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Toyota Motor Corp. (TM), the world’s largest carmaker, has been slowly moving some of its production facilities from Japan and into other countries, particularly in Asia. Although the company has had auto plants in other countries for years, including the United States, it has recently been focused on moving a larger percentage of its factories outside of Japan and into neighboring Asian countries, including China, India, and Thailand. We think that production in these countries will largely be limited to less expensive models, as these tend to sell better in such markets. Most consumers are more concerned with getting a good deal on a car rather than where it was produced, so this should help support the company’s objectives.

Manufacturing costs in Japan and in other regions where it produces cars have been steadily rising, and Toyota management has been looking for ways to cut costs. The automaker currently has a subsidiary, Toyota Motor Thailand, which is the largest auto manufacturer in the country. It produces the Land Cruiser Prado SUV and the one-ton truck Hilux, as well as more familiar brands, including Altis, Camry, Vios, and Yaris. Production and employee-related expenses are lower in Thailand than in Japan. Management is currently deciding whether to move production of some more models into the country, thereby reducing its reliance on Japanese factories. A final decision has not been reached, and we think it could take a few more months before a firm plan is established.

We believe lower costs, along with a strong supplier base, make Thailand an ideal place to increase output. The country is also seeing a huge increase in auto output, as soaring exports are helping to boost economic growth. Toyota also plans to export hybrid cars, including the Prius, from Thailand to expanding Asian markets.

Toyota is currently present in the Indian market through a joint venture with Kirloskar Group, and is investing in a facility in Bangalore to launch a hybrid version of the small car Etios. This facility should allow it to gain a bigger presence in the increasing Indian market. In addition, rising labor costs in Japan make India a sensible option, given its lower employee expenses. However, the company needs to keep a watchful eye on quality control, which has been cited by many as a primary reason for the company’s massive recalls of more than 8.5 million vehicles since October. We think management has learned from its mistake.  

The company is also continuing to invest in China, which is now the world’s largest auto market, and Toyota wants to make sure it is well embedded there. It plans to starts building 100,000 Corolla cars a year at its factory in Changchun starting in 2012. However, some Toyota suppliers have had to deal with strikes in the country. Workers are demanding higher wages, which would clearly hurt profit growth. Nevertheless, the enormous growth potential in the country ought to more than offset this concern.

Currency movements have also played an important role in Toyota’s strategy. A stronger Japanese yen has made exports from Japan less competitive, as they make vehicles more costly to produce at home. This is another reason why Toyota is trying to diversify its production base. Management aims to cut domestic production by about 20% within five years, to about 3.2 million vehicles, as it shifts output to other countries, particularly emerging markets. Management wants Japanese production to specialize in “new concept vehicles” with new technology and low-cost production systems.

Overall, we think Toyota’s decision to slowly cut production domestically and increase its capabilities in emerging markets is a good one. Production costs, including those for labor and material, are cheaper in India and China, and the yen is expected to remain strong in the years ahead. The move also allows the company to maintain a competitive advantage in these huge, largely untapped markets. But as we have mentioned, management needs to be very careful with quality control issues, as it doesn’t want a repeat of the recall disaster which seriously hurt its reputation for quality.

Given management’s focus on lowering expenses and expanding into emerging markets, we think Toyota could be a good investment opportunity for investors looking to get into the auto space. We should note, however, that despite posting stronger performance in recent months, the company is still susceptible to short-term volatility if additional quality or recall issues reemerge.