Honda Motor Company (NYSE:HMC)

Honda Motor Co. Ltd. manufactures and sells motorcycles, automobiles, and power products. It operates through four segments: Motorcycle Business, Automobile Business, Financial Services Business, and Power Product and Other Businesses. The company sells its products through independent retail dealers, outlets, and authorized dealerships primarily in Japan, North America, Europe, and rest of Asia. Honda Motor Co., Ltd. was founded in 1946 and is based in Tokyo, Japan. The company’s recent five-year price to volume performance can be seen below.

Recent Fundamental Highlights

Honda’s ability to generate sales in developed nations appears to be struggling. In Japan, in particular, recalls could delay the release of new models by up to six months. FY2014 shipments expected to total only 839000 units (well below company target of 880000 units). North America targets in terms of sales volume appear to have met targets, but incentive costs are expected to have driven this.

An important decision by management has been the voluntary implementation of the Safety Improvement Campaign in all of their global markets. Essentially the company is making involuntary recalls to find out the root causes of their unprecedented recalls in recent months. This is a bold step to reduce the risk and uncertainty around their products. This initiative is high cost in the short-term, but it should accelerate a solution to the issue and create a turnaround for the brand.

Outlook

Investors should expect the company’s earnings to recover during the second half of 2015. This will be spurred by a big recovery in North America. In particular, the Pilot and Civic models are slates for full model changes in 2015. Coupled with this is the increased disposable income for investors in the North American market. Recent oil price drops should help increase the demand for cars and should incentivize higher spending per purchase.

Additionally, the continued weakness of the Japanese Yen in comparison to the US dollar should boost the company’s long-term global competitiveness despite a change in exports. Furthermore, investment costs are likely to peak next year and new products stand a chance of success. Above all else, they should boost margins and free cash flow after years of underperformance in FX adjusted terms.

Near-term momentum is at least as important as value considerations for global auto stocks, however, for now, Honda’s profits remain under pressure in Japan, the US, China and the Brazilian bike market.

Economic Moat Trend

Honda was 8th in terms of global auto market share in 2012 by sales volume and 1st in motorcycles. It is also noteworthy for proprietary environmental technologies and products, such as fuel cell electric vehicles and hybrid electric vehicles; the company has been aggressively investing to the emerging markets for long-term sustainable growth. Automobile and motorcycle sales are solid in emerging markets, but near term it is expected that the automobile sales in developed nations to struggle.

Shown below is the company’s net profit margin over the past 10 years. As shown, the company’s margins have been highly erratic over this time period and it is indicative of the company’s troubles in developed markets.

Potential Catalysts

  1. Early online production of new plant in Mexico
  2. Faster than expected sales volume growth in China and other Asian markets
  3. Rebound in earnings from sales in Asian motorcycle markets
  4. Major product launches (new vehicles and powertrains) in key markets and next spring’s outlook guidance for FY2016 (FY end march)

Major Risks

  1. In the North American market, increase competition in the passenger car segment from Korean and US automakers
  2. Delays in the plant upgrades in Mexico
  3. Delayed introduction of new models in China

Investment Rationale

Automobile and motorcycle sales are solid in emerging markets, but near term we expect automobile sales in developed nations to struggle. Earnings therefore look poised to remains soft in the near term. North American earnings may not start improving until second half of 2015, leaving only limited potential over the near-term. Proper management of incentive plans as well as the volume-increasing and the cost reducing effect of the launch of a new plant in Mexico should help the company and the stock price in the long-term. HMC currently trades at $29.94 (price as of Jan 13th) and only seems to provide potential in the long-term.

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