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Japan | Industrials

Autos & Auto Parts 21 November 2013

Autos & Auto PartsInitiate Coverage with Seven ImportantMessages

EQU

ITY R

ESEARC

H JA

PAN

Auto OEMs Sector: OperatingIncome Estimates

Source: Jefferies estimates

(¥bn) Operating IncomeCompany TSE FY3/14E FY3/15EToyota Motor 7203 2,450.0 2,510.0Honda Motor 7267 825.0 975.0Nissan Motor 7201 500.0 600.0Mazda 7261 180.0 210.0Suzuki 7269 180.0 197.0FHI 7270 315.0 315.0Daihatsu Motor 7262 145.0 130.0Yamaha Motor 7272 54.0 67.0

Investment Rating and PriceTargets

Source: Jefferies

Ratings TargetToyota Motor Hold 6,700 9%Honda Motor Buy 4,700 17%Nissan Motor Hold 950 6%Mazda Buy 530 17%Suzuki Hold 2,600 7%Fuji Heavy Industries Hold 3,000 9%Daihatsu Motor Hold 1,700 -4%Yamaha Motor Hold 1450 -5%

Jefferies PriceCompanyExpected

Total Return

Takaki Nakanishi *Equity Analyst

[email protected]

* Jefferies (Japan) Limited

Key Takeaway

Japanese automobile sector revival has put it on course to reach record profits,but the jury is still out on whether a golden age is due to return. What we cansay with some confidence is that margins certainly appear somewhat overdonein view of the companies' intrinsic global competitiveness, and they will likelyfind it hard to maintain this unless managements take appropriate directions.We offer 7 important messages as we initiate coverage.

Sector stance is "Neutral": We rate the sector “Neutral” for four reasons: (1) earningsrecovery looks set to hit a plateau; (2) reduced forex sensitivity will mean the weaker yenis no longer a significant share price driver; (3) we recognize the risk that valuations willdecline; and (4) restoration of the global competitiveness of Japanese OEMs is still a work-in-progress.

Investment Strategy for 2014: Strategically speaking, we think the right approach is astaged reduction in weightings in highly forex-sensitive names whose share prices have risensharply, whereas companies which can establish global competitive strength and deliverhigh top-line growth are promising, regardless of how sensitive they are to forex. Our toppick in the sector is Honda Motor (7267), which we rate Buy with a ¥4,700 price target.Among second-tier names we rate Mazda (7261) Buy with a ¥530 price target. Our order ofpreference among the J3 (descending) is 1. Honda, 2. Toyota, 3. Nissan.

Restoring global competitiveness still work-in-progress: The Japanese OEMs haverecovered world-leading earnings power, but the process of restoring real competitivenessis still only half-done, and margins are not backed by robust competitive strength. Weidentify four key elements which we think are important for the automobile industry'scompetitiveness through to 2020: (1) new architecture breakthroughs delivering superiorcosts and performance; (2) innovations which overcome significant scale and complexity;(3) management capabilities on both the strategic and "soft" fronts; and (4) brands andpremium strategies.

Projections for Manufacturing Free Cash Flows

Source: Company data and Jefferies estimates

Jefferies does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Jefferies may have aconflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investmentdecision. Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 45 to 47of this report.

Executive Summary

Investment conclusions

Our stance on the Japan Autos OEM sector is ‚Neutral‛ because (1) sector earnings

recovery looks set to a plateau; (2) reduced forex sensitivity will mean the weaker yen is

no longer a significant share price driver; (3) we recognize the risk that valuations will

decline; and (4) restoration of the global competitiveness of Japanese OEMs is still a work-

in-progress. Our judgement for now is that further improvement in Japanese OEMs sector

profitability is more unlikely to come to reality.

Our top pick in the sector is Honda Motor (7267), which we rate Buy with a ¥4,700 price

target. Among second-tier firms we recommend Mazda (7261) as a Buy with a ¥530 price

target. We rate all the remaining six companies Hold (Toyota Motor, Nissan Motor, Fuji

Heavy Industries, Suzuki Motor, Daihatsu Motor, and Yamaha Motor).

We have not rated any of the companies Underperform for now. However, we think

appropriate care should be taken over companies which are close to the top end of their

DCF-based theoretical share price ranges, given increasingly challenging competition in

emerging markets and smaller weaker yen sensitivity to earnings.

From a portfolio strategy point of view, we believe weightings in highly forex-sensitive

companies whose share prices have risen sharply should be reduced over time, whereas

weightings should be actively increased in Honda and Mazda, which we believe can

improve comparative competitive positions on the global markets and deliver higher top-

line growth, regardless of their relative forex sensitivity.

There are two important anti-consensus views which we try to address in the note. First,

we are downbeat on Toyota’s improving financial leverage hypothesis. Second, we are

thinking that the weaker yen is no longer a significant share price driver for the sector,

similar to the period between CY2001and CY2004 where as Japanese OEMs’ forex

sensitivity cut below 2% and provided the lowest point of their valuations.

We feel Toyota could remain a promising investment if it opts for a switch in its financial

strategy towards increased financial leverage, such as lifting its dividend payout ratio or

actively implementing share buy-backs. However, our anti-consensus view is that Toyota

will not substantially change its financial policy anytime soon, and indeed, we believe it

will belatedly turn around and begin rather stronger capex and future growth aimed

spending. This is an important point in our Hold thesis on the company.

In this note, we tried to analyse the reduced forex sensitivity (i.e. below the 2% mark) of

Japanese Auto OEMs and the potential risk for valuations to decline. In short, we are now

getting more convinced to say that ‚the weaker yen is no longer a significant share price

driver for the sector,‛ except for a couple of names which are still highly sensitive such as

Yamaha Motor and Fuji Heavy.

Fundamentals conclusions

Our estimates are based on the following assumptions.

1. Exchange rates: ¥100/$ and ¥130/€.

2. US SAAR: Gradual growth from 15.6 million units in CY2013 to 16 million units in

CY2014

3. Japanese SAAR: 5.51 million units (up 5.8% YoY) in FY3/14, 5.17 million units (down

6.1% YoY) in FY3/15. As a risk scenario, sales could fall well below 5 million units if

the acquisition tax is not lowered, or if other vehicle automobile related taxes are

increased, even if the acquisition tax is cut.

The automobile sector is likely to achieve record profit in FY3/14. We expect the total

operating profit of the eight companies we cover will be ¥4,649.0 billion (up 62.6% YoY),

topping the ¥4,563.7 billion in FY3/08 for the first time in six years.

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21 November 2013

page 2 of 47 , Equity Analyst, [email protected] Nakanishi

Please see important disclosure information on pages 45 - 47 of this report.

We expect that the total sector operating profit for FY3/15 will be ¥5,004.0 billion (up 8%

YoY). Four companies, namely Honda, Nissan, Mazda and Yamaha, whose earnings

recovery has been delayed, are likely to see their earnings achieve double-digit growth,

while Toyota and FHI, which have enjoyed a relatively stronger recovery to date, are likely

to see their growth slow.

Daihatsu, which has a high domestic sales ratio, is likely to see a fall in earnings. There is a

large difference between our forecasts and the market consensus. Our forecasts for

Daihatsu and Yamaha are anti-consensus calls, as ours are more than 10% lower than the

consensus. Our forecasts for Toyota and Nissan are 5% and 9% lower than the consensus,

respectively.

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Chapter 1: Sector investment opinion

and investment thesis

Seven Important Messages

Chart 1: Japanese Auto Sector: Investment rating and valuation

Note: Yamaha Motor's fiscal year end is December. Source: Jefferies estimates, company data

In this report we have the following seven important messages to convey as we initiate

coverage of the eight main companies in Japan's auto OEMs sector.

1. Our stance on the Japan Autos OEM sector is ‚Neutral‛. We envisage the average

sector price to rise around 7% over the coming 12 months (note: an average of the

expected changes to our price targets for companies we cover), which might

possibly struggle to outperform TOPIX. There are four reasons for our Neutral

stance: (1) sector earnings recovery looks set to a plateau; (2) reduced forex

sensitivity will mean the weaker yen is no longer a significant share price driver; (3)

we recognize the risk that valuations will decline; and (4) restoration of global

competitiveness of Japanese OEMs is still a work-in-progress.

2. We rate two companies Buy, namely Honda Motor and Mazda Motor, and all the

remaining six companies Hold (Toyota Motor, Nissan Motor, Fuji Heavy Industries,

Suzuki Motor, Daihatsu Motor, and Yamaha Motor).

3. Our top pick in the sector is Honda Motor (7267), which we rate Buy with a ¥4,700

price target. Among second-tier firms we recommend Mazda (7261) as a Buy with a

¥530 price target.

4. Our recommended order among the J3 is (1) Honda, (2) Toyota, (3) Nissan. We

think investors should gradually shift portfolio weightings from Toyota to Honda.

5. Valuations are low across the board, and we see no risk of a large fall in share prices,

in the absence of any untoward downturn in earnings, and we have thus not rated

any of the companies Underperform. However, we think appropriate care should be

taken over companies which are close to the top end of their DCF-based theoretical

share price ranges, given increasingly challenging competition in emerging markets

and smaller weaker yen sensitivity to earnings.

6. From a portfolio strategy point of view, we believe weightings in highly forex-

sensitive companies whose share prices have risen sharply should be reduced over

time, whereas weightings should be actively increased in Honda and Mazda, which

we believe can improve comparative competitive positions on the global markets

and deliver higher top-line growth, regardless of their relative forex sensitivity.

7. We feel Toyota could remain a promising investment if it opts for a switch in its

financial strategy towards increased financial leverage, such as lifting its dividend

TSE Company Rating Price (¥) Price Target Expected PER (x) PBR (x) Core EV/EBITDA (x) E

P2013/11/19 (¥) Returns FY3/13 A FY3/14 E FY3/15 E FY3/13 A FY3/14 E FY3/15 E FY3/13 A FY3/14 E FY3/15 E

7203 Toyota Motor Hold 6,300 6,700 9% 20.7 10.9 11.0 1.6 1.4 1.3 7.6 4.6 4.3

7267 Honda Motor Buy 4,095 4,700 17% 20.1 12.2 10.5 1.5 1.3 1.2 7.7 5.4 4.7

7201 Nissan Motor Hold 926 950 6% 11.3 10.6 9.3 1.0 0.9 0.9 3.8 4.0 3.4

7261 Mazda Buy 452 530 17% 39.4 13.1 9.7 2.7 2.2 1.8 14.1 7.4 6.0

7262 Daihatsu Motor Hold 1,823 1,700 -4% 9.5 9.6 10.6 1.6 1.4 1.3 4.3 4.0 4.2

7269 Suzuki Hold 2,471 2,600 7% 17.2 13.2 12.5 1.2 1.1 1.0 4.9 4.0 3.7

7270 Fuji Heavy Ind. Hold 2,804 3,000 9% 18.3 9.5 11.1 3.7 2.7 2.2 12.5 5.9 5.5

7272 Yamaha Motor Hold 1,550 1,450 -5% 72.2 16.1 13.9 1.8 1.5 1.4 8.0 4.5 3.7

Following seven important messages

to convey…

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payout ratio or actively implementing share buy-backs. Such a decision could be an

important catalyst not only for Toyota shares but also in terms of stimulating the

Japanese stock market overall. However, our view is that Toyota will not

substantially change its financial policy anytime soon, and indeed, we believe it will

belatedly turn around and begin capex expansion. This is an important point in our

Hold thesis on the company.

Earnings recovery looks set to hit a plateau We think earnings growth in FY3/15 will have a diminishing rate, with aggregated

operating profit for the 8 companies in our coverage rising only 7%. We estimate that

sector profits will plateau at a high level from 2H FY3/14, and that factors driving

improved earnings will start to dry up. Indeed, the demerits of the weaker yen and the

cost-push associated with high wages and imported material prices is set to come through

after a time-lag while sales volume growth slows, expansion halts in Asia and in Japan,

and the country mix worsens as well. Competition in global markets continues to escalate,

and there are almost no markets where prospects look bright. The only bright spot is

margin improvement in North America. N. American profitability, centering on US

margins, has disappointingly lagged behind the rest, but we expect eventually the

intrinsic earnings power of Japanese OEMs to start to rebuild, thanks to significant efforts

of business reforms and rebuilding more attractive products.

Chart 2: Autos OEM sector Operating Profit, OP margins

Source: Jefferies estimates and company data

We estimate that sector profits will

plateau.

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Paradoxically, reduced forex sensitivity will mean the weaker yen is no longer a significant share price driver We estimate auto sector yen-dollar rate sensitivity (the theoretical change in operating

profit caused by a 1% change in the yen) will drop below 2% in FY3/15 for the first time

since FY3/01. Even if we lift our forex assumption from ¥100/$ to ¥105/$, profit sensitivity

of a mere 10% would no longer lead immediately to a change in investment opinions.

Chart 3: Long-term trend in yen-dollar rate sensitivity

Source: Jefferies Note: Yen-dollar rate sensitivity is the theoretical change in operating profit caused by a 1% change in the yen

From foreign investors' perspective, a 1% fall in the yen delivers only a 1% benefit, even if

profits rise by 2%, currency depreciation offsets 1%. The appeal of such small benefits

from yen depreciation is thus likely to diminish for foreign investors, who are the major

shareholders. The story might be different if the yen weakens by, say, ¥20, but we do not

believe such a scenario looks realistic, while the picture for the global and Japanese

economy would perhaps have worsened to a degree that hardly bears thinking about in

this event.

Chart 4: Simulation of earnings and valuation based on Forex sensitivity

Source: Jefferies estimates and company data

Concerns that valuations could be marked down Automobile sector valuations are arguably low compared with other domestic sectors, but

they are not heavily discounted on a global comparison. P/Es based on FY3/15 forecasts

are 10.2x for the Japanese OEMs (J3), 8.8x for the US auto-makers, 9.3x for European firms

(excluding structurally loss-making PSA), and 6.1x for Korean manufacturers. The

Japanese OEMs used to carry high premiums, because of (1) accounting factors, mainly

their accelerated depreciation methods, (2) growth prospects in global markets, mainly

FY3/15E FY3/15E FY3/15E

OP (¥bn) EPS (¥) P/E　(x)

US$ 95 100 105 110 95 100 105 110 95 100 105 110

Euro 124 130 137 143 124 130 137 143 124 130 137 143

Toyota 2,240.0 2,510.0 2,780.0 3,050.0 521.2 574.1 626.9 679.8 12.1 11.0 10.0 9.3

Nissan 532.5 600.0 667.5 735.0 89.7 99.7 109.7 119.7 10.3 9.3 8.4 7.7

Honda 907.5 975.0 1,042.5 1,110.0 368.5 391.7 414.9 438.2 11.1 10.5 9.9 9.3

Mazda 174.0 210.0 246.0 282.0 37.8 46.8 55.9 64.9 12.0 9.7 8.1 7.0

Suzuki (1) 172.2 197.0 221.7 246.5 180.1 197.9 215.7 233.4 13.7 12.5 11.5 10.6

Fuji Heavy 269.0 315.0 361.0 407.0 215.9 252.4 289.0 325.5 13.0 11.1 9.7 8.6

Daihatsu 136.8 143.0 149.3 155.5 162.2 171.3 180.4 189.5 11.2 10.6 10.1 9.6

Yamaha Motor 55.5 67.0 78.5 90.0 90.9 111.3 131.7 152.2 17.1 13.9 11.8 10.2

Total 4,487.5 5,017.0 5,546.5 6,076.0 -- -- -- -- 12.6 11.1 9.9 9.0

…and the power of the stock driver

from sensitivity is thus likely to

diminish.

The sector yen-dollar rate sensitivity

is now approaching the lowest ever

in the history…

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the US and Asia, (3) a premium for the Japanese OEMs' exceptionally strong global

competitiveness, and (4) upbeat expectations of earnings growth inherent in high forex

sensitivity.

Factors supporting a high P/E premium in Japan's auto sector are now evaporating, and

although we do not expect a discount to accrue, we think the reduced valuation gap is

broadly fair. We note that Japanese auto sector P/Es have plunged to about 8x in the past.

Earnings reached elevated levels in FY2001–04, but the J3's P/Es were marked down,

stalling at 8–10x for a prolonged period. Interestingly, yen-dollar sensitivity fell below 2%

at that time.

Chart 5: J3 1-year Forward P/E

Source: Jefferies estimate, Bloomberg

Japanese OEMs yet to restore global competitiveness The Japanese OEMs have recovered world-leading earnings power, but we do not believe

these margins are the results of robust competitive strength. If current earnings are not

supported by genuine competitiveness, it will not be easy to maintain their earnings

power, in our view. The companies have steadily reaped the rewards from strategic

restructuring since the financial crisis (so-called Lehman Shock in Japan), but rivals have

also evolved quickly. The gap cannot easily be closed, evidenced by the fact Japanese

brands' global market shares are not recovering to the same degree as hoped. We identify

four key elements that we think are important for the automobile industry's

competitiveness through to 2020: (1) new architecture breakthroughs delivering superior

costs and performance; (2) innovations which overcome significant scale and complexity;

(3) management capabilities on both the strategic and "soft" fronts; and (4) brands and

premium strategies. We address global competitiveness analysis in more detail in Chapter

2.

Japanese OEMs’ Fundamentals Snap Views The total operating profit in 2Q (Jul-Sept) of the eight companies we cover was ¥1,081.1

billion (up 52% YoY). Nissan Motor announced significantly lower operating profit than

the consensus in 2Q, and its substantial downward revision to the full-year earnings

forecast and the shakeup of the management structure announced at the same time

became the largest negative surprise. Meanwhile, FHI revised significantly upwards its full-

year operating profit forecast, from ¥198.0 billion to ¥278.0 billion, but this was within

the scope of the consensus.

As there was no major surprise except for Nissan, there were no sharp movements in the

market. With respect to the earnings forecasts of each company, they are talking about

their estimates with a great deal of caution in preparation for pay-raise negotiations in the

spring wage round. Although they have raised their exchange rate assumptions for the

FY2001–04, the J3's P/Es were

marked down, stalling at 8–10x for a

prolonged period. Interestingly, yen-

dollar sensitivity fell below 2% at

that time.

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21 November 2013



second half from ¥90/US$ to ¥95/US$, further surprises on the upside are very likely, as

their exchange rate assumptions are still cautious, given the current exchange rates.

Chart 6: FY3/14 Quarterly OP estimates (unit: ¥bn)

(¥bn) 1QA YoY% 2QA YoY% 3QE YoY% 4QE YoY FY3/14E YoY

Toy ota Motor 663.4 88% 592.1 74% 584.3 368% 610.2 21% 2,450.0 85%

Honda Motor 185.0 5% 171.5 70% 228.5 73% 240.1 77% 825.0 51%

Nissan Motor 108.1 -10% 113.8 -32% 125.5 102% 152.6 -12% 500.0 -4%

Mazda 36.5 1929% 37.4 287% 37.8 363% 68.2 99% 180.0 234%

Suzuki 44.1 24% 46.2 52% 44.0 65% 45.7 -12% 180.0 25%

FHI 69.6 302% 81.1 213% 82.0 172% 82.3 75% 315.0 162%

Daihatsu Motor 43.2 14% 27.0 -25% 32.9 67% 41.8 6% 145.0 9%

Yamaha Motor (1) 16.4 95% 11.9 497% 11.8 NM 20.1 45% 54.0 190%

Total 1,166.3 55% 1,081.1 52% 1,146.9 187% 1,261.0 26.2% 4,649.0 63%

Note: (1) Yamaha Motor figures are 2Q, 3Q, 4Q of FY12/13E, 1Q FY 12/14E and FY12/13E since fiscal year end is December. Source: Company data and Jefferies estimates

Medium-term fundamentals forecasts Our estimates are based on the following assumptions.

1. Exchange rates: ¥100/$ and ¥130/€

2. US SAAR: Gradual growth from 15.6 million units in 2013 to 16 million units in 2014

3. Japanese SAAR: 5.51 million units (up 5.8% YoY) in FY3/14, 5.17 million units (down

6.1% YoY) in FY3/15.

4. Japan’s mini-vehicles SAAR: Estimates of 2.2mn units for FY3/14 (up 11.5% year on

year) and 2.01mn units for FY3/15 (down 8.4% YoY). If a stepwise reduction in the

acquisition tax is put off or the mini-vehicle road tax increases, demand may

deteriorate further.

Our current forecasts have factored in the emergence of last-minute demand for

approximately 200,000 units in the second half (Oct-Mar) of the current fiscal year and

the arrival of a period of pay-back fall in the first half (Apr-Sept) of the next fiscal year. In

our risk scenario, there is a risk that domestic demand for new vehicles may fall

significantly below 5mn units if the reduction in the automobile acquisition tax is

postponed or if other automobile related taxes such as road taxes are raised even if the

acquisition tax is reduced. Even if some of this negative impact can be offset by higher

exports, it seems difficult to avoid lower earnings. As the basic policy for these tax

revisions is likely to be concluded by the end of the year in the Research Commission on

the Tax System of the Liberal Democratic Party, we will need to monitor this carefully.

Although sector earnings are

expected to increase gradually from

3Q to 4Q with the addition of the

last-minute-demand in Japan, it is

difficult to be too optimistic, given

the risk during the period of a

reactionary fall.

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Chart 7: FY3/14 earnings forecasts summary

Note: (1) Yamaha Motor figures are FY12/13E since fiscal year end is December. Total shows total of eight companies, including Yamaha Motor. Source: Company data and Jefferies estimates

Chart 8: FY3/15 earnings forecasts summary

Note: (1) Yamaha Motor figures are FY12/14E since fiscal year end is December. Total shows total of eight companies, including Yamaha Motor. Source: Company data and Jefferies estimates

While the domestic market could be rough, we expect Japanese OEM’s global sales

volume will increase steadily to 23.6mn units (up 7% YoY) in FY3/14 and 24.71mn units

(up 5% YoY) in FY3/15. We expect sales volume will bottom out in Western Europe and

Russia and that stable growth in the United States and China will offset negative growth in

Japan. However, differences among companies are fairly large. While the sales volume is

expected to grow only 2% YoY in FY3/15 for Toyota and FHI, above-average sales volume

is likely to be recorded at Honda, Nissan and Mazda. Chart 76 shows details of our sales

volume forecasts by company.

The automobile sector is likely to achieve a record profit in FY3/14. We expect that the

total operating profit of the eight companies we cover will be ¥4,649.0 billion (up 62.6%

YoY), topping the ¥4,563.7 billion in FY3/08 for the first time in six years. While FHI and

Daihatsu are likely to set consecutive record highs, Suzuki, Mazda and Toyota are likely to

achieve record profits. Honda, Nissan and Yamaha are expected to start out late.

Although sector earnings are expected to increase gradually from 3Q to 4Q with the

addition of the last-minute-demand in Japan, it is difficult to be too optimistic, given the

risk during the period of a reactionary fall. Consequently, it is unlikely to receive a higher

evaluation from the market. As sector earnings are generally approaching their peak, it is

Jefferies estimate CoE Bloomberg Jefferies estimate CoE Bloomberg

New YoY % Deviation% Deviation% New YoY Deviation% Deviation%

Toyota Motor 2,450.0 85% 2,200.0 11.4% 2,439.6 0% 578.8 91% 467.1 23.9% 578.5 0%

Honda Motor 825.0 51% 780.0 5.8% 835.7 -1% 336.2 65% 321.8 4.5% 341.3 -1%

Nissan Motor 500.0 -4% 480.0 4.2% 561.4 -11% 87.3 7% 100.2 -12.9% 93.6 -7%

Mazda 180.0 234% 160.0 12.5% 178.8 1% 34.5 201% 23.4 47.4% 35.5 -3%

Suzuki 180.0 25% 170.0 5.9% 178.9 1% 187.2 31% 178.3 5.0% 188.7 -1%

FHI 315.0 162% 278.0 13.3% 290.8 8% 294.7 92% 155.0 90.1% 248.2 19%

Daihatsu Motor 145.0 9% 137.0 5.8% 148.4 -2% 190.4 0% 192.4 -1.0% 205.4 -7%

Yamaha Motor (1) 54.0 190% 55.0 -1.8% 57.3 -6% 96.5 349% 97.4 -1.0% 101.0 -4%

Total (1) 4,649.0 63% NA NA 4,690.9 -1% 1,805.7 63% NA NA 1,792.2 1%

Operating profit estimate in FY3/14 (¥bn) EPS estimate in FY3/14(¥)

Jefferies estimate CoE Bloomberg Jefferies estimate CoE Bloomberg

New YoY % Deviation% Deviation% New YoY Deviation% Deviation%

Toyota Motor 2,510.0 2% NA NA 2,655.0 -5% 574.1 -1% NA NA 622.3 -8%

Honda Motor 975.0 18% NA NA 948.3 3% 391.7 17% NA NA 393.0 0%

Nissan Motor 600.0 20% NA NA 657.4 -9% 99.7 14% NA NA 111.6 -11%

Mazda 210.0 17% NA NA 214.8 -2% 46.8 36% NA NA 51.3 -9%

Suzuki 197.0 9% NA NA 188.2 5% 197.9 6% NA NA 198.4 0%

FHI 315.0 0% NA NA 315.7 0% 252.4 -14% NA NA 258.1 -2%

Daihatsu Motor 130.0 -10% NA NA 146.1 -11% 171.3 -10% NA NA 201.6 -15%

Yamaha Motor (1) 67.0 24% NA NA 76.6 -13% 111.3 15% NA NA 140.3 -21%

Total (1) 5,004.0 8% NA NA 5,202.1 -4% 1,845.3 2% NA NA 1,976.7 -7%

Operating profit estimate in FY3/15 (¥bn) EPS estimate in FY3/15(¥)

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difficult to anticipate significant growth unless there is any change in our assumptions for

exchange rates and sales volumes.

We expect that the total sector operating profit for FY3/15 will be ¥5,004.0 billion (up 8%

YoY). Four companies, namely Honda, Nissan, Mazda and Yamaha, whose earnings

recovery has been delayed, are likely to see their earnings achieve double-digit growth,

while Toyota and FHI, which have enjoyed a relatively stronger recovery to date, are likely

to see their growth slow down. Daihatsu, which has a high domestic sales ratio, is likely to

see a fall in earnings. There is a large difference between our forecasts and the market

consensus. Our forecasts for Daihatsu and Yamaha are an anti-consensus call, as ours are

more than 10% lower than the consensus. Our forecasts for Toyota and Nissan are 5%

and 9% lower than the consensus, respectively.

Share price implications We note the following five implications.

1. Although Daihatsu’s share price does not appear to have a large downside risk as it

seems to have already factored in sluggish earnings, we think that the delay in the

relative performance will be extended. Even if earnings of Yamaha do not reach the

consensus, we don’t think the share price will fall significantly as the market seems

to look at the rate of change, the summer rally, and the long-term recovery cycle of

leisure demand in the developed markets.

2. The slower growth of Toyota is likely to disappoint the market. However, as the

weak yen and expectations of a dividend increase are able to be maintained, the

share price could be stable. Caution will be needed when the policy shift to increase

capital outflow to investments becomes evident in the future.

3. Although our forecasts for Honda and Mazda are not that different from the

consensus, the conviction of the market does not seem to be particularly strong. If

confidence in the consensus figure strengthens as quarterly results progress, it will

be possible to expect a positive impact on their share prices.

4. The outlook for Nissan is uncertain. Depending on the new management structure

to be determined by April 2014 and the details of measures to bring back earnings,

it should be possible to anticipate changes in the outlook.

5. Even though the overall forex sensitivity of the sector to the US dollar has fallen

below 2%, changes in exchange rates will have a relative impact on earnings. Our

point is that the power of this as a share price driver will weaken. While J3, whose

forex sensitivity has fallen below 2%, will be less sensitive to exchange rates, FHI and

Yamaha, which still have high forex sensitivity to the US dollar, will continue to be

affected by fluctuations in exchange rates.

Investment recommendations and thesis Toyota Motor (7203 JP, Hold)

Investment thesis: Key arguments in our Hold rating are as follows: (1) three-year

operating profit CAGR of 4% in FY3/15–FY3/17 looks mediocre, well below the sector

average of 7%; (2) Toyota is unlikely to lift its 30% benchmark payout ratio anytime soon,

so expectations of higher dividends are overblown, creating the risk of disappointment;

(3) we take the view that the company’s business reform benefit would not give full

ability until 2015 or beyond, creating mediocre medium-term product competitiveness,

production capacity shortages hampering volume growth, and a cost-push stemming

from soaring investments for the future.

Price target: We initiate coverage with a Hold rating. Our price target for the coming 12

months is ¥6,700, calculated as a P/E of 12x based on our FY3/15 EPS estimate. This

represents a 10% premium to the sector average of around 11x to reflect Toyota's high

level of cash on hand and to pay out dividends.

Our forecasts for Daihatsu and

Yamaha are an anti-consensus call.

Based on our fundamentals outlook,

there are five key implications to the

share price movements including…

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21 November 2013



Valuation/Risks: Our DCF model using a discount rate of 7.0–7.5% and terminal

growth of 0–1% yields a theoretical share price range of some ¥6,000–6,800. Our price

target is near the top of this range, but we believe this can be supported by opportunities

from the weaker yen and the FY3/14 prospective dividend yield (around 2.7%).

Foreseeable risks are changes in operating profit of just over 2% for a 1% move in forex,

and just under 2% for a 1% variation in sales volume. Developments with domestic

consumption tax and automobile taxes represent major risks for the company.

Honda Motor (7267 JP, Buy)

Investment thesis: Key arguments in our Buy investment rating are threefold. (1) We

expect quarterly earnings to turn up from 3Q, and restored market confidence in Honda's

growth strategy should be a powerful catalyst for share price recovery. (2) We forecast

three-year CAGR of 13% in FY3/15–FY3/17, well above the sector average of 7%. (3) The

company will start to recover upfront investment, and its capacity for dividend growth

will increase. There are plenty of other catalysts, including solid quarterly earnings and

open days at the new Yorii Plant.

Price target: We initiate coverage with a Buy rating. Our price target for the coming 12

months is ¥4,700, equivalent to a P/E of just under 12x based on our estimates for FY3/15,

our base-year for valuations. We forecast CAGR of 13% in Honda's FY3/15–FY3/17

operating profit, and we factor in a premium to reflect earnings growth potential capable

of eclipsing sector average CAGR of 7%. Accordingly, we use a 10% premium to the

sector average of 11x for our P/E multiple.

Valuation/Risks: Our 2-stage DCF model (assuming a discount rate of 7.0–7.5%,

terminal growth of 0–1%) yields a theoretical share price range of some ¥4,565–5,513.

Our price target is at the bottom of this range, and we expect valuations to remain

relatively cautious until the market is firmly convinced of the efficacy of Honda's growth

strategy. Every ¥1 move (around 1%) in forex affects operating profit by around 1.5%,

including ¥13 billion for yen-dollar and ¥3 billion for yen-Brazilian real.

Nissan Motor (7201 JP, Hold)

Investment thesis: There are three key arguments in our Hold rating: (1) doubts over

the efficacy of the Power 88 growth strategy; (2) the time needed to win back market

confidence under an unstable management structure; and (3) low credibility in any return

to sustainable competitive strength, even if near-term cost-cutting restores earnings,

giving low confidence in earnings growth. The share price has underperformed by a wide

margin, and there is no great downside risk, but there is little chance that it can outshine

rivals, either.

Price target: Our price target for the coming 12 months is ¥950, equivalent to a P/E of

just under 10x on earnings in FY3/15, our base-year for valuations. Valuations have been

marked down sharply as the medium-term plan has foundered and there is uncertainty

over whether operations can stay competitive, and we think it will be a while before they

can recover. We thus apply a 10% discount to the sector average of around 11x.

Valuation/Risks: Our DCF model (discount rate of 8.0–8.5%, terminal growth of 0–1%)

yields a theoretical share price range of ¥946–1,096. Our price target is just about at the

bottom of this range. Every ¥1 change in forex (about 1%) affects operating profit by

around 2.5%, while a 1% change in sales volume also affects operating profit by 2.5%.

Nissan relies heavily on China profits, and changes in this market's demand, competitive

landscape, and political situation pose high risks.

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21 November 2013



Suzuki Motor (7269 JP, Hold)

Investment thesis: Our Hold investment thesis comprises three points. (1) Since there

are numerous uncertainties and risks, such as the Indian economy, revisions to the

Japanese automobile tax system, and the outcome of the arbitration with VW, we believe

that investors should gauge the most appropriate timing in terms of risk and reward. (2)

Although the company’s business base remains fairly good, wariness over risk will have to

retreat for valuation to improve. (3) It is impossible to forecast the outcome and share

price impact related to the dissolution of Suzuki’s tie-up with VW. If these uncertain

factors could be cleared up, fundamentals would be very good and there would be

expectations of a turn for the better.

Price target: We initiate coverage with a Hold rating. Our price target for the coming 12

months is ¥2,600. This corresponds to our estimated EV/EBITDA of 4x for the calculation

base year of FY3/15. There are considerable distortions from its conservative accounting

policy and accelerated depreciation, but EV/EBITDA has worked effectively in the past,

moving in a range of 4–6x. Successful investment opportunities are created when this

multiple drops deeply below 4x. Our target price corresponds to our estimated P/E of 13x

for FY3/15, which looks low in the historical average of 20x.

Valuation/Risks: With a discount rate of 7.5–8.0% and terminal growth of 0–1%, our 2-

stage DCF model gives a theoretical share price range of some ¥2,671–¥2,980. Our price

target is at the bottom limit of this range but the valuation will likely remain low in view of

current risks and uncertainties. The biggest risk at hand is the possibility of revisions to the

Japanese tax system for mini-vehicles.

Fuji Heavy Industries (7270 JP, Hold)

Investment thesis: There are three investment theses for our "Hold" rating: (1) profit

growth will plateau; (2) there is no next robust market to drive FHI’s future growth

besides Japan and the US; and (3) the company’s valuation may contract. The increasing

possibility of Subaru Indiana Automotive (SIA) in the US ending OEM production of the

Camry in 2016 will have an adverse impact on the company’s long-term growth strategy.

We don’t take an entirely optimistic view on the company’s next medium-term plan.

Price target: Our price target for the next 12 months will be ¥3,000. It is equivalent to a

P/E of 12x on earnings in FY3/15, our base-year for valuations and would represent a 10%

premium to the sector average of around 11x.

Valuation/Risks: Our 2-stage DCF model (discount rate of 7.0–7.5%, terminal growth

of 0–1%) yields a theoretical share price range of ¥2,503–¥3,056. Our price target is just

about at the top of this range. Given the superior advantages of the yen’s depreciation

and the satisfactory performance of the new model cycle, this target will be supported. A

change in the dollar-to-yen exchange rate of ¥1 (about 1%) would result in a change in

operating profit of ¥8.5bn (about 3%). A 1% variation in sales volume would shift

operating profit by a little less than 2%.

Mazda (7261 JP, Buy)

Investment thesis: Our arguments for our Buy rating are threefold. (1) The peak period

of the new car cycle is approaching, so there will be growing expectations of earnings

improvement, which is linked to increasing production volumes of new models with

better profitability. (2) The growth story of the restructuring of US operations will gain

traction. (3) CAGRs for the FY3/15–FY3/17 period will be 11% for operating profit and

16% for EPS, far above sector averages, and valuations are expected to soar. The

company’s performance to date can largely be explained by the swing to yen weakness,

but a growth drive on the back of products boasting competitive strength could be

realized over the next three years.

Price target: Our price target for the coming 12 months is ¥530. This would correspond

to a P/E of 13x for the calculation base-year of FY3/15 and would represent a 20%

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21 November 2013



premium to the sector average of around 11x. Our view is that Mazda will have an

operating profit CAGR of 11% in FY3/15–FY3/17, higher than the sector average, that its

16.8% average ROE for the same period will stand out, and that Mazda can maintain a

relatively high P/E in terms of the ROE-PBR relationship.

Valuation/Risks: Our 2-stage DCF model using a discount rate of 7.0–7.5% and

terminal growth of 0–1% yields a theoretical share price range of some ¥400–¥530. Our

price target is at the top of this range. The largest calculable risks are exchange rate

changes: a ¥1 move in developed market currencies would change operating profit by

approximately 3.4%. A 1% variation in sales volume would shift operating profit by about

3.5%.

Daihatsu Motors (7262 JP, Hold)

Investment thesis: The following three points underpin our Hold investment rating: (1)

a low possibility of profit growth; (2) no catalyst for a revaluation; and (3) uncertainty in

taxations and regulation changes is rather high. The risk of a decline in profits will arise in

FY3/15. There is a material difference between our estimates and the Bloomberg

consensus. However, the FY3/14 P/E has declined 9x, and the market apparently is

reflecting a considerable deterioration in the company’s earnings in coming years.

Price target: We are setting our price target for the next 12 months at ¥1,700. This is

equivalent to 10 times the estimated P/E for FY3/15, our base-year for valuations. We

apply a 10% discount to the sector average of around 11x.

Valuation/Risks: Our 2-stage DCF model (discount rate of 6.5–7.0%, terminal growth

of 0–1%) yields a theoretical share price range of some ¥1,624–¥1,958. Our price target is

in the lower level of the range. Due to harsh external conditions, this is likely to float

around the lower level for the moment. Risks are high, due to factors such as the

Indonesian economy, fluctuations in Rupiah exchange rates, and the potential tax

changes for mini-vehicles in Japan. A ¥1 change in the dollar-to-yen rate would result in a

¥1.3bn change in operating profit with a relatively low sensitivity.

Yamaha Motor (7272 JP, Hold)

Investment thesis: Our investment thesis rests on the following three points: (1) we

aren’t confident on a recovery in the company’s business in developed countries; (2)

more time is needed for its platform strategy for leading cost competitiveness in emerging

nations to take effect; and (3) the company is unattractively valued.

Price target: We initiate coverage of Yamaha Motor with a Hold rating, setting our price

target for the next 12 months at ¥1,450. As our calculation basis, we assigned a 20%

premium to the average sector P/E of some 11x to correspond to the estimated PER of 13x

for FY12/14, our base-year for valuations. We took into consideration a growth cycle that

remained close to a trough and a high growth rate compared with the mean reversion for

the business. At 18%, the average operating profit growth rate for FY12/13 to FY12/15 is

prominently high in the sector.

Valuation/Risks: The theoretical share price for the company ranges from about

¥1,007–¥1,719, based on our 20-stage DCF model, assuming a discount rate of 5.5%–

6.0% and a terminal growth rate of 0%–1.0%. Our price target is located in the middle of

this range. The company’s theoretical share price, suggested by our SOTP-based buildup

method, also stands at ¥1,425. The risk of foreign exchange fluctuations is extremely high.

Every ¥1 fluctuation (approximately 1%) affects operating profit by ¥1.6bn for US$ and

¥0.4bn for euro. Such exchange fluctuations would cause operating profit to fluctuate by

approximately 3.4%.

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21 November 2013



Chart 9: Toyota Motor – 1-Year P/E Band Chart


Chart 10: Honda Motor – 1-Year P/E Band Chart


Chart 11: Nissan Motor – 1-Year P/E Band Chart


Chart 12: Suzuki Motor – 1-Year P/E Band Chart


Chart 13: FHI – 1-Year P/E Band Chart


Chart 14: Mazda Motor – 1-Year P/E Band Chart


Chart 15: Daihatsu Motors – 1-Year P/E Band Chart


Chart 16: Yamaha Motor – 1-Year P/E Band Chart


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Chart 17: Toyota Motor – 1-Year P/B Band Chart


Chart 18: Honda Motor – 1-Year P/B Band Chart


Chart 19: Nissan Motor – 1-Year P/B Band Chart


Chart 20: Suzuki Motor – 1-Year P/B Band Chart


Chart 21: FHI – 1-Year P/B Band Chart


Chart 22: Mazda Motor – 1-Year P/B Band Chart


Chart 23: Daihatsu Motors – 1-Year P/B Band Chart


Chart 24: Yamaha Motor – 1-Year P/B Band Chart


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21 November 2013



Chart 25: Global comparative valuations

Source: Jefferies estimate, Bloomberg consensus Note: Japanese OEMs are based on Jefferies estimates while all others are based the Bloomberg consensus.

Chart 26: Creation of values in the period between 2001 and 2013

Source: Jefferies, Bloomberg Note: Based on stock prices on October 10, 2013. Strategic position names are based on McKinsey & Co. (2002)

TSE Company ROE (% ) EV/EBITDA (x)Code FY12A FY13E FY14E FY12A FY13E FY14E FY13 E FY13 E7203 Toyota Motor Corp 20.7 10.9 11.0 1.6 1.4 1.3 12.3 4.67267 Honda Motor Co Ltd 20.1 12.2 10.5 1.5 1.3 1.2 10.5 5.47201 Nissan Motor Co Ltd 11.3 10.6 9.3 1.0 0.9 0.9 3.8 4.0

Japan Big 3 Avg 17.4 11.2 10.2 2.2 2.7 2.2 8.9 4.7

7261 Mazda Motor Corp 39.4 13.1 9.7 2.7 2.2 1.8 16.1 7.47262 Daihatsu Motor Co Ltd 9.5 9.6 10.6 1.6 1.4 1.3 15.4 4.07269 Suzuki Motor Corp 17.2 13.2 12.5 1.2 1.1 1.0 8.7 4.07270 Fuji Heavy Industries Ltd 18.3 9.5 11.1 3.7 2.7 2.2 32.4 5.97272 Yamaha Motor Co Ltd 72.2 16.1 13.9 1.8 1.5 1.4 10.2 4.5

Japan 2nd tiers Avg 31.3 12.1 11.6 2.2 1.8 1.5 16.5 5.1Japan Automakers Avg 24.4 11.7 10.9 2.2 2.2 1.8 12.7 4.9

- General Motors Co 12.4 11.4 8.3 2.0 1.6 1.4 18.6 3.2- Ford Motor Co 11.5 10.2 9.2 4.2 3.0 2.4 36.3 4.9

US Automakers Avg 12.0 10.8 8.8 3.1 2.3 1.9 27.5 4.1

- Daimler AG 10.5 11.7 10.5 1.5 1.4 1.3 13.0 9.2- Bayerische Motoren Werke AG 10.6 10.4 10.2 1.8 1.6 1.5 15.9 8.8- Volkswagen AG 4.0 9.1 7.9 1.1 1.1 0.9 11.8 7.5- Renault SA 9.6 12.2 7.2 0.8 0.7 0.7 5.0 10.9- Fiat SpA 20.8 28.1 12.1 0.8 0.7 0.7 2.3 2.6- Peugeot SA -0.7 -4.8 39.6 0.4 0.4 0.4 -8.5 12.0

EU Automakers Avg 11.1 14.3 9.6 1.2 1.1 1.0 9.6 7.8

- Hyundai Motor Co 13.3 7.5 6.8 1.5 1.3 1.1 18.2 3.9- Kia Motors Corp 11.9 6.6 6.1 1.7 1.3 1.1 20.9 5.0- Dongfeng Motor Group Co Ltd 11.8 11.0 10.2 2.0 1.7 1.5 17.4 4.5- Tata Motors Ltd 12.6 9.3 7.8 3.3 2.5 1.9 29.6 4.2- Mahindra & Mahindra Ltd 13.6 12.7 10.9 2.8 2.4 2.1 19.4 8.6- Maruti Suzuki India Ltd 19.9 16.8 14.3 2.6 2.3 2.0 14.4 9.4

Asia Automakers Avg 13.9 10.6 9.4 2.3 1.9 1.6 20.0 6.0Overseas Automakers Avg 12.3 11.9 9.2 2.2 1.8 1.5 19.0 5.9Global Automaker Avg 18.3 11.8 10.1 2.2 2.0 1.7 15.9 5.4

PER (x) PBR (x)

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21 November 2013



Chart 27: Earnings Outlook for the OEMs in Japan

Revenues Operating income Recurring income Net income EPS DPS

(¥bn) YoY (%) (¥bn) YoY (%) (¥bn) YoY (%) (¥bn) YoY (%) (¥) (¥)

Toyota Motor

FY3/12A 18,583.7 -2.2% 355.6 -24.1% 432.9 -23.2% 283.6 -30.5% 90.2 50.0

FY3/13A 22,064.2 18.7% 1,320.9 271.4% 1,403.6 224.3% 962.2 239.3% 303.8 90.0

FY3/14E 25,281.4 14.6% 2,450.0 85.5% 2,592.4 84.7% 1,833.0 90.5% 578.8 170.0

FY3/15E 26,299.5 4.0% 2,510.0 2.4% 2,646.0 2.1% 1,818.0 -0.8% 574.1 170.0

FY3/16E 27,585.8 4.9% 2,590.0 3.2% 2,736.0 3.4% 1,889.0 3.9% 596.5 180.0

FY3/17E 29,135.4 5.6% 2,730.0 5.4% 2,886.0 5.5% 1,994.0 5.6% 629.6 190.0

Honda Motor

FY3/12A 7,948.1 -11.1% 231.4 -59.4% 257.4 -59.2% 211.5 -60.4% 117.3 60.0

FY3/13A 9,877.9 24.3% 544.8 135.5% 488.9 89.9% 367.0 73.5% 203.6 76.0

FY3/14E 12,105.5 22.6% 825.0 51.4% 809.7 65.6% 606.0 65.1% 336.2 88.0

FY3/15E 13,508.6 11.6% 975.0 18.2% 955.0 17.9% 706.0 16.5% 391.7 110.0

FY3/16E 14,523.4 7.5% 1,090.0 11.8% 1,070.0 12.0% 781.0 10.6% 433.3 130.0

FY3/17E 15,650.4 7.8% 1,195.0 9.6% 1,175.0 9.8% 850.0 8.8% 471.6 140.0

Nissan Motor

FY3/12A 9,409.0 7.2% 545.8 1.6% 535.1 -0.5% 341.4 7.0% 81.6 20.0

FY3/13A 9,629.6 2.3% 523.5 -4.1% 529.3 -1.1% 342.4 0.3% 81.7 25.0

FY3/14E 10,000.3 3.8% 500.0 -4.5% 530.0 0.1% 366.0 6.9% 87.3 30.0

FY3/15E 10,719.6 7.2% 600.0 20.0% 661.0 24.7% 418.0 14.2% 99.7 35.0

FY3/16E 11,603.5 8.2% 720.0 20.0% 792.0 19.8% 504.0 20.6% 120.2 40.0

FY3/17E 12,416.6 7.0% 800.0 11.1% 887.0 12.0% 568.0 12.7% 135.5 55.0

Mazda Motor

FY3/12A 2,033.1 -12.6% -38.7 NM -36.8 NM -107.7 NM -57.8 0.0

FY3/13A 2,205.3 8.5% 53.9 NM 33.1 NM 34.3 NM 11.5 0.0

FY3/14E 2,696.0 22.3% 180.0 233.7% 136.1 311.2% 103.2 200.8% 34.5 0.0

FY3/15E 2,916.8 8.2% 210.0 16.7% 208.2 53.0% 140.0 35.7% 46.8 3.0

FY3/16E 3,058.6 4.9% 230.0 9.5% 228.2 9.6% 153.0 9.3% 51.2 5.0

FY3/17E 3,218.5 5.2% 245.0 6.5% 243.2 6.6% 163.0 6.5% 54.5 5.0

Suzuki Motor

FY3/12A 2,512.2 -3.7% 119.3 11.6% 130.6 6.6% 53.9 19.4% 88.4 15.0

FY3/13A 2,578.3 2.6% 144.6 21.2% 155.6 19.2% 80.4 49.1% 143.3 18.0

FY3/14E 2,912.3 13.0% 180.0 24.5% 190.0 22.1% 105.0 30.6% 187.2 22.0

FY3/15E 3,181.3 9.2% 197.0 9.4% 207.0 8.9% 111.0 5.7% 197.9 26.0

FY3/16E 3,422.4 7.6% 230.0 16.8% 240.0 15.9% 128.0 15.3% 228.2 30.0

FY3/17E 3,576.8 4.5% 240.0 4.3% 250.0 4.2% 132.0 3.1% 235.3 34.0

Daihatsu

FY3/12A 1,631.3 4.6% 115.5 11.6% 128.2 14.3% 65.1 23.9% 152.9 45.0

FY3/13A 1,765.0 8.2% 133.0 15.2% 148.2 15.6% 81.4 25.0% 191.0 56.0

FY3/14E 1,826.1 3.5% 145.0 9.0% 160.4 8.3% 81.1 -0.3% 190.4 56.0

FY3/15E 1,786.9 -2.1% 130.0 -10.3% 143.0 -10.8% 73.0 -10.0% 171.3 50.0

FY3/16E 1,838.8 2.9% 149.0 14.6% 162.2 13.4% 83.0 13.7% 194.8 50.0

FY3/17E 1,854.6 0.9% 150.0 0.7% 163.3 0.7% 87.0 4.8% 204.2 50.0

Yamaha Motor

FY12/11A 1,276.1 -1.4% 53.4 4.1% 63.5 -4.0% 27.0 47.3% 77.2 15.5

FY12/12A 1,207.7 -5.4% 18.6 -65.2% 27.3 -57.0% 7.5 -72.2% 21.5 10.0

FY12/13E 1,400.8 16.0% 54.0 190.3% 57.2 109.8% 34.0 353.6% 96.5 20.0

FY12/14E 1,521.6 8.6% 67.0 24.1% 69.4 21.3% 39.0 14.7% 111.3 20.0

FY12/15E 1,587.6 4.3% 75.0 11.9% 77.4 11.5% 44.0 12.8% 126.0 30.0

FY12/16E 1,714.5 8.0% 88.0 17.3% 90.4 16.8% 51.0 15.9% 146.1 36.0

Fuji Heavy

FY3/12A 1,517.0 -4.0% 44.0 -47.8% 37.3 -54.7% 38.5 -23.6% 49.3 9.0

FY3/13A 1,913.0 26.1% 120.4 173.9% 100.6 169.9% 119.6 211.0% 153.2 10.0

FY3/14E 2,399.5 25.4% 315.0 161.6% 310.3 208.4% 230.0 92.3% 294.7 45.0

FY3/15E 2,562.8 6.8% 315.0 0.0% 310.4 0.0% 197.0 -14.3% 252.4 50.0

FY3/16E 2,630.7 2.6% 285.0 -9.5% 280.4 -9.7% 177.0 -10.2% 226.8 55.0

FY3/17E 2,747.1 4.4% 295.0 3.5% 290.4 3.6% 184.0 4.0% 235.8 60.0

Industry Total

FY3/12A 44,910.5 -2.5% 1,426.2 -26.7% 1,548.1 -28.1% 913.2 -33.2% -- --

FY3/13A 51,241.0 14.1% 2,859.8 100.5% 2,886.6 86.5% 1,994.8 118.4% -- --

FY3/14E 58,621.9 14.4% 4,649.0 62.6% 4,786.1 65.8% 3,358.3 68.4% -- --

FY3/15E 62,497.2 6.6% 5,004.0 7.6% 5,200.0 8.6% 3,502.0 4.3% -- --

FY3/16E 66,250.6 6.0% 5,369.0 7.3% 5,586.2 7.4% 3,759.0 7.3% -- --

FY3/17E 70,313.9 6.1% 5,743.0 7.0% 5,985.3 7.1% 4,029.0 7.2% -- --

Source: Company data and Jefferies

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Chapter 2: Discussion of Key

Fundamentals Issues in Japan Autos

Differences in capex cycle and in capacity utilization Automobile manufacturers' earnings are heavily influenced by capacity utilization rates at

production facilities and by their capital expenditure cycles, including upfront investment.

The capital expenditure cycle is an element which plays a tremendous role in profitability

and growth rates, in the same way as the new model cycle. A huge gap has opened in

investment cycles at the three Japanese majors (the J3) and we think this is a major cause

of differences in earnings power. Hitherto, Toyota Motor and Fuji Heavy Industries (FHI)

have maintained outstandingly rich margins thanks to high capacity utilization and low

costs associated with ramping up new factories. Margins have been worse at Honda

Motor, Nissan Motor, and Mazda Motor, which have incurred onerous upfront investment

on new factory capacity, while capacity utilization has also been consistently weighed

down.

Chart 28: Capex as % of Revenues


Chart 29: Depreciation as % of Revenues


Toyota has stuck by its approach of avoiding investment in new factories, using its

intelligence to generate the required volume of vehicles in cooperation with its workforce,

based on the leadership of CEO Akio Toyoda, whose goal is "Always Better Cars" rather

than pursuing volume. In line with this, the company announced its plans to freeze new

factory investment for three years, until the start of 2015.

Honda and Nissan have accelerated their programs of expansion in emerging economies

and investment in capacity expansion, and a major gap has thus opened up in the three

companies' investment cycles. The current divergence in capacity utilization is widening,

and there is also a major gap in fixed cost outlays. There is a wide variation in medium-

term capacity expansion plans, with Toyota's 2015 global production capacity of 9.67

million units representing CAGR of only 1% from 2010. Honda plans to expand capacity

to 6.05 million units giving CAGR of 6%, while Nissan is targeting capacity of 7.17 million

units at CAGR of 8%, based on our analysis.

Toyota's production capacity expansion is mainly at existing factories, and is limited. The

same is true in the US, where we think securing production capacity is clearly a pressing

issue. The company's capacity utilization has increased sharply in all regions, and we have

to recognize the risk that sales volume growth will slow unless it changes its approach.

January–September capacity utilization reached 105% in North America, 98% in Japan,

115% in Thailand, and 120% in Indonesia. Assuming maximum capacity utilization of just

The capital expenditure cycle is an

element which plays a tremendous

role in profitability and growth rates.

Toyota's 2015 global production

capacity of 9.67 million units

represents CAGR of only 1% from

2010.

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21 November 2013



over 120%, using overtime and weekend shifts as far as is feasible, capacity utilization is

approaching its limits in North America and major Asian countries.

One important debate will be the timing of any decision to resume capacity expansion,

investing in factories that can start operations from 2015. We think full-scale debate over

capacity expansion targeting a ramp-up from 2015 will begin in 2014.

Chart 30: Global capacity ('000 units)

Source: Company data, Jefferies estimates

Chart 31: Global capacity utilization

Source: Company data, Jefferies estimates

Differences in reliance on domestic production, and forex sensitivity Variations in the weightings of domestic production in total output have given rise to

pronounced variations in near-term earnings power. Based on FY3/13 results, Mazda

ranked top of the list of domestic production as a proportion of global output at 73%,

followed by FHI at 66%, and Toyota at 39%, remaining elevated. High forex sensitivity has

led to a huge variation in FY3/14 earnings growth rates. We expect domestic production

weightings to remain high in FY3/15, since Toyota and FHI have no plans to transplant

vehicle production offshore on a large scale anytime soon. Thus, Toyota and FHI's

earnings remain at considerable risk of change associated with fluctuations in exchange

rates. There will be no problems provided the yen continues to weaken, but we have to

conclude there is great risk if the turnaround in exchange rates ends and the weakness

inherent in a domestic manufacturing base is exposed once more.

On the other hand, domestic production weightings are likely to continue to fall at Honda,

Nissan, and Mazda, whose new Mexican factories will come up to full speed. This

weighting is due to fall to around 15% by FY3/17 at Honda and Nissan, and it looks as

though they will swiftly realign their profiles to leave them relatively unaffected by

currency swings or changes in terms of trade for domestic manufacturing.

Chart 32: % of domestic production in global production units


High domestic production weightings are good for near-term earnings, but inevitably

leave issues for the future. The US market is a major destination for export volume. The

picture of earnings improvement delivered by the weaker yen, exports, and the US is the

FY3/11A FY3/12A FY3/13A FY3/14E FY3/15E FY3/16E FY3/17E

Toyota 41% 41% 39% 37% 35% 33% 31%

Honda 26% 28% 22% 21% 20% 18% 16%

Nissan 26% 25% 22% 21% 18% 16% 15%

FHI 73% 73% 66% 72% 71% 69% 62%

Mazda 68% 72% 73% 76% 69% 62% 61%

Suzuki 35% 36% 36% 34% 30% 28% 25%

Due to fall to around 15% by FY3/17

at Honda and Nissan

Industrials

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21 November 2013



Japanese OEMs' erstwhile structure when they flourished in the 2000s. Even if profitability

improves temporarily on the back of this structure, we have to recognize the risk that this

may not prove sustainable. Indeed, there is the risk that over-performing under this old

structure will delay the necessary response to change.

Chart 33: FY3/15Forex sensitivity to operating income

Source: Jefferies based on companies data. Yamaha Motor based on FY12/14 since its fiscal year ends December. Note: Theoretical impact on FY3/15 operating income per ¥1 change against foreign currencies. (1) Suzuki's total sensitivity includes Indian Rupee (¥6.5bn per ¥0.1/INR)

Comparative study of regional growth strategies The Japanese OEMs' strategic business profile road-maps broadly run along the same lines,

albeit with differences in degree. There are five major points.

1. Reconstruct developed market business: The companies need to enhance rich

contents to polish up the product appeal and value-for-money on which Japanese

brands were founded, and to establish competitive strength in areas such as fuel

consumption and safety features.

2. Establish business models for emerging markets: The firms urgently need to

establish manufacturing capabilities and cost-competitive strength corresponding to

emerging nations' local product quality requirements. They will need to come up

with the best-possible products for emerging economies, and build up production

capacity.

3. Improve internal combustion engine (ICE) performance: The Japanese

OEMs need to go beyond just gearing up their already excellent hybrid technology,

and push forward the transition to direct injection gasoline engines and turbo-

charged low-emission engines (downsizing turbo), cranking up ICE-related

performance with an eye on the Chinese market.

4. Raise overseas production capacity and local procurement ratios: They

need to establish local operations that are unaffected by changes in forex and

Japan's terms of trade. While localizing front-end processes such as design and

development is also an important issue, it will be increasingly important to build up

management capabilities and staff training to push forward comprehensive

localization, including sales and services.

5. Create new architecture: The companies need to build innovative architecture to

reduce costs and manage growing complexity in both developed and emerging

markets, and pursue platform strategies which make full use of such architecture.

There is a considerable difference in individual companies' attitudes for each of these.

Below we summarize the J3's approach. We are convinced that Honda well start to reap

the rewards from its drive to strengthen products and lift capacity from 2014, and we

envisage a major upturn in fundamentals. We think prospects for delivering attractive

growth are improving, in light of the impact of new models already on the market. Over

the near term Toyota's margins are likely to recover conspicuously thanks to its strategy of

OP Sensitiv ity per ¥1 change (¥bn) FY3/15E OP OP Sensitiv ity

US$ Euro CAD AUD Total ¥bn US$ Euro Total

Toyota 45.0 4.0 1.0 4.0 54.0 2,510.0 1.8% 0.2% 2.2%

Nissan 12.0 0.0 1.0 0.5 13.5 600.0 2.0% 0.0% 2.2%

Honda 13.0 0.5 0.0 0.0 13.5 975.0 1.3% 0.1% 1.4%

Mazda 2.5 1.5 1.2 2.0 7.2 210.0 1.2% 0.7% 3.4%

Suzuki (1) 0.5 0.7 0.1 0.2 5.0 197.0 0.3% 0.4% 2.5%

Fuji Heavy 8.6 0.3 0.3 -- 9.2 315.0 2.7% 0.1% 2.9%

Daihatsu 1.3 0.0 0.0 0.0 1.3 143.0 0.9% 0.0% 0.9%

Yamaha Motor 1.6 0.4 0.0 0.0 2.3 67.0 2.4% 0.6% 3.4%

Total 87.1 8.4 4.1 8.5 111.5 5,017.0 1.7% 0.2% 2.2%

Strategic business profile road-maps

broadly run along the same 5 key

points.

Industrials

Autos & Auto Parts

21 November 2013



returning to its roots, but we feel its long-term capacity for growth is very unstable.

Nissan's upbeat medium-term plan has foundered, and we think it urgently needs to

rebuild the framework of its plan.

Toyota Motor — hybrids are its biggest focus Toyota is running a strategy which puts more emphasis on its own unique approach

rather than pursuing growth. Although we feel that returning to its roots is probably the

wise option for Toyota, which has suffered deeply, putting a foot wrong could accelerate

the progression towards maturation. It is hard to forecast whether or not the company

will succeed over the long term, but this is at least likely to hamper growth over the

medium term. Five-year CAGR in production capacity from 2010 through 2015 is running

at an extremely low level of 1%. High capacity utilization can drive profitability up to a

certain point, but after this it becomes inefficient, and can even impair growth potential.

Supply shortages look likely to hamper Toyota's top-line growth if global demand

continues to expand steadily.

Strengthening products on a regional axis lies at the heart of the product strategy.

Manufacturing vehicles under the Always Better Cars slogan seeks to reform the

traditional head-office-led approach to development and design, and transfer authority for

product development to the regional level. Within this context, the company has

established new architecture (TNGA), looking to simultaneously strengthen products'

intrinsic appeal and reduce costs. TNGA can be seen as the basic platform for Toyota's

structural realignment, simultaneously achieving greater localization, cost-savings, and

enhanced product muscle in terms of design. Conceptually this is very close to the

"integrated planning" and "common architecture" drawn up by Mazda several years ago.

This program is to embrace three platforms: ‚New M/C Platform‛, ‚K-Platform‛, and

‚New NBC Platform.‛ Total volume for the three platforms will amount to about 5mn

units, allowing the company to plan nearly 50% of its total production in a unified

program, modularizing functions and evolving a procurement structure that transcends

the framework of its existing group suppliers. We believe the new Prius due in 2015 is

likely to be the first in line. This is likely to be followed by the next-generation Camry in

2016, with the program completed via the next Yaris/Vitz in 2017. Thus, the full rollout of

TNGA is not until 2015, so it will likely take a really long time to genuinely strengthen

product profiles.

Chart 34: Production volumes of Toyota from each platform

Source : Jefferies, Fourin

Toyota plans to continue to focus on growth in emerging markets, but it does not appear

to have any powerful, decisive products at this stage, in our view. In 2013 Toyota

overhauled its organizational structure, splitting into "Toyota No. 1" to cover developed

markets, and "Toyota No. 2" in charge of emerging markets, looking to speedily deploy

products tailored to the respective needs, ensuring growth. At the point global sales of

TNGA will deliver more than 5

million units of vehicles in by 2017

and onward.

Industrials

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21 November 2013



Toyota/Scion brand vehicles reaches 10 million units, Toyota intends to generate half (5

million) of the total in emerging economies. It cites the rollover to the new model of the

next IMV (Hilux) in 2015 as the likely turning point. In addition to enhancing intrinsic

product appeal, we think we can look for the benefits of advanced localization and a more

solid foundation for training local staff to come through.

Chart 35: Percentage of merging market in Toyota’s global retail sales units

Source: Company data

Hybrids will basically form the core of its powertrain strategy, and Toyota Hybrid System

(THS) will play an important role for the company to achieve break-throughs in terms of

performance costs when it transitions to the next-generation THS in 2015. This could

improve fuel-efficiency by 10–15% compared with the current generation. The company

may well gear up ICE growth in stages. It has already decided to roll out a 2.4l direct-

injection low-emission turbo-charged engine, but we think it will take a considerable

while to rebuild its entire range.

Honda Motor Current margins are not particularly strong because the company is accelerating its drive

to gear up product power, while at the same time actively expanding capacity and

upgrading its powertrains. The background to this is that Honda has simultaneously

shouldered (1) content costs in developed nations on rebuilding its brand proposition

and (2) investment costs on new factory construction/powertrain upgrades, so the pace

of recovery in earnings power has fallen well behind that of Toyota. If the current cost

burden leads to higher market share in the future, earnings growth should follow, so the

true worth of this will likely be put to the test.

In its medium-term strategy through FY3/17, unveiled in 2012, Honda is targeting

automobile sales of 6 million units (3.93 million units in FY3/13). Sales are expected to rise

from 2.54 million units to 3 million units in developed nations (Japan, North America,

Europe) and from 1.38 million units to 3 million units in emerging economies, with

growth thus driven by the latter. The company will implement three key initiatives to

support growth in its automobile business, namely (1) concurrent development in its six

regions, (2) locally optimized design drawings, and (3) enhancements to productivity.

The concrete embodiment of this new profile will be the new Fit/Jazz marketed in

September 2013, and subsequent models in the series. Honda is adding 1 million units to

capacity, mainly in emerging economies. It plans to increase global production capacity

to 6.05 million units by 2015, giving CAGR of 6% from 2010.

In emerging markets Honda is to launch the Brio/Amaze and the seven-seater Mobilio

MPV one after the other through into 2014. Adding in the Fit/Jazz, global small car sales

volume has the potential to rise from an estimated 700,000 units in 2012 to 1.5 million

units by around 2016. Asia-Pacific sales are to provide powerful momentum, and the

company has an ambitious plan to lift volume from 600,000 units in 2012 to 1.2 million

Chart 36: Honda's Global

Production Capacity Expansion

Source: Jefferies estimates, company data

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21 November 2013



units in 2016. It is targeting volume of 300,000 units (26% share) in Thailand, 300,000

units (20%) in Indonesia, and 300,000 units (5%) in India.

The drive to enhance its engines in line with its Earth Dreams Technology strategy is

already in full swing. It has already developed direct injection versions of its core 1.3-1.5l,

1.8-2.0l, and 2.4l engines. In hybrid systems it has already launched new 1-, 2-, and 3-

motor systems, fully closing the performance gap with Toyota. It will start to fit turbo-

charged low-emission engines from 2015, rapidly building up its line-up with 1.0l, 1.5l,

and 2.0l turbo-charged units. It will establish an extensive range, from electrified engines

through to low-emission turbos.

Chart 37: Honda Motor’s Mobilio in Indonesia

Source: Honda Motor

Chart 38: Honda Motor’s LCGC Brio Satio in Indonesia

Source: Honda Motor

Nissan Motor The Power 88 medium-term plan targets global market share of 8% and a consolidated

operating profit margin of 8% by 2016, and consists of two stages. Step 1 involves inter-

regional integration of global core models, and improved efficiency and margins in its

developed nation business by rebuilding North American operations, achieved through

2013. Step 2 was to consist of reinvesting the efficiency and profitability acquired through

the former in its emerging market business, seeking to simultaneously achieve volume

and margin growth.

However, the performance of global core models and North American business — the

basis for the plan's framework — are not living up to expectations at this juncture. It looks

very much as though new products are not sufficiently competitive, and operational

disruption in the North American business has yet to be completely resolved. Accordingly,

the company had to revise down its FY3/14 profit guidance. Nissan's management team

does not believe it has come adrift from the basic Power 88 roadmap, and aims to come

up with countermeasures to get back on track, but we are highly skeptical. We believe

prospects for achieving this plan have receded.

The key feature of Nissan's strategy for emerging markets is that it will launch dedicated

low-priced brands, developing the Venucia for China, and the Datsun brand for countries

such as Russia, Indonesia, and India. The success or failure of new brands from 2014 will

hold a vital key to Nissan's growth. The heart of the ‚Datsun strategy‛ is to develop

independent products tailored to each market's needs, conducting both parts

procurement and manufacturing locally. The GO is to be the first in the Datsun brand, and

will be a genuine small model, based on the old March and with a 1.2l engine. In India it

will be priced in the same range as Suzuki's mini-vehicle-based Alto and Hyundai's EON.

The length of the GO+ is to be kept within 4 meters, and it will thus be a seven-seater MPV

benefiting from tax breaks in India and Indonesia. Datsun sales are to get into full swing

across all regions from 2014. The company is achieving attractive products and pricing,

but we think the key will be to overcome the difficulties inherent in brand recognition.

Chart 39: Datsun GO+

Source: Nissan Motor

Chart 40: Datsun GO

Source: Nissan Motor

Industrials

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21 November 2013



FCF analysis, dividend capability analysis The gap in the J3's capacity to generate manufacturing segment cash flow has been

growing, but we envisage that this trend will reverse in the near future. We think the

reversal of this trend is likely to have a powerful impact on sector share price performance.

In addition to diverging investment cycles, differences in exposure to domestic

production have given rise to a major gulf in near-term earnings power, consequently

causing a similar gap to open up in the capacity to generate cash flow. This gap is unlikely

to close anytime soon if the yen continues its current downtrend. However, based on our

assumption of ¥100/$, we estimate that the gap will rapidly narrow from FY3/15. If

Toyota accelerates upfront investment, the differential will likely close even faster. Honda

Motor ran a deficit in its free cash flow for a while, suffering from excessive investment

and lower margins than expected in recent quarters, but it finally returned to a surplus in

2Q FY3/14. We estimate that free cash flow will return to growth following a period of

hefty investment.

Chart 41: Projections for Manufacturing Free Cash Flows


Hopes that Toyota will raise payout ratio somewhat overblown Toyota's profitability has turned up sharply, magnified by a low capex burden,

consequently delivering rich free cash flow. We estimate that free cash flow before

dividends (cash flow from operations less investment) will reach ¥852.2 billion in FY3/14

and a hefty ¥1,129.2 billion in FY3/15. Even if the company pays out ¥500 billion or so a

year in dividends, it will accumulate substantial cash in hand, as shown above. End-

FY3/13 manufacturing segment net cash reached ¥4,599.4 billion, and we estimate that

this will swell to ¥4,916 billion in FY3/15 and ¥5,506.8 billion in FY3/16.

It is hard to deny that market expectations about how high Toyota's dividend will go are

an important driver for its share price. Management has hitherto targeted net cash of ¥5

trillion, and it is within sight of achieving this, fuelling market expectations of an increase

in its dividend payout ratio. However, according to recent company briefings, it has

shifted its net cash target to ¥5–6 trillion. There are no great doubts that it will deliver a

payout ratio close to the promised 30%, but expectations that it will raise the payout ratio

benchmark look somewhat overblown. Furthermore, if its earnings growth peaks and

investment turns up in the future, we think dividends will also begin a period of stable

expansion from FY3/15. Be that as it may, the company has yet to reach a final decision on

its financial strategy, and it is currently considering this on a long-term perspective, while

carefully monitoring the economic picture.

The gap in the J3's capacity to

generate manufacturing segment

cash flow has been growing, but we

envisage that this trend will reverse

in the near future.

Toyota has shifted its net cash target

to ¥5–6 trillion, and expectations

that it will raise the payout ratio

benchmark look somewhat

overblown.

Industrials

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21 November 2013



Chart 42: Toyota Motor: Outlook of manufacturing net debt

(cash)

Company data and Jefferies estimate

Chart 43: Toyota Motor: DPS and Dividends payout ratio

Company data and Jefferies estimate

Industrials

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21 November 2013



Chapter 3: Analysis of global

automobiles' competitiveness

Key sector changes since 2008 It is hard to believe the automobile industry appeared almost mortally injured just four

years ago amid the financial crisis triggered by the sub-prime loan problem. Today the US

OEMs are making a substantial revival, while the Japanese OEMs are reaching to record-

high profits. Can we therefore assert the crisis is truly past? The answer is ‘No.’

This crisis triggered a historical paradigm-shift in the automobile industry. First, the

mainspring for demand growth in the automobile industry has shifted from developed

nations to emerging markets. Second, more and more elements within automobiles are

becoming commoditized. Third, the competitive gap between global automakers has

narrowed sharply, putting them on a level-footing and setting the industry on a collision

course towards a tumultuous period of major competition.

As a result, although earnings power and growth potential in the US market were key

factors in past success for the Japanese OEMs, these have conspicuously receded, while

the product quality and value-for-money which previously supported brand value have

lost their edge. The companies are restructuring and redefining their long-term strategies,

but their global rivals have not waited around, either. It is important to reference any

discussion of sector competitiveness to the three trends noted above.

Chart 44: Global SAAR trend: Developed Markets vs. Emerging Markets

0

10,000

20,000

30,000

40,000

0

10,000

20,000

30,000

40,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Developed (lhs) Emerging (rhs)

('000units) ('000units)

Source: Autodata, Automotive news, ACEA, JAMA, KAMA, CIA, TAIA, CAAM, and Jefferies Note: Data includes US, Canada, Mexico, W. Europe, Russia, Japan, China, India, Thailand, Malaysia, Indonesia, Korea, and Brazil. Based on light vehicles, but some countries include med/heavy-duty vehicles

Shift to emerging markets Everybody recognized that the structure of global automobile consumption would shift

from developed markets to emerging markets, but the Lehman Shock brought this

structural transition firmly to the fore. Translating monthly new automobile sales into a

seasonally adjusted annualized rate (SAAR) and tracking data series for developed and

emerging markets shows that the structure of automobile consumption has shifted from

the former to the latter. Nearly five years have elapsed since the crisis, but demand in

developed nations has recovered to only 85% of the peak level. Demand in emerging

markets has swept past the previous high and has just about doubled to reach 190% of

the level that prevailed at time of the crisis, while the size of the market has outstripped

that of developed nations.

According to the interim report issued by a METI panel on targeting the new middle class,

emerging markets' middle class is expected to swell sharply from 1.66bn people in 2010

Demand in emerging markets has

swept past the previous high and has

just about doubled to reach 190% of

the level that prevailed at time of the

crisis.

Industrials

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21 November 2013



to 2.15bn in 2020 and 2.36bn in 2030. Three countries — China, India, and Indonesia —

account for 80% of the new middle class. Assuming the upper-middle class starts to buy

new vehicles, growth in emerging markets has only just begun, and their role as an

engine of demand is set to become even more powerful going forwards.

The era of large-scale expansion in emerging markets will likely require the automobile

manufacturers to control scale and proliferating complexity to a degree they have never

experienced. What is worrying is the scenario already visible under which the

performance required of cars in developed nations and emerging markets respectively in

terms of road-handling, the environment, and safety will converge towards 2020. It will

be increasingly important for managements to be able to deliver in terms of both costs

and performance. The US market formed the heart of the business model that gave the

Japanese OEMs their competitive edge, so this market's sudden decline and the rapid

transition of power to emerging markets completely wrong-footed the Japanese industry.

Japanese OEMs are right in the midst of implementing structural reforms.

Commoditization Automobile demand in developed nations has started to become increasingly marked by

commoditization, and it has become very hard to generate earnings simply through the

past approach of pushing out vehicles with an array of functions. The main source of

purchasing is shifting from baby-boomers, who favored large, high-emission and multi-

function vehicles, to younger buyers who prefer small, fuel-efficient cars. There are also

endless requirements for safety and environmental features for automobiles.

Requirements for collision avoidance systems and other safety features are escalating,

while environmental restrictions such as on CO2 emissions are being tightened up sharply,

and costs are being driven relentlessly higher. It has started to become very difficult to

recover such costs through prices.

The struggle is even more intense in emerging markets, where purchasing power is lower

than in developed markets. At this juncture, mass-sales models in emerging economies

have not completely escaped the realms of "low prices regardless of quality," but we

envisage that build and performance will converge to a degree which will render

discussion of the boundaries between emerging markets and developed nations

meaningless by 2020, and we think companies will have to provide products at nearly-

equal standards to those in developed nations but at significantly lower prices. We expect

this tendency to be particularly pronounced in China, the largest emerging market. It is

unlikely to be easy to control costs while maintaining large-scale volume growth without

radical changes to manufacturing concepts and product planning. Companies will also

need to build a global strategy across the whole range of R&D, design, procurement, and

manufacturing.

Build and performance will converge

to a degree which will render

discussion of the boundaries

between emerging markets and

developed nations meaningless by

2020.

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21 November 2013



Chart 45: CO2 emission regulations by the key country

Source: ICCT

Competitive gap to narrow Great changes are taking place in the global automobile industry's competitive landscape,

affected by the 2008 Lehman Shock and Japanese/US manufacturers' fading competitive

advantages. It is clear that manufacturers in the 2nd tier are rapidly closing the gap with

GM and Toyota, which used to tower over the industry. The hierarchy revolving around

US brands has broken down, and the world's top five manufacturers are intermingled,

locked in fierce competition. Looking at global sales rankings in 2012, growth was

lackluster at Toyota and GM, which formerly boasted an overwhelming advantage in

terms of scale, against growth of 45% from 2007 at VW, 20% at fourth-ranked

Renault/Nissan, and 70% at fifth-ranked Hyundai Group.

We attribute the narrowing gap between rival firms to maturing basic automobile

technology, which reduces the scope for product differentiation, as well as to the

prevailing trends of the times, whereby European manufacturers' increasing use of

components from mega-suppliers to overcome manufacturing and product quality

domains in which they struggle is allowing them to open up their business models and

pursue multi-brand strategies in a new approach, delivering greater benefits effectively.

We think this pattern will likely continue for a while longer. Among the laggard second-

tier companies, we flag the possibility that Ford and Honda could crank up their strategic

fight back going forwards, likely stoking even more intense competition.

Chart 46: Global Retail Sales Units by OEMs

Source: 2002-2007 Automotive News, 2008-2012 FOURIN

CO2 emissions are being tightened

up sharply, and they all are similar

by 2020.

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Autos & Auto Parts

21 November 2013



Analysis of global competitiveness Tokyo University’s Professor Fujimoto divides competitive strength in the automobile

industry into three layers, namely "deep-layer competitiveness", "surface-layer

competitiveness," and "earnings power." The visible elements of product strength,

performance, and price which appeal directly to the customer constitute "surface-layer

competitiveness." The resulting financial performance is "earnings power." Factors such as

strategic positioning, management power, QCD (quality, cost, delivery), efficiency, and

productivity which are not visible on the surface make up "deep-layer competitiveness,"

but this is hard to measure. Looking at these in terms of duration, earnings power

fluctuates near-term on a quarterly basis, while surface-layer competitiveness may rise and

fall within model cycles, deep-layer competitiveness is highly stable, and can be explained

as broadly correlating with "organizational capabilities for manufacturing," so long as

there is no major transformation in product architecture.

Surface-layer approach

Chart 47: Japanese Brand’s Market Share Gains/Losses between 2007 and 2012

Note: Gains and losses of market share between 2007 and 2012 for the 55 countries Source: Jefferies based on MarkLines’ data

The global-level competitive strength formerly enjoyed by Japanese-branded vehicles has

visibly eroded, and there is an inescapable perception that the edge given by surface-layer

competitiveness in terms of product attributes, design, and product quality has been

dilluted. The fall in Japanese brands' global market share is plain to see, down from 31.1%

in 2007 to an abnormal figure of 26.8% in 2011 in the wake of the catastrophic

earthquake, but then remaining weak at around 29% even in 2012, close to the level of

the low-point immediately after the Lehman Shock.

Chart 48: Japanese brands' market shares and volume CAGRs

Source: Jefferies, company data Note: The size of circle represents Japanese brands' sales volumes of the each region

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Industrials

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21 November 2013



The causes for this are complex. The first point is a lack of effort arising from hubris and

wrong management decisions. Outstandingly fuel-efficient Japanese-branded vehicles

sold extremely well in the US market when crude oil prices soared, but the manufacturers

used the funds delivered by rich earnings to invest in large/luxury models, deferring the

investments they needed to make in developing low-fuel-consumption engines and low-

cost platforms. Second, the so-called Six Troubles accelerated the retreat in the domestic

manufacturing sector's international competitiveness (strong yen, high corporate tax rate,

delayed response to free trade agreements, tighter labor regulations, tighter

environmental restrictions, electricity shortage). Third, evolution in automobiles' design

concept (architecture) may have begun to blunt the Japanese OEMs' much-vaunted edge

in manufacturing.

Deep-layer approach

Chart 49: Product Architecture – Integral vs. Modular

Source: Fujimoto, Tokyo University (2001)

The design concept according to which functions are allocated and the interfaces

between such components are drawn up is called "architecture." The basic palette onto

which these components are mounted (i.e., vehicle frame) is called the "platform".

Innovations are taking place in automobile architecture and business models, and the

erosion of the competitive advantages formerly enjoyed by Japan's manufacturing sector

is a grave reality.

In the past the domestic automobile industry derived its global competitive strength from

(1) manufacturing capabilities, (2) a vertically integrated, multi-layer supply chain

structure through partnerships, which supported manufacturing, and (3) an integral

(individually optimized) development model in which suppliers were intimately involved.

The three key-words of "manufacturing," "suppliers," and "integrated development" used

to be the Japanese OEMs' strengths, allowing them to deliver high-quality automobiles at

attractive prices.

Architecture can be approached from two angles: products and inter-company

relationships. At the product level there is the snap-on (modular) approach with

standardized interfaces or the individually optimized integrated (integral) approach, while

inter-company relationships are either open or closed. Plotting the matrix created by this,

automobiles clearly typically fall into the "closed" "integrated" camp, whilst PCs are "snap-

on" "open" products.

In the past, components based on individually optimized "integrated" architecture were

used to assemble the top cars in the world, with high product quality, outstanding cost-

competitiveness, and attractive, individual appeal. These parts have been sold extensively,

delivering benefits of volume growth, as well as cutting costs and improving cost-prices in

a virtuous cycle of success breeding further success. On the other hand, this architecture

Integral Modular

Closed Automobile, Motorcycle Mainframe

Game software Machine tool

Small & compact Lego

home electric appliance, etc

Open PC and software

Internet

New financial product

Bicycle

Closed Integral Closed Modular

Open Modular

Automobiles clearly typically fall into

the "closed" "integrated" camp,

whilst PCs are "snap-on" "open"

products.

Industrials

Autos & Auto Parts

21 November 2013



lends itself to insular components, divorced from the ongoing global trend towards open,

standardized development. In other words, it easily falls prey to the Galapagos Effect. This

is an impediment to emerging market business, which needs low-cost, localized

procurement.

At present, individual optimization is running into the limits of resources as the

automobile industry sees explosive growth in volumes and regional coverage, and it is

proving increasingly challenging to run complex process-management based on

individual optimization. The domestic manufacturing sector's virtuous cycle of the past

has started to turn into a vicious circle. The sector needs to overhaul Japan's mother-shop

role, which formerly delivered competitiveness at the development, procurement, and

production stages, respectively, and the necessary structural realignment needs to be

pushed through without delay.

Financial approach So what about earnings power, which is the financial performance resulting from

competitiveness? This shows remarkably good results, and today's Japanese OEMs have

started to establish their strongest-ever competitiveness in terms of earnings. It is worth

noting that the upturn in financial competitiveness — running counter to surface- and

deep-layer competitiveness, in which they are losing their strengths — could be

overstated, resulting from the coincidence of their investment cycles and exchange rate

fluctuations. The Japanese firms are well-placed to surpass the record-high profits of

FY3/08. Whether or not this earnings power is genuine hinges on whether it is supported

by intrinsic competitiveness.

Regardless of surface- and deep-layer competitiveness, any assessment of competitive

strength is distorted more by forex and external factors than the underlying picture.

Appraisal of the Japanese OEMs was at rock-bottom from 2008, but this was clearly

because the downturn was over-accentuated by external factors, and the underlying

picture was not as bad as was implied. The current picture is a quasi-reversal of this, with

overheads and investment reined in sharply in accounting terms, and upfront

development and preparation for the future being deferred, leaving costs extremely low.

Cooperative parts pricing from suppliers agreed during the period of yen strength also

persists. It is clear that a sharp fall in the yen under such circumstances is bound to deliver

a profit bonanza. The true test of the Japanese OEMs will be whether they can maintain

their current earnings power while also delivering the sustained development and

investment needed to lift their surface-layer and deep-layer competitiveness.

Chart 50: EBIT margin trend by Global OEMs

Source: Company data, Jefferies estimates and Bloomberg consensus Note: Japanese EBIT margin is based on Jefferies estimates. All the others are based on Bloomberg consensus.

The Japanese firms surpass record-

high profits.

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Autos & Auto Parts

21 November 2013



The requisite shape of competitiveness from now We identify the following four points defining the automobile industry's competitiveness

through to 2020.

1. New architecture breakthroughs delivering superior costs and performance,

2. Innovations which overcome significant scale and complexity,

3. Management capabilities on both the strategic and "soft" fronts, and

4. Brands and premium strategies

The basic architecture for automobiles remains essentially unchanged, even more than

100 years after the first car was born. We are unlikely to see the same kind of revolutionary

changes evident in the electronics industry, even looking ahead. However, it is irrefutable

that the traditional gentle pace of evolution is starting to bring challenges. The industry is

moving into an era of massive competition bringing disruption on a global scale. The era

of large-scale expansion in emerging markets will require the automobile manufacturers

to control scale and proliferating complexity to a degree they have never experienced. The

performance attributes required of cars in developed nations and emerging markets are

likely to converge, and there is a pressing need for break-through to deliver superior costs

and performance.

The automobile industry needs to come up with innovations which transcend scale and

complexity. Technological reforms and new business models are needed to provide fresh

innovations in order to appropriately manage costs, volumes, and the environmental

burden. In the past the idea of global sales volume of 10mn units appeared to be a whole

new order of magnitude. Now 10mn units is merely seen as a new starting line, and

unless companies can find a way to manage both product portfolios inflated by this scale

and globalized operations, thereby securing earnings, they will be unable to flourish on a

permanent basis.

Brands and premium strategies will likely become significantly more important.

Automobiles' functions and product attributes are becoming increasingly commoditized,

implying that elements which govern relative competitiveness are shifting from product

quality/technology to prices/costs. Building capabilities to manage marketing, design,

brands, and other elements of the "soft" aspect of the business may take on an even more

important role than in the past.

The horizontal distribution of work may evolve in comparative terms, while inter-

company relationships may also progress to a relatively open structure. It will likely

become increasingly important to strategically identify in which areas companies can

make a profit. This is not a time to seek to beat the competition just through

manufacturing. The auto-makers could find themselves paupers amid plenty unless they

can strategically build business models with a clear framework to determine where and

how they can generate profits, in addition to their manufacturing capabilities. We think

the need for management capabilities on both the business model and "soft" front will

become significantly more important.

The automobile industry needs to

come up with innovations which

transcend scale and complexity.

Industrials

Autos & Auto Parts

21 November 2013



Chapter 4: Abreast of markets and

Japanese OEMs' positioning

Japan — tax reforms could play a major role

Outlook for tax system reforms Not only is the impact of the April 2014 consumption tax hike unclear (from 5% to 8%),

but it is also hard to tell how overall automobile tax system reforms will take shape, and

the outlook for domestic automobile sales is uncertain.

The main scenario we envisage is a follows.

1. The LDP's Tax System Reform Committee is set to decide by December on tax levies

on automobile bodies in its broad framework for the tax system in FY3/15. In the

main scenario we envisage four points: (1) a cut in acquisition tax (from 5% to 2%

for registered vehicles, from 3% to 0% for mini-vehicles — stepwise cut); (2) the

rejection of the plan put forward by Ministry of Internal Affairs and Communications

(MIC) to increase the tax on mini-vehicles; (3) covering a staged cut in the

acquisition tax in FY3/15 by sourcing funds temporarily from elsewhere (for example,

the automobile weight tax); and (4) deferral of any radical reforms until the broad

framework for the tax system in FY3/16.

2. Accordingly, we expect the demand rush ahead of the tax hike to be mitigated to

some degree, but we think this will still amount to around 200,000 units in

October–March. The corresponding pullback will come through in April–September

2014.

3. Looking ahead to the October 2015 consumption tax hike (from 8% to 10%), radical

reforms to taxes levied on vehicle bodies will constitute a topic for the discussions in

the run-up to the broad framework for the FY3/16 tax system, and there will be a

long-term debate while monitoring market activity after the consumption tax hike.

4. We estimate that FY3/14 domestic vehicle sales will rise 5.8% YoY to 5.51 million

units. We then forecast a decline of 6.1% YoY to 5.17 million units in FY3/15. As a

risk scenario, there could be a double-figure drop in sales to below 5 million units in

the event of an automobile related tax hike.

Chart 51: Trend "Eco-car subsidies" covered vehicle unit

composition ratio

Note: Based on "New Eco-car subsidies" system from April 2012 Source: JAMA

Chart 52: Trend of Automobile Related Tax Revenues

Source: Ministry of Internal Affairs and Communications

The main scenario we envisage is…

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Autos & Auto Parts

21 November 2013



Chart 53 gives details for automobile related taxes. When an automobile is purchased,

consumption tax and automobile acquisition tax are levied as national taxes, while vehicle

ownership requires automobile road tax (registered vehicles) and mini-vehicle road tax

(mini-vehicles) as local taxes, and automobile weight tax as a state/local tax. Scrapping

the roughly ¥180 billion in acquisition tax would leave local authorities short of funds, so

the MIC, which oversees local tax funding, has suggested a hike in automobile/mini-

vehicle taxes within the various local tax sources. The fact that the argument of funding

has not extended to include the bigger pool of state taxes under the Ministry of Finance's

auspices is a regrettable consequence of Japan's over-compartmentalized administrative

system, and is likely to be hard to understand from overseas investors' perspective.

The eco-car tax cut currently extends to more than 80% of domestic sales volume, while

50% are effectively tax-exempt. As shown in Chart 52, acquisition and weight taxes have

already been slashed, leading to a reduction of over ¥500 billion per fiscal year.

Substantial tax breaks already apply to HEVs (tax-exempt) and to mini-vehicles (almost all

of which are also tax-exempt). Even if the acquisition tax is cut at the same time the

consumption is raised, the burden from the consumption tax will rise in real terms. We

believe the rising tax rate is likely to deal a body blow to domestic new automobile sales,

leading to a consistent gradual downtrend. However, we do not currently envisage any

sharp fall in domestic production volume. The impact of the correction in the strong yen

is gradually improving conditions for exports, and it looks as though previous concerns of

plummeting export volumes were unfounded. We think that the decline in domestic

production will be relatively gentle, and violent changes do not form part of our main

scenario.

Chart 53: Automobile Related Tax Revenues

Source: JAMA

Tax Revenue

(¥ bn)Original Tax Rate Current Tax Rate

On acquisition Registration vehicles 3% Registration vehicles 5%

Mini-vehicles 3% Mini-vehicles 3%

Consumption tax 696.2 5% 5%-->8%(Apr., 2014)-->10%(Oct., 2015)

During

ownershipWeight tax 650.9

¥2,500/0.5t per year (Registered vehicles for private

use)

¥4,100/0.5t per year (Registered vehicles for

private use)

Automobile road tax 1,549.7 Passenger cars (for private use) Passenger cars (for private use)

‐ Up to 1,000cc ¥29,500 / year ‐ Up to 1,000cc ¥29,500 / year

1,001 to 1,500cc ¥34,500 / year 1,001 to 1,500cc ¥34,500 / year








‐Over 6,001cc ¥111,000 / year ‐Over 6,001cc ¥111,000 / year

Mini-vehicle road tax 185.2 Mini-vehicles (for private use) Mini-vehicles (for private use)

　　 Passenger cars ¥7,200 / year 　　 Passenger cars ¥7,200 / year

Total 3,272.0

Taxes on

Automobiles

Acquisition tax 190.0

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Autos & Auto Parts

21 November 2013



Medium-term demand forecasts and key points

Chart 54: Japan SAAR trend

Source: JAMA, Jefferies estimates

The domestic SAAR reached 5.56 million units in October, and it looks as though the

demand to beat the consumption tax hike has already started to come through. The April–

October SAAR amounted to 5.37 million units. Bearing in mind accelerating pre-emptive

demand ahead of the tax hike, we assume the SAAR will run at 5.6 million units in

October–December and 5.8 million units in January–March, giving domestic sales growth

of 5.8% YoY to 5.51 million units in FY3/14.

The subsequent pullback will depend on automobile related taxes, but under our main

scenario we estimate that the SAAR will run at 4.6 million units in April–June, 4.9 million

units in July–September, and then recover to 5.2 million units in 2H to give full FY3/15

sales of 5.17 million units (down 6.1% YoY). As a risk scenario, there could be a double-

figure drop in sales to below 5 million units in the event of an automobile related tax hike.

Our forecasts for domestic new vehicle sales, exports, and production volumes are shown

in Chart 55.

We assume the SAAR will run at 5.6

million units in October–December

and 5.8 million units in January–

March.

Industrials

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21 November 2013



Chart 55: Outlook of Sales, Exports, and Production (Fiscal year base)

Source: JAMA, JADA, and Jefferies estimates

Chart 56: Outlook of vehicle exports from Japan (Fiscal year base)


Long-term demand forecasts The risk of a long-term decline in domestic sales has become keenly apparent. The Japan

Automobile Dealers Association's (JADA) long-term forecasts made in 2013 give a very

wide spread in domestic sales projections through FY3/21, varying from 3.9 million units

in the worst case to 4.6 million units in the median case, and 5.1 million units in the best

case. The worst-case scenario posits no cut in automobile related tax while the

consumption tax hike goes through as planned, and we think the probability of this is low.

We have to conclude that a government policy of cutting automobile related taxes, which

are high by global standards, is vital to maintain domestic demand. We think demand can

stay at a range of 4.5–5 million units, based on which we estimate that domestic

production volume can remain above 9 million units. Conversely, if it looks as though

YoY Change

(000 units) FY3/06 FY3/07 FY3/08 FY3/09 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14E FY3/15E FY3/16E FY3/13 FY3/14E FY3/15E FY3/16E

Domestic market sales ('000)

Registered vehicle 3,912 3,588 3,432 2,882 3,182 2,977 3,064 3,238 3,313 3,162 3,148 5.7% 2.3% -4.5% -0.5%

Mini-vehicles 1,948 2,031 1,893 1,809 1,698 1,629 1,689 1,973 2,200 2,015 1,970 16.8% 11.5% -8.4% -2.2%

Total sales in Japan 5,860 5,619 5,325 4,690 4,880 4,606 4,753 5,210 5,513 5,177 5,118 9.6% 5.8% -6.1% -1.1%

Exports ('000)

Passenger cars:

N. America 1,940 2,488 2,451 1,877 1,541 1,678 1,691 1,792 1,761 1,681 1,531 6.0% -1.7% -4.6% -8.9%

Europe 1,153 1,302 1,456 1,246 730 972 921 805 800 800 800 -12.6% -0.7% 0.0% 0.0%

Asia 261 248 331 306 335 415 408 344 370 400 420 -15.7% 7.5% 8.1% 5.0%

Oceania 372 377 393 342 345 356 362 378 370 370 370 4.5% -2.1% 0.0% 0.0%

Mid East Asia 409 452 678 624 375 427 321 395 400 390 390 22.9% 1.2% -2.5% 0.0%

Others 461 576 683 517 308 397 355 338 350 370 380 -4.6% 3.4% 5.7% 2.7%

Passenger car exports total 4,595 5,443 5,992 4,911 3,634 4,246 4,058 4,053 4,051 4,011 3,891 -0.1% 0.0% -1.0% -3.0%

Truck/bus:

N. America 41 52 28 13 13 16 25 21 20 20 20 -14.2% -7.0% 0.0% 0.0%

Europe 69 58 69 63 18 32 29 16 15 15 15 -44.9% -6.9% 0.0% 0.0%

Asia 144 132 158 137 125 164 175 196 200 200 200 11.9% 2.2% 0.0% 0.0%

Oceania 63 71 70 56 49 46 52 52 60 60 60 -0.2% 16.3% 0.0% 0.0%

Mid East Asia 152 167 200 189 112 117 112 142 150 150 150 27.1% 5.8% 0.0% 0.0%

Others 193 216 254 235 138 178 172 181 190 200 210 5.2% 5.2% 5.3% 5.0%

Truck/bus exports 661 695 778 692 454 552 564 607 635 645 655 7.7% 4.6% 1.6% 1.6%

Total exports 5,257 6,130 6,770 5,603 4,087 4,798 4,622 4,658 4,686 4,656 4,546 0.8% 0.6% -0.6% -2.4%

Japan make total sales 10,850 11,504 11,856 10,106 8,793 9,214 9,152 9,623 9,907 9,561 9,394 5.1% 3.0% -3.5% -1.7%

Change in inventory 42 -4 -71 -114 71 -225 113 -70 -27 60 60

Production in Japan ('000) 10,892 11,501 11,785 9,992 8,865 8,989 9,264 9,553 9,880 9,621 9,454 3.1% 3.4% -2.6% -1.7%

YoY Change


N. America 1,981 2,540 2,479 1,889 1,553 1,694 1,716 1,814 1,781 1,701 1,551 5.7% -1.8% -4.5% -8.8%

Europe 1,222 1,360 1,524 1,309 748 1,004 950 821 815 815 815 -13.6% -0.8% 0.0% 0.0%

Asia 405 379 488 444 460 579 583 540 570 600 620 -7.4% 5.6% 5.3% 3.3%

Oceania 435 447 462 397 394 401 414 430 430 430 430 3.9% 0.1% 0.0% 0.0%

Mid east Asia 561 619 879 813 487 544 433 537 550 540 540 24.0% 2.4% -1.8% 0.0%

Others 654 792 937 752 446 576 526 519 540 570 590 -1.4% 4.1% 5.6% 3.5%

Total exports ('000) 5,257 6,130 6,770 5,603 4,087 4,798 4,622 4,658 4,686 4,656 4,546 0.8% 0.6% -0.6% -2.4%

Toyota 2,126 2,598 2,709 2,140 1,644 1,698 1,671 1,923 1,883 1,880 1,800 15.1% -2.1% -0.2% -4.3%

Nissan 674 617 726 624 522 680 741 608 583 550 540 -17.9% -4.3% -5.6% -1.8%

Honda 539 645 696 574 230 310 253 163 121 120 100 -35.5% -25.7% -1.1% -16.7%

Mazda 651 749 825 743 649 719 654 703 761 780 760 7.5% 8.3% 2.6% -2.6%

Suzuki 305 387 414 336 215 268 241 186 165 140 160 -22.8% -11.5% -15.0% 14.3%

Fiji Heavy 225 240 272 299 279 330 315 383 467 480 480 21.9% 21.7% 2.9% 0.0%

Daihatsu 107 148 154 100 52 32 20 8 6 4 4 -61.8% -18.8% -34.9% 0.0%

Total exports ('000) 5,257 6,130 6,770 5,603 4,087 4,798 4,622 4,658 4,686 4,656 4,546 0.8% 0.6% -0.6% -2.4%

We think demand can stay at a range

of 4.5–5 million units, based on

which we estimate that domestic

production volume can remain

above 9 million units.

Industrials

Autos & Auto Parts

21 November 2013



domestic demand could fall below 4.5 million units, domestic production would likely fall

below 9 million units, while factory capacity utilization would drop under 80%, returning

the industry to crisis mode. It will be vital to monitor the LDP's Tax System Reform

Committee's thinking very closely.

Chart 57: New Vehicle Sales Units Outlook in Japan

Source: JADA

Chart 58: Passenger Car Ownership Outlook in Japan

Source: JADA

Chart 59: Production capacity in Japan

Source: Source: Companies data and Jefferies estimates

Chart 60: Capacity utilization rates (%)

Source: Companies data and Jefferies estimates

Chart 61: Outlook of vehicle production in Japan (Fiscal year base)


YoY Change


Toyota 3,863 4,185 4,265 3,393 3,207 3,004 3,120 3,369 3,362 3,254 3,175 8.0% -0.2% -3.2% -2.4%

Nissan 1,365 1,192 1,263 1,050 1,025 1,073 1,199 1,060 1,066 989 977 -11.6% 0.5% -7.2% -1.2%

Honda 1,243 1,348 1,297 1,148 902 912 870 876 966 975 936 0.6% 10.2% 1.0% -4.0%

Mitsubishi 706 776 876 670 514 663 586 486 615 632 623 -17.0% 26.4% 2.8% -1.5%

Mazda 904 967 1,047 899 828 864 847 879 954 966 943 3.8% 8.5% 1.3% -2.4%

Suzuki 1,133 1,212 1,219 1,139 959 994 1,020 1,044 979 913 929 2.3% -6.3% -6.7% 1.7%

Fuji Heavy 467 484 490 474 453 459 468 585 662 683 670 24.9% 13.2% 3.1% -1.9%

Daihatsu 722 816 785 771 673 619 690 757 777 717 705 9.8% 2.5% -7.7% -1.7%

Production in Japan ('000) 10,892 11,501 11,785 9,992 8,865 8,989 9,264 9,553 9,880 9,621 9,454 3.1% 3.4% -2.6% -1.7%

Industrials

Autos & Auto Parts

21 November 2013



US — SAAR trends and medium-term estimates

Chart 62: US SAAR Trend

Source: Autodata

Chart 63: Japanese Brand Market Shares in the U.S.

Source: Autodata, Jefferies estimate

The US SAAR has returned to more than 90% of the pre-financial crisis level, and there has

been tremendous momentum in recovery in terms of employment and the economic

environment. Our US analyst estimates the SAAR at 15.6 million units in 2013 and 16

million units or so in 2014, with gentle volume growth likely to continue. Adding in

progress in tapping into replacement demand on the back of low interest rates and

recovery in house prices, sales have benefited to a considerable degree from attractive

programs that have made it easy to buy. From the manufacturers' perspective,

competition is becoming furious, and it does not look as though earnings are picking up

to the same degree as volumes.

Chart 64: U.S. Demand / Market Share Outlook

Source: Jefferies estimates, Autodata, company data

(Calendar year base) 2003A 2004A 2005A 2006A 2007A 2008A 2009A 2010A 2011A 2012A 2013A 2014E 2015E 2016E

Sales unit ('000)Car 7,610 7,506 7,660 7,773 7,572 6,786 5,495 5,723 6,227 7,414 7,440 7,680 7,824 7,920

Light Truck 9,029 9,361 9,334 8,783 8,578 6,457 4,935 5,866 6,551 7,078 8,060 8,320 8,476 8,580

Light Vehicle Total 16,639 16,867 16,994 16,556 16,150 13,243 10,430 11,588 12,778 14,492 15,500 16,000 16,300 16,500

Toyota 1,866 2,060 2,260 2,543 2,621 2,223 1,770 1,764 1,645 2,083 2,290 2,442 2,540 2,649

Honda 1,350 1,394 1,462 1,509 1,552 1,429 1,151 1,230 1,147 1,423 1,540 1,634 1,733 1,813

Nissan 795 986 1,077 1,019 1,068 952 770 909 1,043 1,142 1,273 1,335 1,356 1,427

Total JPN 3 4,011 4,441 4,799 5,071 5,241 4,604 3,691 3,903 3,834 4,647 5,104 5,412 5,628 5,888

Other Japanese 796 720 672 702 721 638 535 578 635 709 790 842 859 897

Total Japanese 4,807 5,161 5,471 5,773 5,962 5,243 4,226 4,480 4,469 5,356 5,894 6,254 6,487 6,785

YoY (%)

Car -6.1% -1.4% 2.0% 1.5% -2.6% -10.4% -19.0% 4.1% 8.8% 19.1% 0.3% 3.2% 1.9% 1.2%

Light Truck 3.6% 3.7% -0.3% -5.9% -2.3% -24.7% -23.6% 18.9% 11.7% 8.0% 13.9% 3.2% 1.9% 1.2%

Light Vehicle Total -1.1% 1.4% 0.8% -2.6% -2.5% -18.0% -21.2% 11.1% 10.3% 13.4% 7.0% 3.2% 1.9% 1.2%

Toyota 6.3% 10.4% 9.7% 12.5% 3.1% -15.2% -20.4% -0.4% -6.7% 26.6% 10.0% 6.6% 4.0% 4.3%

Honda 8.2% 3.3% 4.9% 3.2% 2.8% -7.9% -19.5% 6.9% -6.8% 24.0% 8.3% 6.1% 6.0% 4.6%

Nissan 7.4% 24.1% 9.2% -5.3% 4.8% -10.9% -19.1% 18.0% 14.7% 9.5% 11.5% 4.9% 1.5% 5.3%

Total JPN 3 7.1% 10.7% 8.1% 5.7% 3.3% -12.1% -19.8% 5.7% -1.7% 21.2% 9.8% 6.0% 4.0% 4.6%

Japanese total 3.3% 7.3% 6.0% 5.5% 3.3% -12.1% -19.4% 6.0% -0.3% 19.8% 10.1% 6.1% 3.7% 4.6%

Market shares (%)

Car 45.7% 44.5% 45.1% 47.0% 46.9% 51.2% 52.7% 49.4% 48.7% 51.2% 48.0% 48.0% 48.0% 48.0%

Light Truck 54.3% 55.5% 54.9% 53.0% 53.1% 48.8% 47.3% 50.6% 51.3% 48.8% 52.0% 52.0% 52.0% 52.0%

Light Vehicle Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Toyota 11.2% 12.2% 13.3% 15.4% 16.2% 16.8% 17.0% 15.2% 12.9% 14.4% 14.8% 15.3% 15.6% 16.1%

Honda 8.1% 8.3% 8.6% 9.1% 9.6% 10.8% 11.0% 10.6% 9.0% 9.8% 9.9% 10.2% 10.6% 11.0%

Nissan 4.8% 5.8% 6.3% 6.2% 6.6% 7.2% 7.4% 7.8% 8.2% 7.9% 8.2% 8.3% 8.3% 8.6%

Total JPN 3 24.1% 26.3% 28.2% 30.6% 32.5% 34.8% 35.4% 33.7% 30.0% 32.1% 32.9% 33.8% 34.5% 35.7%

Total Japanese 28.9% 30.6% 32.2% 34.9% 36.9% 39.6% 40.5% 38.7% 35.0% 37.0% 38.0% 39.1% 39.8% 41.1%

Industrials

Autos & Auto Parts

21 November 2013



Japanese brands' share is past the worst, and they continue to make solid progress in

winning back lost ground. We think their market share will rise steadily from 38% in 2013

to 39% in 2014. It looks as though it will be 2016 at the earliest before they can top their

record-high of 40.5%. Japanese brands continue to raise their tarnished brand

propositions and product power, but rivals' competitiveness has also improved sharply,

making it hard to open up a competitive gap. Harrowing competitive pressure is

spreading.

Analysis of Japanese brands' competitiveness and profitability The Japanese OEMs' US new vehicle earnings have not improved as much as had been

expected. We think margins on models exported from Japan are rising steeply thanks to

forex, but such benefits are concentrated into firms with high export ratios (Toyota, FHI,

Mazda), as well as leading to improvements in Japan segments. Honda and Nissan have

high local production ratios, and are suffering.

Splitting up North American segmental operating profit into financial services and

automotive segments, Toyota, Honda, and Nissan are set to generate automotive

segment operating profit margins of a mere 2.4% in FY3/14. Excluding profits from high-

margin genuine parts sales, pure new vehicle profits are likely to stall at the break-even

line. We believe the fact margins on new vehicle sales remain lackluster despite the

rollover to new models and a fall in incentives is proof that (1) upfront costs have risen

sharply (= contents costs) due to enrichment to equipment and engine performance as

the companies seek to rebuild brand propositions, and (2) US consumers are still very

committed to seeking deals (= prices).

Chart 65: N. America Segment OP - Breakdown of

Automotive and financial services

Source: Company data and Jefferies estimates Note: Including Toyota, Honda and Nissan

Chart 66: N. America Segment: Mfg. Business Operating

Margin


Industrials

Autos & Auto Parts

21 November 2013



Global sales forecasts

Chart 67: Global Vehicle Demand Projections (000 unit) 2005 A 2006 A 2007 A 2008 A 2009 A 2010 A 2011 A 2012 A 2013 E 2014 E 2015E

USA 16,948 16,505 16,090 13,195 10,402 11,555 12,734 14,492 15,500 16,000 16,300

Canada 1,580 1,612 1,651 1,634 1,459 1,555 1,582 1,677 1,761 1,849 1,942

Mexico 1,125 1,133 1,093 1,020 753 819 904 988 1,088 1,142 1,165

North America 19,653 19,250 18,833 15,849 12,613 13,928 15,221 17,157 18,349 18,992 19,407

YoY % Change 1% -2% -2% -16% -20% 10% 9% 13% 7% 4% 2%

China 5,765 7,210 8,784 9,371 13,635 18,042 18,533 19,303 21,462 23,075 24,901

Japan 5,852 5,740 5,354 5,082 4,609 4,956 4,210 5,370 5,280 5,287 5,143

India 1,440 1,751 1,993 1,980 2,264 3,039 3,293 3,333 3,446 3,628 3,973

Korea 1,143 1,164 1,219 1,154 1,394 1,465 1,570 1,533 1,533 1,533 1,533

Thailand 703 682 631 614 549 786 796 1,435 1,250 1,150 1,250

Indonesia 534 319 434 608 486 765 894 1,116 1,140 1,140 1,368

Malaysia 551 489 487 548 537 605 600 628 627 646 659

Other 1,831 1,737 1,835 1,664 1,544 1,681 1,689 1,637 1,680 1,753 1,805

Asia/Pacific 17,818 19,093 20,738 21,022 25,019 31,339 31,586 34,354 36,417 38,211 40,632

YoY % Change 5% 7% 9% 1% 19% 25% 1% 9% 6% 5% 6%

France 2,489 2,441 2,526 2,510 2,666 2,669 2,634 2,280 2,143 2,229 2,318

Germany 3,539 3,677 3,382 3,318 3,982 3,110 3,403 3,302 3,176 3,303 3,369

Italy 2,459 2,568 2,739 2,388 2,339 2,128 1,920 1,615 1,486 1,545 1,607

Spain 1,917 1,910 1,890 1,327 1,060 1,098 912 776 776 807 839

UK 2,769 2,678 2,750 2,430 2,192 2,261 2,207 2,283 2,512 2,512 2,612

Other 3,344 3,442 3,567 3,407 2,749 3,164 3,299 3,264 2,946 3,034 3,141

Western Europe 16,518 16,715 16,853 15,379 14,989 14,430 14,375 13,521 13,039 13,430 13,887

YoY % Change 0% 1% 1% -9% -3% -4% 0% -6% -4% 3% 3%

Eastern Europe 3,814 4,314 5,342 5,644 3,301 3,836 4,708 4,901 5,101 5,311 5,528

YoY % Change 7% 13% 24% 6% -42% 16% 23% 4% 4% 4% 4%

South Americal (1) 2,647 3,111 3,996 4,220 4,178 4,975 5,431 5,358 5,465 5,629 5,798

YoY % Change 16% 18% 28% 6% -1% 19% 9% -1% 2% 3% 3%

Middle East 1,035 1,203 1,297 1,372 1,544 1,762 1,766 1,052 1,087 1,102 1,135

Africa/Other 3,577 4,268 4,715 3,737 4,120 4,739 5,009 5,382 5,651 5,821 5,995

Global total 65,062 67,954 71,775 67,224 65,763 75,009 78,095 81,725 85,111 88,495 92,382

YoY % Change 4% 4% 6% -6% -2% 14% 4% 5% 4% 4% 4%

Source: JDPower, Autodata, CNW, MarkLines, KAMA, CAAM, JAMA, AIAM, GAIKINDO, Toyota Thailand, and Jefferies estimates Note: Figures for Japan, China and India are based on total vehicle base, other figures are based on light vehicle base. Those estimates are aimed at assumptions for Japanese OEMs’ earnings forecasts and may be different from Jefferies' economists and country analysts' official estimates.

Chart 67 sets out the global vehicle sales volume forecasts we use in our earnings

forecasts for the Japanese automobile sector. We assume stable growth of around 4% in

2013 through 2015, supported by steady expansion in the US and China, and bottoming

sales in Western Europe. We forecast global retail sales for the Japanese OEMs of 23.6

million units (up 7% YoY) in FY3/14, 24.71 million units (up 5% YoY) in FY3/15, and 26.35

million units (up 7% YoY) in FY3/16, outstripping market growth rates, mainly in

emerging markets, and continuing to win back global market share, which has fallen,

albeit only gently. However, sales volume is set to decline in high-margin Southeast Asia

and Japan, so it looks as though any uplift to earnings power will be meager.

Our assessment is that it is important to identify advantages at manufacturers with secular

growth stories. There are two key turning points to recognize in FY3/15: (1) performance

at Toyota and FHI has shone through FY3/14, but growth at these two is to slow to

around 2%; and (2) there will be comparatively strong momentum in growth at Honda,

Mazda, and Nissan as their new Mexican factories contribute.

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Chart 68: Trend of SAAR: US

4

8

12

16

20

2008 2009 2010 2011 2012 2013

SAAR 6 month MA

(mn units)

Source: Autodata

Chart 69: Trend of SAAR: EU

4

8

12

16

20

2008 2009 2010 2011 2012 2013

SAAR 6 month MA

(mn units)

Source: ACEA

Chart 70: Trend of SAAR: Japan

2

3

4

5

6

7

8

2008 2009 2010 2011 2012 2013

SAAR 6 month MA

(mn units)

Source: JAMA

Chart 71: Trend of SAAR: China

4

8

12

16

20

24

2008 2009 2010 2011 2012 2013

SAAR 6 month MA

(mn units)

Source: Marklines

Chart 72: Trend of SAAR: India

1.0

2.0

3.0

4.0

5.0

2008 2009 2010 2011 2012 2013

SAAR 6 month MA

(mn units)

Source: Marklines

Chart 73: Trend of SAAR: ASEAN 3 (Thailand, Indonesia,

and Malaysia)

0.0

1.0

2.0

3.0

4.0

2008 2009 2010 2011 2012 2013

SAAR 6 month MA

(mn units)

Source:GAIKINDO, Toyota Motor Thailand, and Marklines

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Japanese brands' competitiveness in the still-challenging Chinese market Recovery in Japan brands' competitive strength remains slow following the anti-Japan

unrest associated with the sovereignty of the disputed Senkaku Islands. Anti-Japan

movements have taken place in the past, too, and the companies were affected to some

degree, but there was no severe, protracted boycotting at that time, whereas the latest

round triggered significant brand-switching. The US market — formerly a rich source of

earnings — is maturing, and the Chinese market was the golden hope for the Japanese

OEMs, expected to drive both volume growth and margins. However, repeated anti-Japan

demonstrations and state-level diplomatic disputes created greater-than-expected

geopolitical risk which the companies were unable to control through their own efforts. If

they want to enter China, they need to diversify risk and swiftly establish manageable

operating structures. We believe the Japanese OEMs need to put greater priority on

increasing investment in other emerging markets besides China, and find a point of

contact with manageable China business.

Chart 74: Japanese Brand Market Shares in China between Anti-Japan

Demonstrations

Source: Jefferies based on CAAM data

The Japanese OEMs' China business earnings remain stalled. Although there is no official

disclosure from the companies, Chart 75 sets out our proprietary analysis of Chinese

profits. Amongst the J3, Nissan still relies on China for over 20% of its profits. We estimate

that Toyota's exposure to China has fallen to a scant 8%.

Chart 75: China profit contributions as % of total

Source: Jefferies estimates

FY3/14E Operating income Equity Income China Net Income

(Y bln) Total China % China Total China % China Total China % China

Toyota Motor 2,450.0 132.9 5% 276.9 66.0 24% 1,833.0 152.4 8%

Honda Motor 825.0 45.5 6% 131.1 73.7 56% 606.0 103.3 17%

Nissan Motor 500.0 25.0 5% 77.1 63.9 83% 366.0 80.9 22%

Suzuki 180.0 3.0 2% 0.4 0.0 0% 105.0 2.0 2%

Mazda 180.0 4.3 2% 7.2 0.8 11% 103.2 4.1 4%

Fuji Heavy 315.0 8.9 3% 0.1 0.0 NM 230.0 5.8 3%

Total 4,450.0 219.6 5% 492.8 204.4 41% 3,243.2 348.4 11%

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Chart 76: Japanese Auto OEMs: Trend in Global Retail Sales


000 units FY3/10A FY3/11A FY3/12A FY3/13A FY3/14E FY3/15E FY3/16E FY3/17E

Toyota Motor Domestic 1,534 1,406 1,412 1,610 1,607 1,484 1,485 1,510 US 2,081 2,053 1,870 2,351 2,618 2,744 2,853 2,975 Europe 858 812 789 795 831 851 864 898 China 768 886 900 826 929 1,022 1,103 1,214 Asia 889 1,106 1,157 1,479 1,460 1,465 1,561 1,643 Others 1,149 1,293 1,286 1,625 1,702 1,798 1,905 2,002 Global Retail Sales 7,280 7,556 7,413 8,685 9,147 9,363 9,771 10,242 YoY -2% 4% -2% 17% 5% 2% 4% 5%

Honda Motor Domestic 661 609 601 717 850 855 836 794 US 1,358 1,470 1,327 1,652 1,842 1,889 1,991 2,090 Europe 277 257 180 179 172 189 216 242 China 612 655 608 603 725 783 877 964 Asia 352 398 252 543 609 756 925 1,106 Others 229 165 152 232 252 272 291 312 Global Retail Sales 3,490 3,553 3,120 3,929 4,453 4,744 5,136 5,508 YoY -2% 2% -12% 26% 13% 7% 8% 7%

Nissan Motor Domestic 630 600 655 647 690 639 609 591 US 1,066 1,245 1,402 1,466 1,633 1,697 1,751 1,831 Europe 517 607 709 660 650 725 854 982 China 756 1,024 1,247 1,182 1,252 1,352 1,487 1,636 Asia 223 238 296 486 437 556 704 774 Others 321 471 535 474 477 539 577 619 Global Retail Sales 3,514 4,185 4,845 4,914 5,138 5,507 5,983 6,432 YoY 3% 19% 16% 1% 5% 7% 9% 8%

Suzuki Domestic 616 584 596 672 684 633 629 604 US 41 33 32 30 2 - - - Europe 281 243 223 197 195 209 223 235 China 262 290 296 254 232 255 281 303 Asia 1,016 1,335 1,254 1,334 1,399 1,556 1,769 1,900 Others 133 140 140 174 181 197 214 233 Global Retail Sales 2,349 2,625 2,541 2,661 2,693 2,851 3,116 3,275 YoY 2% 12% -3% 5% 1% 6% 9% 5%

Mazda Domestic 221 206 206 216 228 211 209 203 US 307 342 371 373 418 444 471 484 Europe 239 212 183 174 193 206 223 242 China 196 236 223 175 184 208 229 256 Asia - - - - - - - - Others 230 277 263 297 293 313 334 375 Global Retail Sales 1,193 1,273 1,246 1,236 1,316 1,381 1,466 1,560 YoY -6% 7% -2% -1% 6% 5% 6% 6%

Fuji Heavy Industries Domestic 178 165 178 169 195 188 174 177 US 257 297 307 385 473 501 515 553 Europe 47 60 52 61 52 54 59 62 China 49 57 56 43 44 53 58 64 Asia - - - - - - - - Others 66 72 53 60 89 77 80 82 Global Retail Sales 597 651 646 719 853 872 885 938 YoY 5% 9% -1% 11% 19% 2% 1% 6%

Major Japanese OEMs Total Domestic 3,840 3,570 3,647 4,031 4,253 4,010 3,942 3,880 US 5,111 5,440 5,309 6,257 6,986 7,273 7,582 7,933 Europe 2,220 2,191 2,136 2,066 2,094 2,234 2,439 2,662 China 2,642 3,148 3,330 3,083 3,365 3,672 4,034 4,437 Asia 2,480 3,077 2,959 3,842 3,905 4,333 4,959 5,423 Others 2,129 2,417 2,429 2,865 2,997 3,197 3,402 3,622 Global Retail Sales 18,423 19,842 19,810 22,143 23,600 24,718 26,358 27,956 YoY 0% 8% 0% 12% 7% 5% 7% 6%

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Chart 77: Japanese Auto OEMs: Trend in Global Production Units


000 units FY3/10A FY3/11A FY3/12A FY3/13A FY3/14E FY3/15E FY3/16E FY3/17E

Toyota Motor Domestic 3,207 3,004 3,120 3,369 3,362 3,254 3,175 3,145 US 1,446 1,428 1,352 1,776 1,905 2,025 2,146 2,225 Europe 546 448 472 439 493 470 560 590 China 722 759 821 713 902 1,022 1,103 1,229 Asia 1,027 1,309 1,364 1,822 1,820 1,945 2,105 2,265 Others 331 352 400 445 542 615 625 700 Global Production 7,279 7,301 7,529 8,564 9,024 9,330 9,714 10,154 YoY 2% 0% 3% 14% 5% 3% 4% 5%

Honda Motor Domestic 902 912 870 173 148 160 160 160 US 1,151 1,244 1,235 1,155 1,443 1,571 1,885 2,069 Europe 99 139 105 598 803 823 917 1,004 China 653 697 636 76 91 150 200 220 Asia 340 397 199 234 210 140 180 200 Others 159 148 76 1,810 1,757 1,947 1,824 1,841 Global Production 3,304 3,537 3,121 4,046 4,452 4,791 5,166 5,495 YoY -8% 7% -12% 30% 10% 8% 8% 6%

Nissan Motor Domestic 1,025 1,073 1,199 1,060 1,066 975 930 929 US 837 1,073 1,221 1,344 1,448 1,574 1,635 1,635 Europe 445 571 647 643 668 705 795 875 China 547 714 858 794 924 1,053 1,173 1,290 Asia 152 353 409 535 480 641 671 881 Others 277 366 462 460 405 439 554 606 Global Production 3,282 4,150 4,797 4,836 4,991 5,386 5,758 6,215 YoY 8% 26% 16% 1% 3% 8% 7% 8%

Suzuki Domestic 959 994 1,020 1,044 979 913 929 882 US - - - - - - - - Europe 180 164 174 151 164 180 180 180 China 272 292 289 252 222 255 281 303 Asia 1,134 1,427 1,319 1,430 1,481 1,678 1,930 2,094 Others (0) - (1) - - - - - Global Production 2,545 2,877 2,802 2,877 2,845 3,026 3,319 3,459 YoY 2% 13% -3% 3% -1% 6% 10% 4%

Mazda Domestic 828 864 847 879 954 944 919 944 US 39 45 18 19 - 125 240 240 Europe - - - - - - - - China 196 236 235 154 192 208 229 256 Asia 40 89 76 110 91 90 100 120 Others 39 45 - 42 16 - - - Global Production 1,142 1,279 1,175 1,205 1,253 1,366 1,488 1,560 YoY 1% 12% -8% 3% 4% 9% 9% 5%

Fuji Heavy Industries Domestic 453 459 468 505 592 626 613 588 US 99 159 171 184 164 193 213 315 Europe - - - - - - - - China - - - - - - - - Asia - - - - - - - - Others (0) - - - - - - - Global Production 552 618 639 689 756 819 826 903 YoY 0% 12% 3% 8% 10% 8% 1% 9%

Major Japanese OEMs Total Domestic 7,373 7,306 7,524 7,030 7,100 6,872 6,726 6,649 US 3,572 3,950 3,996 4,479 4,960 5,487 6,118 6,484 Europe 1,270 1,322 1,398 1,831 2,128 2,178 2,452 2,649 China 2,389 2,698 2,840 1,989 2,331 2,687 2,986 3,298 Asia 2,692 3,575 3,366 4,131 4,082 4,494 4,985 5,559 Others 806 910 938 2,757 2,720 3,002 3,004 3,147 Global Production 18,104 19,762 20,063 22,217 23,321 24,719 26,270 27,787 YoY 1% 9% 2% 11% 5% 6% 6% 6%

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Analyst CertificationI, Takaki Nakanishi, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) andsubject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendationsor views expressed in this research report.Registration of non-US analysts: Takaki Nakanishi is employed by Jefferies (Japan) Limited, a non-US affiliate of Jefferies LLC and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore maynot be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearancesand trading securities held by a research analyst.

As is the case with all Jefferies employees, the analyst(s) responsible for the coverage of the financial instruments discussed in this report receivescompensation based in part on the overall performance of the firm, including investment banking income. We seek to update our research asappropriate, but various regulations may prevent us from doing so. Aside from certain industry reports published on a periodic basis, the large majorityof reports are published at irregular intervals as appropriate in the analyst's judgement.

For Important Disclosure information on companies recommended in this report, please visit our website at https://javatar.bluematrix.com/sellside/Disclosures.action or call 212.284.2300.

Meanings of Jefferies RatingsBuy - Describes stocks that we expect to provide a total return (price appreciation plus yield) of 15% or more within a 12-month period.Hold - Describes stocks that we expect to provide a total return (price appreciation plus yield) of plus 15% or minus 10% within a 12-month period.Underperform - Describes stocks that we expect to provide a total negative return (price appreciation plus yield) of 10% or more within a 12-monthperiod.The expected total return (price appreciation plus yield) for Buy rated stocks with an average stock price consistently below $10 is 20% or more withina 12-month period as these companies are typically more volatile than the overall stock market. For Hold rated stocks with an average stock priceconsistently below $10, the expected total return (price appreciation plus yield) is plus or minus 20% within a 12-month period. For Underperformrated stocks with an average stock price consistently below $10, the expected total return (price appreciation plus yield) is minus 20% within a 12-month period.NR - The investment rating and price target have been temporarily suspended. Such suspensions are in compliance with applicable regulations and/or Jefferies policies.CS - Coverage Suspended. Jefferies has suspended coverage of this company.NC - Not covered. Jefferies does not cover this company.Restricted - Describes issuers where, in conjunction with Jefferies engagement in certain transactions, company policy or applicable securitiesregulations prohibit certain types of communications, including investment recommendations.Monitor - Describes stocks whose company fundamentals and financials are being monitored, and for which no financial projections or opinions onthe investment merits of the company are provided.

Valuation MethodologyJefferies' methodology for assigning ratings may include the following: market capitalization, maturity, growth/value, volatility and expected totalreturn over the next 12 months. The price targets are based on several methodologies, which may include, but are not restricted to, analyses of marketrisk, growth rate, revenue stream, discounted cash flow (DCF), EBITDA, EPS, cash flow (CF), free cash flow (FCF), EV/EBITDA, P/E, PE/growth, P/CF,P/FCF, premium (discount)/average group EV/EBITDA, premium (discount)/average group P/E, sum of the parts, net asset value, dividend returns,and return on equity (ROE) over the next 12 months.

Conviction List Methodology

1. The aim of the conviction list is to publicise the best individual stock ideas from Jefferies Global Research2. Only stocks with a Buy or Underperform rating are allowed to be included in the recommended list.3. Stocks are screened for minimum market capitalisation and adequate daily turnover. Furthermore, a valuation, correlation and style screen

is used to ensure a well-diversified portfolio.4. Stocks are sorted to a maximum of 30 stocks with the maximum country exposure at around 50%. Limits are also imposed on a sector basis.5. Once a month, analysts are invited to recommend their best ideas. Analysts’ stock selection can be based on one or more of the following:

non-Consensus investment view, difference in earnings relative to Consensus, valuation methodology, target upside/downside % relativeto the current stock price. These are then assessed against existing holdings to ensure consistency. Stocks that have either reached theirtarget price, been downgraded over the course of the month or where a more suitable candidate has been found are removed.

6. All stocks are inserted at the last closing price and removed at the last closing price. There are no changes to the conviction list duringthe month.

7. Performance is calculated in US dollars on an equally weighted basis and is compared to MSCI World AC US$.8. The conviction list is published once a month whilst global equity markets are closed.9. Transaction fees are not included.

10. All corporate actions are taken into account.

Risk which may impede the achievement of our Price TargetThis report was prepared for general circulation and does not provide investment recommendations specific to individual investors. As such, thefinancial instruments discussed in this report may not be suitable for all investors and investors must make their own investment decisions basedupon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Past performance of

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https://javatar.bluematrix.com/sellside/Disclosures.action

https://javatar.bluematrix.com/sellside/Disclosures.action

the financial instruments recommended in this report should not be taken as an indication or guarantee of future results. The price, value of, andincome from, any of the financial instruments mentioned in this report can rise as well as fall and may be affected by changes in economic, financialand political factors. If a financial instrument is denominated in a currency other than the investor's home currency, a change in exchange rates mayadversely affect the price of, value of, or income derived from the financial instrument described in this report. In addition, investors in securities suchas ADRs, whose values are affected by the currency of the underlying security, effectively assume currency risk.

Other Companies Mentioned in This Report• Daihatsu Motor (7262 JP: ¥1,824, HOLD)• Ford Motor Co. (F: $16.92, BUY)• Fuji Heavy Industries (7270 JP: ¥2,790, HOLD)• General Motors Company (GM: $37.69, HOLD)• Honda Motor (7267 JP: ¥4,100, BUY)• Mazda Motor (7261 JP: ¥450, BUY)• Nissan Motor (7201 JP: ¥923, HOLD)• Suzuki Motor (7269 JP: ¥2,477, HOLD)• Toyota Motor (7203 JP: ¥6,290, HOLD)• Yamaha Motor (7272 JP: ¥1,534, HOLD)

Distribution of RatingsIB Serv./Past 12 Mos.

Rating Count Percent Count Percent

BUY 829 47.78% 186 22.44%HOLD 763 43.98% 121 15.86%UNDERPERFORM 143 8.24% 1 0.70%

Other Important Disclosures

Jefferies Equity Research refers to research reports produced by analysts employed by one of the following Jefferies Group LLC (“Jefferies”) groupcompanies:

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Hong Kong: Jefferies Hong Kong Limited, which is licensed by the Securities and Futures Commission of Hong Kong with CE number ATS546; locatedat Suite 2201, 22nd Floor, Cheung Kong Center, 2 Queen’s Road Central, Hong Kong.

Singapore: Jefferies Singapore Limited, which is licensed by the Monetary Authority of Singapore; located at 80 Raffles Place #15-20, UOB Plaza 2,Singapore 048624, telephone: +65 6551 3950.

Japan: Jefferies (Japan) Limited, Tokyo Branch, which is a securities company registered by the Financial Services Agency of Japan and is a memberof the Japan Securities Dealers Association; located at Hibiya Marine Bldg, 3F, 1-5-1 Yuraku-cho, Chiyoda-ku, Tokyo 100-0006; telephone +813 52516100; facsimile +813 5251 6101.

India: Jefferies India Private Limited, which is licensed by the Securities and Exchange Board of India as a Merchant Banker (INM000011443) and aStock Broker with Bombay Stock Exchange Limited (INB011491033) and National Stock Exchange of India Limited (INB231491037) in the Capital MarketSegment; located at 42/43, 2 North Avenue, Maker Maxity, Bandra-Kurla Complex, Bandra (East) Mumbai 400 051, India; Tel +91 22 4356 6000.

This material has been prepared by Jefferies employing appropriate expertise, and in the belief that it is fair and not misleading. The information setforth herein was obtained from sources believed to be reliable, but has not been independently verified by Jefferies. Therefore, except for any obligationunder applicable rules we do not guarantee its accuracy. Additional and supporting information is available upon request. Unless prohibited by theprovisions of Regulation S of the U.S. Securities Act of 1933, this material is distributed in the United States ("US"), by Jefferies LLC, a US-registeredbroker-dealer, which accepts responsibility for its contents in accordance with the provisions of Rule 15a-6, under the US Securities Exchange Act of1934. Transactions by or on behalf of any US person may only be effected through Jefferies LLC. In the United Kingdom and European EconomicArea this report is issued and/or approved for distribution by Jefferies International Limited and is intended for use only by persons who have, or havebeen assessed as having, suitable professional experience and expertise, or by persons to whom it can be otherwise lawfully distributed. JefferiesInternational Limited has adopted a conflicts management policy in connection with the preparation and publication of research, the details of whichare available upon request in writing to the Compliance Officer. Jefferies International Limited may allow its analysts to undertake private consultancywork. Jefferies International Limited’s conflicts management policy sets out the arrangements Jefferies International Limited employs to manage anypotential conflicts of interest that may arise as a result of such consultancy work. For Canadian investors, this material is intended for use only byprofessional or institutional investors. None of the investments or investment services mentioned or described herein is available to other personsor to anyone in Canada who is not a "Designated Institution" as defined by the Securities Act (Ontario). In Singapore, Jefferies Singapore Limited isregulated by the Monetary Authority of Singapore. For investors in the Republic of Singapore, this material is provided by Jefferies Singapore Limitedpursuant to Regulation 32C of the Financial Advisers Regulations. The material contained in this document is intended solely for accredited, expert orinstitutional investors, as defined under the Securities and Futures Act (Cap. 289 of Singapore). If there are any matters arising from, or in connectionwith this material, please contact Jefferies Singapore Limited, located at 80 Raffles Place #15-20, UOB Plaza 2, Singapore 048624, telephone: +656551 3950. In Japan this material is issued and distributed by Jefferies (Japan) Limited to institutional investors only. In Hong Kong, this report isissued and approved by Jefferies Hong Kong Limited and is intended for use only by professional investors as defined in the Hong Kong Securities andFutures Ordinance and its subsidiary legislation. In the Republic of China (Taiwan), this report should not be distributed. The research in relation to

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21 November 2013



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21 November 2013



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