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Race for new technology dents Toyota's earnings

Automaker forced to invest despite flagging sales in China and US markets

The e-Palette concept car unveiled by Toyota Motor last year. The automaker envisions offering the fully autonomous vehicle as a delivery and ride-sharing platform. (Photo by Masaaki Kudo)

NAGOYA -- Toyota Motor's earnings took a hit last quarter due to the growing costs of developing connected and self-driving vehicles as Japan's largest automaker grapples with a fast-changing environment.

The results released Wednesday look solid at first glance, with group operating profit up 9% on the year for the nine months ended Dec. 31 thanks to brisk sales. But operating profit for the October-December period alone rose just 0.4% to 676.1 billion yen ($6.16 billion), marking Toyota's first quarter of sub-double-digit growth since April to June of 2017, when operating profit fell.

The need for massive investments comes at a tough time for the industry as demand slows in the world's two most important markets, China and the U.S. Honda Motor's operating profit tumbled 40% last quarter, while Ford Motor reported a net loss. Toyota looks good by comparison, but its future earning power remains in question.

Toyota needs to stay ahead by pouring money into emerging technologies dubbed CASE: connected, autonomous, shared and electric vehicles. As these technologies gain traction, efficient research investment and how to reap profits from new mobile services are growing more important to automakers' profitability.

Toyota and other big-name automakers face competition in this area from relative newcomers to the industry. Google spinoff Waymo launched a ride-hailing service late last year using level 4 automated vehicles, which can drive themselves under certain conditions and are just one step below fully autonomous level 5 vehicles. In electric vehicles, Tesla and Chinese players are challenging the established order.

Toyota has established Silicon Valley and Tokyo sites to research artificial intelligence and self-driving technology. The carmaker aims to triple annual sales of electrified vehicles -- including hybrids -- to more than 5.5 million by around 2030 and is joining forces with Panasonic to accelerate development of new types of batteries.

But this investment in the industry's future is taking a toll on earnings now. Toyota expects to spend 1.08 trillion yen on research and development this fiscal year, up roughly 20% from five years ago, with about 35% going toward next-generation technologies. Employing more engineers has added to overhead as well.

"Our fixed costs have gone up more than 1 trillion yen over the past five years," a Toyota executive said.

 

Toyota kept its projections of revenue and operating income unchanged at 29.5 trillion yen and 2.4 trillion yen for the year ending March 31. (Photo by Maho Obata)

Even as the range of R&D projects broadens, the return on this investment is shrinking. Toyota's ratio of net profit over the three years ended fiscal 2017 to R&D spending over the previous three years is 2.1 -- down slightly from 2.2 for the period that began in fiscal 2007, when the focus was still on conventional engines. Volkswagen's ratio dropped to 0.4 from 1, while BMW's fell to 1.4 from 2.

As connected autos and cars with self-driving capabilities start to come on the roads, automakers are considering how to make these technologies contribute to earnings. Services will be key, and Toyota is already working on this under President Akio Toyoda's goal of transforming from a manufacturer to a "mobility company."

The automaker is teaming up with Southeast Asian ride-hailing company Grab to develop such services as insurance using data collected from connected cars. In Japan, Toyota will launch a car subscription service with connected vehicles next month, alongside the premium version with Lexus cars that rolled out on Wednesday.

On top of R&D investment, Toyota's October-December earnings were also hit by a weak yen and rising materials costs.

Also on Wednesday, Toyota cut its earnings forecast for the year ending March, saying it expects net profit to be 25% lower than last year due to losses on investments.

The company insisted the revision was not due to falling profits in its automobile business, but a result of weaker markets affecting its portfolio of equity investments in other companies.

Toyota also sounded the alarm over the confusion surrounding the terms of Britain's withdrawal from the European Union. It reiterated its warning that production at a factory in the U.K., one of its main global manufacturing centers, could be suspended if there is no agreement on withdrawal.

The company said it now expects net profit of 1.87 trillion yen. The profit decline is steeper than the Prius maker forecast in November, when it forecast 2.3 trillion yen -- down 7.8% from the previous fiscal year.

Toyota left its revenue and operating profit projections unchanged at 29.5 trillion yen and 2.4 trillion yen.

The automaker also updated exchange rate assumptions. It now expects the euro to trade at 128 yen at the end of March, compared with 130 in the previous forecast.

The company projects its consolidated global vehicle sales to hit 10.55 million, up 50,000 units from the previous forecast.

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