Honda Motors (NYSE:HMC) is scheduled to announce its Q3 earnings on January 31. Japan’s third largest automaker has recovered impressively in the last year after supply chain disruptions lowered its sales volume significantly in 2011. Furthermore, Honda is chasing a target of 6 million annual sales by 2017 as part of its mid-term plan. The stock has surged more than 20% in the last three months, helped partially by a weaker Yen.
The automaker’s margins should widen now that sales have normalized post the supply chain disruptions. Higher sales mean that the operating expenses will spread out over a larger revenue base, resulting in higher margins. The company-wide operating profits swelled more than 260% in the first half of its fiscal (i.e. April-September). Profitability in 2011 was abnormally low as the company was badly hurt by the earthquake in Japan. 
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The automaker has made a strong recovery in the U.S. with sales up 24% in 2012, helped by model refreshments of its best sellers Accord, Civic and the CR-V. North America is Honda’s biggest market and accounts for more than 40% of its sales. The automaker plans to carry on the momentum by launching new, smaller vehicles such as the refreshed Fit and the urban SUV, which it showcased at the recently concluded Detroit Auto Show. 
China is the automaker’s second biggest international market after the U.S. and accounts for about a sixth of the sales. Last year, Japanese auto companies such as Toyota Motors (NYSE:TM), Honda, Nissan and Mazda, suffered in China after tensions ignited between China and Japan over claims to disputed islands in the East China Sea. Overall, China sales were down 3% to 600,000 units in 2012, and December sales were down 19%. Although the Chinese sales are slowly returning to normal levels, it will take some time before the Japanese companies revert to the growth trajectory. 
Honda’s Japanese sales could weaken this quarter since incentives provided by the government to revive the economy have ended. Although the full-year sales will be strong, they can largely be attributed to subsidies provided by the Japanese government, which lasted through September. People rushed to register their vehicles before the subsidies ended which could consequently impact the 2013 sales. Therefore, we expect the Japanese market to remain flat or even decline this year.
Japan’s newly-elected Prime Minister, Shinzo Abe, plans to devalue the Yen by unlimited printing and has raised the inflation target to 2% from 1%. A strong Yen has been seen as an impediment to the competitiveness of the export-dependent Japanese companies and so a weak domestic currency should benefit them in the long run. However, the recent currency devaluation is not expected to play a significant role in the upcoming quarterly results since most companies usually have their currencies hedged. The effects of a weak Yen might be visible from the fourth quarter (i.e. Jan-March), or even later.
Our price estimate of $36 for Honda’s stock is about 5% below the current market price.Notes: