By JOHN MURPHY
May 8, 2008 7:25 a.m.

TOKYO -- Toyota Motor Corp.'s fourth-quarter net profit dropped 28% as the Japanese car maker forecast that a stronger yen, soaring raw-material costs and a continued U.S. slowdown will likely lead to its first annual profit decline in seven years in the current fiscal year.

The grim forecast by the world's most profitable auto maker underscores the impact shrinking auto demand in the U.S. is having on car makers' profits, even as they scramble to offset losses with aggressive growth in China and other emerging markets.

After a steady run of record-breaking profits and robust global growth, Toyota said it expects to see earnings fall 27% to ¥1.25 trillion ($12.01 billion) in the fiscal year ending March 2009.

"We are facing a severe business environment. However, Toyota considers this headwind as a valuable opportunity to turn into a more flexible and stronger company," Toyota President Katsuaki Watanabe said. He added that the company plans to pursue cost-cutting measures to lessen the impact of higher material costs and has been scaling back production at some U.S. plants to meet the reduced demand.

For the full fiscal year ended March 31, Toyota said its net income grew 4.5% to ¥1.718 trillion, as the company continued its rapid expansion in China, the Middle East, Russia and other emerging markets.

Still, the company continues to depend on North America, where sales are slumping, for more than a third of its overseas profits. Evidence of the difficulties ahead for Toyota could be seen in the car maker's performance during the fiscal fourth quarter, when profits fell to ¥316 billion from ¥440 billion a year earlier as weak U.S. sales and a stronger yen eroded earnings. In North America, Toyota's sales fell 7% in the January-March quarter to ¥2.14 billion from the year-earlier period.

Even so, Toyota far outperformed its troubled Detroit rivals, unseating General Motors Corp. as the world's largest car maker by sales volume for the January-to-March quarter, as high gasoline prices drew Americans to Toyota's line up of smaller, fuel-sipping vehicles such as the Yaris and the Prius gasoline-electric hybrid vehicles. In the U.S., Yaris sales shot up 58 % for the quarter over last year and Prius sales increased 23%.

All Japanese auto makers are expecting a tough year as earnings are battered by a stronger Japanese yen, which diminishes the value of overseas earnings, and rising costs of steel and other materials. Honda Motor Corp., which recorded an 86% fall in net profit for the January-March quarter, is forecasting an 18% fall in net profit this year. Nissan Motor Co. reports its earnings next Tuesday.

The shift away from larger, more costly sport-utility vehicles and other gas-guzzlers to smaller, fuel efficient models benefits Japanese auto makers. Still, Toyota says it is feeling a financial pinch from the change because compact, lower cost cars generally turn slimmer profits than larger vehicles.

Amid growing concern about profit growth in the U.S. market, Toyota announced earlier this month that it is raising the prices on some of its most popular models, including the 2008 Yaris, by $200, or 1.6%, and the Prius, up $400, or 1.8%, citing higher raw-material costs.

Toyota says it plans to sell 9.06 million vehicles during this fiscal year ending March 2009, a modest 147,000 increase over this fiscal year's sales of 8.91 million. Sales growth is forecast in all markets except North America, where sales are projected to slip by 188,000 vehicles.

To be sure, Toyota's profit forecasts have historically been very conservative. Toyota forecast a 4.5% drop in net profit for the year ended March 2007, for instance, only to finish the year with a 19.8% gain.

The last time Toyota saw a decline in net profit for the fiscal year was in the year ended March 2002, when its annual earnings plunged 17%.