Subaru's Operating Profit Slides on Price Pressures

Subaru Corporation (NASDAQOTH: FUJHY) said that its operating profit slid 4.1% in the quarter that ended on Dec. 31, as it faced increasing pressure to discount prices in the United States, its largest market.

The Japanese automaker's operating profit of 94.18 billion yen ($859.86 million) fell short of Wall Street's consensus estimate of 95.18 billion yen, as reported by Thomson Reuters.

The raw numbers

Like many Japanese companies, Subaru uses a fiscal year that begins on April 1. The quarter that ended on Dec. 31, 2017, was the third quarter of Subaru's 2018 fiscal year.

All financial numbers are shown in billions of yen. As of Feb. 8, $1 = about 109.4 yen.

What happened in the quarter

Like its much larger rival Toyota (NYSE: TM), Subaru has seen some bottom-line benefit from favorable exchange-rate movements over the last several months. But because Subaru manufactures a much larger percentage of its vehicles overseas, the benefit to its bottom line has been much less dramatic. (Subaru's 55% year-over-year increase in net income is explained by a big recall-related one-time charge in the year-ago quarter.)

In the current quarter, that exchange-rate benefit was also more than offset by an increase in selling, general, and administrative expenses ("SG&A"), specifically, in "selling expenses associated with rising interest rates in the U.S.," the company said in its usual terse fashion. The upshot was a decline in operating profit from a year ago -- and that year-ago quarter was a weak one.

A cyclical increase in pricing pressure in the U.S. was bound to hit Subaru harder than most. About 62% of the vehicles sold worldwide by Subaru in the quarter were sold in the U.S., making it Subaru's largest single market by a wide margin, and the U.S. has been the key driver of much of the company's profit growth over the last several years.

Many automakers have seen profits jump as Americans' automotive preferences have shifted away from traditional sedans in favor of car-based "crossover" SUVs, as crossovers are generally more profitable than sedans. But Subaru has benefited more than most: Its Outback and Forester models arguably defined the crossover category. Both remain huge sellers. (In fact, one could argue that all of Subaru's current models are crossovers.)

Americans' appetite for Subarus remained strong in 2017, as sales rose 5.3% despite a sluggish overall new-car market on strong results for its new Impreza and Crosstrek models. However, as rivals have increased incentives in an effort to generate incremental sales growth, and as interest rates in the U.S. have begun to rise, even traditionally stingy Subaru has been forced to respond with incentives of its own.

But it's important to note that Subaru's profitability is still outpacing most of its larger rivals'. Subaru's operating margin of 10.7% in the most recent quarter may have been down from a year ago, but it still beat Toyota (NYSE: TM) (8.9%), General Motors (NYSE: GM) (8.2%), Fiat Chrysler Automobiles (NYSE: FCAU) (7.9%), and Ford Motor Company (NYSE: F) (6.8%) -- and most others.

Looking ahead: Updated guidance for the full fiscal year

In light of recent exchange-rate movements and increasing selling expenses, Subaru modified its guidance for fiscal 2018 from that given at the end of the second quarter. It now expects:

• Revenue of 3.41 trillion yen, versus 3.38 trillion yen in prior guidance (fiscal 2017: 3.33 trillion)
• Operating income of 380 billion yen, unchanged from prior guidance (fiscal 2017: 410.8 billion)
• Net income of 207 billion yen, unchanged from prior guidance (fiscal 2017: 282.4 billion)
• Currency assumptions of 112 yen to the U.S dollar (up from 111 in prior guidance), and 128 yen to the euro (down from 130 in prior guidance)

Note that while Subaru expects its profit to be down year over year, its guidance still implies a full-year operating margin off 11.1% -- impressive for a mass-market automaker under any circumstances.

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