or even a choice at all, among America’s wealthy — some who have a fleet of cars. It looks like this will change however, as Toyota is readying to break into the “prestige luxury” segment. And how about the stock of parent-Toyota?

First, a quick recap of the article:

Lexus dispatched a special team — “the super-affluent team” — in ’05 to interview and research car buyers with at least $5 million (ex-primary residence) in assets to better understand their wants and needs, naturally, in order to become able to serve this segment. A once conservative spender on marketing and advertising, Lexus is now reportedly spending six-figures on parties hosted by its dealerships across the U.S.Lexus’ sales grew 7% to 322,000 autos sold last year. The WSJ notes BMW and Mercedes by comparison, sold 179k autos combined in February. Still, while the two are seemingly trying to expand their consumer base to include those who would have probably never thought of being able to drive European luxury before, Lexus is more aggressively targeting the opposite end.

Not only are car sales in the “prestige luxury” segment growing rapidly (sales doubled over the past five years), but the number of people that can afford such cars are also growing at a healthy clip — according to recent wealth surveys and heightened debate over the widening rich-poor gap, and even a widening gap among the rich and super-rich.

This is exactly what to look for: rising income/wealth and a growing pie.

Now, about Toyota’s stock:

How much of Lexus and its future growth is figured into Toyota’s stock price? It arguably cannot be too much. It was only last year that Lexus began selling in Toyota’s home market. Also, last year there was an interesting report in the U.S. business press that many U.S. fund managers where unaware Toyota was even traded in the U.S. For that matter, does Toyota have analyst coverage in the U.S.?

At present, most of the focus for Toyota’s stock is related to the impact of the yen-dollar and the yen carry trade. It works as simple as this: yen weakens against the dollar –> Toyota’s stock rises a percent or two; yen strengthens against the dollar –> Toyota’s stock may lose up to a percent, but could gain a percent.

Why?

Because in the second main focus for Toyota, monthly U.S. auto sales, it is smashing the competition. And even in its unattractive home market, it has been able to sustain its leading market share, while targeting higher growth with Lexus in the high-end and Daihatsu mini-cars and Toyota compacts in the lower-end.

Thus, regardless of the foreign currency exchange rate, Toyota is executing. A weak yen in theory means repatriated profits are worth more, but if Toyota keeps investing overseas, the currency argument is somewhat diminished. Also, a stronger yen will lower materials import costs at home.

Here’s a look at the trailing and forward P/E ratios for Japan’s big-3 auto:

Toyota (JP: 7203) 18.6; 18.3 f/p/e (period ending 03/2008)
Nissan (JP: 7201) 10.5; 13.1 f/p/e (03/2007)
Honda (JP: 7267) 12.3; 14.0 f/p/e (03/2007)
* As of 03/23/07 close

You will have to a pay a premium for Toyota compared to its domestic rivals. By the way, do Ford (F) and General Motors (GM) even have earnings to compare?

With Toyota, you are getting Japan’s largest company, the most represented company in the Japan ETFs trading in the U.S., and undoubtedly the same for Japan mutual funds and overseas Japan investment funds as well.

Its ADRs’ (NYSE: TM) P/E and F/P/E look even better and there’s downside protection (upside boost) from a stronger yen, if/when the yen carry trade unwinds; however, currency is another post in itself.

And back to the source of this article, there’s the Lexus factor.

Overall, Toyota is in great shape and making all the necessary investments, while its rivals are either cutting back spending (think U.S. — Ford and GM) or coming up short (think Japan — esp. Nissan).

In closing, we think Toyota is a solid candidate for a core holding. In fact, it could be a short-term trade and a long-term holding. A strategy with Toyota for non-Japanese investors is to buy a Japan ETF such as iShares MSCI Japan Index (EWJ) and look at adding some more exposure by building a position in its ADRs. The CurrencyShares Japanese Yen Trust (FXY) ETF can be used to hedge, if desired.

Separately, and perhaps offering more profit potential, is to consider Daihatsu (JP: 7262), the second largest mini-car manufacturer in Japan, in which Toyota owns a 51.1% stake. The mini-car segment, as mentioned earlier, is another case of a growing pie and in Japan this is despite a weak overall auto market; but globally, mini-cars offer excellent growth opportunities.

On the subject of autos, let’s close by pointing out Nissan (Nasdaq: NSANY) and Honda (NYSE: HMC) are both worthy investments from a risk/reward perspective. Nissan is more of a “dogs” of Japan auto strategy. It is liked for its valuation and even more so for its dividend yield. We don’t see any particular rush to get into Honda. Nissan however, could see some nice one-day and weekly jumps, as its monthly sales are expected to improve over the rest of this year and in ’08.