Emerging Markets Strength To Offset Japan, U.S. Weakness For Honda

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Japanese automaker Honda Motors’ (NYSE:HMC) North America sales are on the downward slide, and it is making investors anxious. North America is Honda’s largest market, making up more than half of Honda’s total car sales in a year. The Japanese company has held the second spot among Japanese car makers in the U.S., behind Toyota, for a few decades now, but Nissan is catching up close. In the previous quarter, Honda’s sales in the U.S. slumped by 3% to about 480,000 units, even as industry-wide sales improved. In contrast, Nissan registered a strong quarter with a 13% sales growth taking its unit sales tally up to 466,000. [1] To some extent, Honda’s decline was exacerbated by the problems encountered in switching to a new production method in its Mexico factory, which delayed the launch of a remodeled version of the subcompact Fit and a new luxury sedan Acura TLX. [2] However, Honda has an aging fleet in the U.S. It sells only 16 models in the U.S. and nearly 70% of its sales come from just 3 models – Accord, Civic and CR-V. In contrast, Nissan sells 27 models in the country and only 50% of its sales come from the top three cars- Altima, Sentra and Rogue.((Nissan May Overtake Honda in US Sales by 2016, Car Scoop, August 2014))

As a result, Honda expects at least 90% of its automotive sales growth in the current fiscal year to come from Asia. The Japanese automaker is building factories and introducing a number of new cars to grow its revenues in the region. As Honda’s sales cool in North America, Asia is rapidly becoming the key market for the company. Following the fall in demand in U.S. and Europe brought about by the global recession, emerging markets have become important to these companies. Rising demand for vehicles in China, Southeast Asia and Latin America helped to offset the dip in U.S., European and Japanese sales. As the contribution of new cars in the overall fleet of cars in the U.S. continues to drop, the developing economies of Asia, like China, India and Indonesia, are becoming critical to Honda’s sales.

We have a $43 price estimate for Honda Motors, which is about 10% above the current market price.

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Currency Fluctuations Mask U.S. Weakness

In the previous quarter, Honda’s operating profit increased by over 7% on the back of a 5.4% revenue growth. Revenue grew on account of strong automobile and motor cycle sales, as power product sales remained sluggish. Automobile sales jumped 4.3% to nearly 900,000 units as strength in the emerging markets and Japan overshadowed the decline in the U.S. [3] The company also made progress on cutting manufacturing and production costs, but the cost savings were offset by the heavy costs associated with car recalls in the U.S. However, the company made higher than expected profits in the quarter, thanks to a decline in the yen against the U.S. dollar. Over the quarter, the yen fell by 3 units against the U.S. dollar resulting in a positive currency impact of $311.2 million. [3]

Honda got lucky in the previous quarter but it is unlikely to happen again. The company is confident that it will meet its stated U.S. sales forecast on the back of increased sales from the remodeled Fit and the new Acura TLX sedan, for which it will launch an aggressive marketing campaign. The Japanese car maker also plans to introduce its high-performing sports utility vehicle, Vezel, under the name of HR-V in the U.S. Even if sales in the U.S. do increase as a result of new model launches, the impact on the company’s profits is likely to be limited. As a result of a high supply of used cars in the U.S. market, automakers have had to offer several incentives and lower the average transaction price in order to lure customers to the new models. In the past, car companies could bank on new models to command high prices but the trend is now changing. Honda will have to keep its prices competitive in order to drive up sales. [4]

More worryingly, the single biggest driver of Honda’s sales growth in the previous quarter is likely to go missing in the coming quarter. In the previous quarter, Honda’s Japan sales increased by a whopping 44%. Most of these orders were placed prior to the consumption tax hike that came into effect on April 1 and new order levels for Honda dropped by as much as 80% in the month of April. [5] Moreover, according to the Japanese Automobile Manufacturers Association, industry-wide sales could drop by as much as 16% following the consumption tax hike. [6]

Dependency on Emerging Markets

In the previous quarter, Honda’s overall Asia performance was quite impressive. Compared to rivals Toyota and Nissan, who registered sales growths of 2.4% and 1.2% respectively, Honda’s sales grew by 11%. [3] Weakness in Thailand due to the political situation was offset by the high demand for the remodeled Crider and Jade in China, City in India and Mobilio in Indonesia. Emerging markets have the lowest penetration rates in terms of car ownership and as the economic situation in these countries improves the room for growth is enormous. According to automotive research firm IHS, emerging markets will represent more than half of the global vehicle capacity share by 2020. [7] Nissan’s CEO Carlos Ghosn believes that by 2016, 60% of all global auto sales will come from these high growth markets. [8]

Honda has released a number of new models in Asia in the last two years . As income levels in these countries grow, offering a wide variety of options to potential buyers is a surefire way of sustaining sales growth. In 2013, Honda introduced the Fit in Japan, which was an instant success. A similar fate was met by the launches of the sedans City and Amaze in India. The automaker also launched the mini-vehicle N-WGN, a fully remodeled version of the Odyssey minivan, and the compact SUV Vezel in Japan. Honda plants to launch 20 new cars in China in the next two years, following the success of Crider and Jade, both launched in 2013 in the country. The company also plans to launch the Mobilio and Jazz in India. A variant of the Mobilio was introduced in Indonesia earlier this year.

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Notes:
  1. Nissan closes gap with Honda in U.S. thanks to stylish designs, discounts, Reuters, August 2014 []
  2. Honda delays 2015 Fit launch amid assembly difficulties in Mexico, Left Lane News, May 2014 []
  3. FY15Q1 Results, Honda Investor Relations [] [] []
  4. Falling U.S. used-car prices will drive up new-car incentives, Reuters, August 2014 []
  5. Honda Profit Jumps 20%, Lifts Outlook, Wall Street Journal, June 2014 []
  6. Japanese new vehicle registrations decline 5.6% y/y in May, IHS Automotive, June 2014 []
  7. IHS forecasts that by 2020 emerging markets will represent over 50% of global vehicle capacity share, IHS Automotive, January 2014 []
  8. Emerging markets to command 60% of global auto sales by 2016: Carlos Ghosn, Times of India, August 2013 []