Profit From Toyota's Deceleration

Melvin Pasternak's picture

Monday, February 1, 2010 - 4:57pm

by Melvin Pasternak

Just when it seemed the auto industry was beginning to rebound, Toyota Motor Corp. (NYSE: TM) has gone into reverse.

Toyota -- the world's number one selling auto manufacturer -- recently recalled 2.3 million cars in the United States, due to faulty floor mats which trap accelerator pedals and cause sudden and unexpected acceleration. The 2.3 million vehicle recall came on top of a recall of 4.3 million vehicles in October.

While Toyota is working on a solution with its supplier, the company has also halted production in six of its North American manufacturing plants. As well, it is suspending sales on eight of its most popular vehicles, including the Camry and Corolla -- which accounted for 57% of U.S. sales last year.

The news is having a devastating effect on the reputation of the Japanese company. Even after the problem is fixed and production resumes, trust will be difficult to restore. This can affect both sales and profits.

Traders have already voted -- with their feet, so to speak. The stock lost nearly $7 on Wednesday, January 27th. Volume was 3.48 million shares, about four times normal levels. On Thursday, the stock tried to rally, but gave up its gains.

As the chart below shows, Toyota's peak of $91.97 hit on January 19th may mark a major top. First that is the level where a major downtrend line intersects the chart. Toyota has failed at a crucial technical juncture.

Second, there is a shelf of resistance at this same level dating back to August through October 2008. TM's failure to penetrate this resistance is a second technical failure.

This week's large bearish engulfing candle means the stock has penetrated both its 10- and 30-week moving averages.

From a technical standpoint, Toyota is likely to continue falling for several more dollars until it hits support at around $72. Another ledge of support exists near $70 as well.

However, if the company is not able to find a quick fix for the accelerator pedal defect -- and continues to suspend manufacturing and sales as a result -- an accelerated downtrend could result.

In that case, TM could go as low as the mid-50s before finding support. The mid-50s is a major support zone for the stock and an area in which it formed a triple bottom between September of 2008 and April of 2009.

Relative strength index, stochastics and MACD have all recently given sell signals. All show that Toyota is not yet oversold.

Fundamentally, Toyota like other car companies has been under pressure.

Between fiscal year 2008 and 2009, revenue dropped nearly -26%, from $262 billion to $208 billion. In 2010 revenues are expected to take another huge hit, declining to $157 billion, a drop of more than -25%.

Sales aren't expected to climb back up until 2011 when analysts anticipate revenue will increase to $259 billion.

Earnings have fared little better. Toyota's 2008 earnings per share were $5.40. In 2009, analysts expect the company to lose $1.39. The company still won't be in the black in 2010 when it is projected to lose $0.29 a share.

In 2011, analysts expect an earnings recovery. They anticipate Toyota will earn $3.20 a share. At current levels, the 2011 forward price to earnings (P/E) ratio is over 25.11. In other words, the company is not cheap.

The price to sales ratio suggests Toyota is not cheap either. Ford (NYSE: F), which is expected to be profitable in 2010, has a price to sales ratio of 0.33. In contrast, Toyota's is more than double that at 0.73.

The gap on the daily chart between January 26th and January 27th stretches between $81.43 and $86.78. If it is indeed a breakaway gap, it should not be filled. My hunch is Toyota will find temporary support between $70 and $73 and then continue lower.

To learn more how you can profit from my trading suggestions, you will soon be able to subscribe to my newsletter Double-Digit Trading. In this week's issue, I recommend buying a master limited partnership (MLP) and shorting a beverage company that could bring you strong double-digit gains.

Action to Take: Based on the analysis above, here's how I plan to trade TM:

  • Short TM at the close of trading
  • Set a stop loss at $87.05
  • Target Price = $65.05
  • Potential Profit = +15.5%
Melvin Pasternak does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.