Toyota: Quality Cars and a Quality Stock

The year was 1987 and the place was a Delphi auto parts plant in Rochester, N.Y. One of the production engineers was talking about just-in-time delivery of parts, and how it was going to dramatically reduce costs for everyone, including the plant's biggest customer, General Motors. The concept came from Toyota Motors, and the engineer said that someday Toyota, then known mainly as a maker of compact cars, would put GM out of business. He wasn't laughing.

Delphi filed for bankruptcy in 2005, and on April 24 Toyota passed GM in quarterly sales for the first time. Stories quickly pointed out that GM may still remain the sales champ on an annual basis once the figures for all of 2007 are in, but as inevitable as a thrown ball falling back to earth, Toyota is destined to become the world's leading car maker.

As General Motors has shown during the past 20 years, bigger isn't necessarily better. So is this milestone a blessing or a curse for Toyota stockholders? Neither. Toyota itself shrugged it off. "Our only objective is to be number one in terms of quality," says a Toyota spokesman. "We'll let the numbers speak for themselves." That may sound overly self-effacing, but it's true. Quality is the hammer Toyota has used to beat down automakers in the U.S. and most of the rest of the world (Germany being a possible exception).

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But now other manufacturers -- GM included -- have dramatically closed the quality gap. Toyota even admits to quality issues at some of its seven North American assembly plants. Still, Toyota cars have fewer defects than any other make, and Toyota has several other advantages that make the company a compelling investment.

To start, rising gasoline prices are likely, and Toyota is a leader in hybrid technology. It opened its first U.S. hybrid car plant in Kentucky last year. And while Ford and GM are closing plants, Toyota plants here and abroad continue to operate at full capacity, points out a Citigroup research report. Toyota employs as many workers as GM, it just does so much more efficiently. In fact, the last time Toyota had a big layoff was the 1950s.

Toyota is a financial juggernaut. It has been the world's most profitable automaker for years. When earnings slip a bit, the headlines aren't about layoffs and restructuring, they're about the company sinking more yen into research and development or quality control. Analysts on average think Toyota earned $8.69 per share for the fiscal year that ended in March and expect $9.52 per share in the year that ends in March 2008, according to Thomson First Call. Toyota's American Depositary Receipts (symbol TM) closed at $123.89 on April 24, down 0.8% for the day.

Analysts fret over Toyota's slow start in China. A report from Thomas White research warns that GM and Volkswagen already have a head start there. It cautions that Toyota's goal of landing 10% of the total Chinese vehicle market by 2010 "is not going to be an easy task given GM's strong presence in China." I read that line to my friend, the engineer who is now retired from Delphi. This time he laughed.