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Subaru is a niche Japanese automaker focusing on light SUVs and crossovers. The company is unusual in the sense that its main market is the United States, yet it produces most of its vehicles in Japan.
The reason for Subaru’s success is clever marketing and an excellent products. The vehicles are fuel-efficient, safe and reliable with strong off-road performance. Consumer Reports ranked Subaru as the best overall auto brand in 2022.
And customers are fanatic about their Subarus. The brand recently topped JD Power’s US auto brand loyalty study in 2021 for the third year in a row.
The company enjoyed great success until 2016. Margins rose significantly thanks to new model releases, strong US car sales and a high plant utilisation rate. Another key factor was the fact that the Japanese yen depreciated against the US Dollar from 2012 to 2015.
Since then, Subaru’s profits have weakened. I believe that there are three primary reasons for the weaker earnings per share:
- The utilisation rate at Subaru’s Indian plant dropped after Subaru took over the second line from its shareholder Toyota.
- The US auto market flat-lined from 2015, making it somewhat more difficult to grow.
- During COVID-19, Subaru has experienced significant production issues. Since the company relies on just-in-time manufacturing, it did not have enough inventory to weather the storm in terms of semiconductor chip shortages.
It looks like Subaru’s fortunes are finally turning. Over the past 2 months, the Japanese yen has depreciated significantly against the US Dollar, going from 115 yen to 130. The weaker exchange rate will improve Subaru’s competitiveness and increase its gross profit margin. Subaru’s Japanese plant has significant slack of 200,000 vehicles per year that it can put to use by exporting vehicles to the United States.
And Subaru’s production issues will probably ease at some point. We’re seeing early signs that semiconductor chip shortages are easing. Malaysian chip exports have started to accelerate. US auto inventories have started to build again. Second-hand car prices have started to drop from a recent peak.
The company’s problems is not weak demand - customers love their Subarus. Google search query volumes have been flat since 2019, Subaru’s discounts are the lowest in the industry and Subaru’s backorders have reached a record high. All it will take is for supply shortages to be fixed.
Other positive factors include a new model refresh cycle in 2022-2025, as well as the launch of the new Subaru Solterra electric vehicle in 2023.
Assuming Subaru reaches a 23% gross profit margin and hits 1.1 million sales volume with 97% overall plant utilisation by 2025, Subaru would trade at 5.4x earnings, below its 10x historical median.
The key risks are rising prices for raw materials and potential recalls, which have become more frequent is recent years. But in the medium term, the weakening yen and easing of supply chain issues will be the two most important issues to watch.
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