With its vehicles being popular among consumers, Toyota Motor Corporation (NYSE: TM) is one of the largest producers of cars worldwide. Toyota also operates financing, housing and communication lines of business that are not as important to the company's bottom line as its car manufacturing segment. Because Toyota heavily relies on debt to finance its operations and capital expenditures, investors should keep a close eye on the company's leverage indicators, such as debt-to-equity ratio. Profitability return ratios, such as operating margin and return on invested capital (ROIC), are other important indicators for evaluating Toyota's ability to curb its costs and keep itself profitable. Inventory turnover is another metric in the automobile industry that should be looked at, as it gives a sense of Toyota's efficiency in managing its inventory levels.
The automobile industry is highly capital-intensive and requires large capital outlays every year to move new models in its research and development pipeline. Also, car manufacturers, such as Toyota, must build new plants and constantly invest in their production processes to remain efficient. All this requires a significant amount of capital to be deployed, and it typically takes a few years before the benefits are reaped. To avoid dilution, Toyota generally resorts to debt to finance its investment and operating needs.
One financial metric that helps assess whether the company borrowed too much and may face difficulties in meeting its credit obligation is the debt-to-equity (D/E) ratio, which is calculated by taking the company's total debt and dividing it by its common shareholders' equity. Toyota's D/E ratio ranged from 0.50 to 0.68 between 2006 and 2015. For the quarter ending Sept. 30, 2015, Toyota had a D/E ratio of 0.60. This is much lower compared to other car manufacturers such as General Motors with a D/E ratio of 1.17, Ford with 4.13 and Fiat Chrysler with 2.2.
The operating margin tells how efficient a company runs its operations so it can generate a certain operating profit per dollar of sales. High operating margin typically indicates a company's ability to have strong price power or cost efficiencies in its production process. Toyota's manufacturing process is considered a state-of-the-art standard in the automobile industry with a high degree of automation. While Toyota's operating margin significantly fluctuated from 2006 to 2015, the company substantially improved this metric, and the operating profit margin for the 12-month trailing period ending Sept. 30, 2015, was 10.51%, which is one of the highest in the automobile industry. Toyota benefited a lot from the depreciation of the Japanese yen since about half of the company's production output is produced in Japan.
Return on Invested Capital
ROIC tells how much profit a company earns for each dollar of capital, or debt and equity, it employs. Because Toyota employs a significant amount of debt, its ROIC is much lower compared to its return on equity, another important return metric. Toyota's ROIC stands at 3.38% for the 12-month trailing period ending Sept. 30, 2015. This ROIC is likely much lower than the company's cost of capital, which indicates Toyota did not efficiently use its capital more recently to create value for its common shareholders.
Like any other manufacturer, Toyota's success heavily depends on its ability to produce cars that generate appeal among consumers and result in the company's inventory being sold out as many times as possible throughout the year. The inventory turnover ratio indicates how many times a company's inventory is sold and replaced in a given time period. A high inventory turnover ratio by industry standards indicates the company is very efficient at managing its inventory, while a low inventory ratio indicates it invests too much in goods that sit idle in its warehouses. Toyota has an inventory turnover ratio that fluctuates between 10 and 11, and was 10.62 for the 12-month trailing period ending Sept. 30, 2015. Compared to its peers in the automobile industry, Toyota's inventory turnover ratio is somewhere in the middle of the range.