Toyota Motor Corporation (NYSE: TM) is a well-known Japanese car manufacturer. The company operates three business segments. The automobile segment specializes in the manufacturing and sale of automobiles. The financial segment provides financial services associated with selling Toyota's cars. The other segment is involved in housing, information and communication. Beginning in 2013, Toyota faced a series of headwinds related to its recalls and problems associated with airbags produced by Takata Corporation. This has put a dent into the car maker's reputation, especially in the United States. Toyota is also facing stronger competition, in particular from automakers from emerging markets such as China and India. Competitors are expected to sell their cars to consumers from developed markets. Toyota continues its commitment to its dividend policy while it is attempting to improve its image and increase its cost efficiency worldwide.

Dividend Policy

Toyota pays dividends twice a year with its fiscal year ending on March 31. U.S. investors interested in investing in Toyota can do so by purchasing American depositary receipts (ADRs), with each ADR representing two common shares of the company. The depositary for Toyota's ADR is the Bank of New York Mellon.

For the trailing 12-month period ending on Sept. 30, 2015, Toyota has a dividend per common share of JPY225 or JPY450 per ADR. When translated into U.S. dollars using exchange rates at the record date of the dividend, the trailing 12-month dividend per ADR is approximately $3.75. U.S. investors should note that currency fluctuations may significantly change the dividend amount in U.S. dollars.

Toyota is a limited liability, joint-stock company incorporated under the Commercial Code of Japan. The company exists under the Companies Act of Japan. Japanese regulation limits the amount of annual dividend distribution to the extent permissible by the Companies Act and ordinance of the Ministry of Justice in Japan. Toyota's management states it plans to pay out stable dividends with a target payout ratio of 30% after taking into account future investment plans. Because the company operates in a cyclical industry, Toyota constantly maintains cash reserves, and dividends per share may not exhibit constant year-over-year growth.

Toyota has consistently paid dividends since 1999, and its dividends per share in U.S. dollar equivalents has increased by an average annual rate of 14.8% from 1999 to 2015. However, dividends per common share fluctuated significantly as Toyota experienced cash flow problems in 2009-2010 and cut its dividend per common share from $1.40 in 2008 to 48 cents in 2010. Subsequently, the dividends per share steadily increased to $1.87 per share or $3.75 per ADR by 2015.

When compared to the auto and truck manufacturing industry, Toyota has exhibited a much faster growth in its dividends per share. From 2010 to 2015, Toyota demonstrated an average annual growth of 29% in its dividends per share in U.S. dollars, which is much higher compared to the industry's average of 20.7%. While Toyota's dividend growth rate in Japanese yen was 34.7%, part of this growth has been erased by the depreciation of the Japanese currency.

Toyota's payout ratio for the trailing 12-month ending on Sept. 30, 2015, stands at approximately 17%, which is much lower when compared to the industry's average of 31.7%. From 2010 to 2015, the company's payout ratio ranged from 19.2% in 2011 to 30% in 2012, and the average payout ratio for this period was about 23.8%.

Dividend Yield

As of November 2015, Toyota's dividend yield stands at approximately 2.7%. From 2005 to 2015, the yield ranged from 0.6% in 2006 to almost 4.5% in 2009. However, the dividend yield peak in 2009 was of a temporary nature as the company's stock plummeted and Toyota reduced its dividends in response to free cash flow problems associated with low consumer demand for cars worldwide. The average dividend yield was around 2% from 2005 to 2015.

When compared to the overall car industry, Toyota's current yield of 2.7% is slightly smaller than the industry's average of 2.97%. While Toyota's average dividend yield from 2010 to 2015 was 3.1%, the industry's average yield for the same period was 2.44%.

Globally, Toyota competes primarily with other big auto manufacturers, such as Honda, Ford, General Motors, Volkswagen, Nissan, Hyundai and Fiat Chrysler. While these are the largest car producers, Toyota's rivals include smaller companies based in Europe and Japan such as Suzuki Motor Corporation, Bayerische Motoren Werke (BMW) AG, Mazda Motor Corporation and PSA Peugeot Citroen S.A.

As of November 2015, dividend yields of Toyota's competitors vary significantly due to differences in each company's financial standing and ability to effectively compete for consumers. General Motors is one of Toyota's main competitors and offers a much higher dividend yield of 4.2%. Volkswagen, the second-largest rival to Toyota, has a dividend yield of 5.04%. However, this yield is abnormally high by Volkswagen's historic standards, as the company experienced an emission scandal in 2015 and its stock price declined by over 50% in less than a year. Hyundai has a dividend yield of 1.6%, which is significantly lower when compared to Toyota.

Other Toyota rivals that offer slightly higher dividend yields include Nissan with a 2.95% yield, Ford with a 4.31% yield and BMW with a 3.1% yield. Car companies with lower dividend yields include Honda with a 2.26% yield, Suzuki with a 0.82% yield and Mazda with a 1% yield. Fiat Chrysler and Peugeot do not have dividend policies and do not pay dividends as of November 2015.

Because Toyota targets a payout ratio of 30%, its dividends per share are likely to mimic the business cycle of the car industry. Also, other idiosyncratic factors play an important role in generating sufficient cash flows, such as recalls and car safety. Any recall scandals in the future, such as that of 2013, will likely have negative influence on the company's ability to pay out consistently growing dividends.

Dividend Safety

By historic norms, Toyota has experienced significant acceleration of growth in earnings and free cash flows in 2012-2015. After dipping below JPY1.5 trillion in 2012, the company's operating cash flows increased dramatically to almost JPY4 trillion for the trailing 12-month period ending on Sept. 30, 2015. This has resulted in a dividend coverage ratio of 563%.

Toyota has a substantial amount of debt on its books that is about JPY19.5 trillion, resulting in a debt-to-equity (D/E) ratio of 1.14. Almost half of this outstanding obligation is due in one to three years, and Toyota has been successful in rolling over its debt. However, if credit market conditions deteriorate, Toyota may run a risk of having insufficient liquidity to cover not only its operating needs but also financial obligations. At the same time, due to ultra-low interest rates in Japan, Toyota has a relatively stable cost of debt and an interest coverage ratio of 93.5%.

While Toyota has relatively strong financial ratios based on the most recent numbers, investors should still keep in mind the cyclical nature of the car industry. A sudden fall in the demand for cars can result in reduction of free cash flows and dividends. However, in the long term, holding Toyota stock may prove advantageous in resulting favorable shareholders' returns as the company continues to be fully committed to its dividend policy and 30% target payout ratio.

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