Earnings Review: Recall Costs, Sluggish Domestic Car Sales, Weigh Down Honda’s Operating Profits

-10.93%
Downside
36.43
Market
32.45
Trefis
HMC: Honda Motor logo
HMC
Honda Motor

Honda Motors (NYSE:HMC) announced its earnings for the third quarter of fiscal 2015 on January 30. The company reported a 15.1% drop in net income compared to the same period last year, due to high costs associated with the recall of faulty air bags supplied by Takata Corporation and the hybrid systems used in the Fit and Vezel. Total revenues for the quarter jumped around 9% to $27.29 billion, but operating income declined by 15.1% to  $1.13 billion. As a result, the company lowered its full year forecast for net income by 20 billion yen to 745 billion yen or $4.6 billion. [1]

The Japan-based automaker sold roughly 1.03 million cars this quarter, down ~5% from just over 1.08 million a year ago. [2]  The company attributed this decline in sales volume to the negative impact of the economic situation in Japan and the rest of Asia. Following the results, Honda lowered its forecasts from 4.62 million vehicle sales for the fiscal year 2015, to 4.45 million, citing challenging business environments in both North America and Asia. [3] It sold 4.3 million vehicles for the fiscal year ended March 2014.

We have a $41 price estimate for Honda Motors, which is about 30% above the current market price. We are in the process of revising our estimates in order to incorporate the latest earnings.

Relevant Articles
  1. Growth Of Chinese EV Players A Looming Threat For Honda Stock?
  2. What’s Happening With Honda Stock?
  3. Honda Stock Looks Like A Buy Following Strong Q3 Results
  4. Is Honda Stock A Buy As Motorcycle Business Shines?
  5. Is Honda Stock A Buy At $27?
  6. Forecast Of The Day: Average Price of Honda Vehicles

See our complete analysis for Honda Motors


Sales in Japan and North America Decline

During the third quarter, Honda’s sales fell by 25% in Japan compared to the same period last year. In the first quarter of fiscal 2015, sales jumped by 44% helped by the following two factors: 1) A number of people bought cars as they sought to beat an increase in the sales tax to 8% from 5%, which came into effect on April 1; and 2) The introduction of new models and the launch of fully remodeled vehicles, the Fit and Vezel subcompacts, in the region. The introduction of new models, like the N-WGN minicar and the Vezel subcompact, also contributed to the tremendous gain. [4]

In the previous two quarters, however, the negative impact of the hike in sales tax was expected to come into effect as a sales tax hike should make people hesitant in purchasing new cars. Moreover, real wages in Japan have been falling over the previous quarter and the negative impact of this trend might also have been felt on Honda’s sales. ((Shinzo Abe faces rising disenchantment in Japan, Financial Times, July 2014)) Honda’s domestic rival Toyota Motor Corp also cut its guidance for 2015 on the expectation of declining domestic sales.

North America is Honda’s biggest market and it accounts for more than 40% of the unit sales. During the quarter, sales in the U.S. for the Japanese automaker stayed flat but the company’s Accord and CR-V achieved solid sales momentum that should continue into 2015. In the first half of fiscal 2015, sales had fallen by 3% on a year-on-year basis for the company, while it had guided for a 3% increase in overall unit sales for the year.  Despite that, the company did not cut its guidance for North America for the full year when it announced its earnings for the second quarter. The company was banking on several strategies to lift its sales.  One of these strategies was the model refresh of the CR-V. Previously, the CR-V has made up about one-fifth of the total car sales in the U.S.  Through November, Honda had sold about 302,000 CR-Vs, comprising 24% of its total sales in the U.S.  In October and November, CR-V sales grew by 30% and 38%, compared with year-ago levels. Considering that the U.S. auto industry sales are expected to surpass 17 million units in 2015, and the SUV/compact crossover segment is still growing, the CR-V sales momentum could continue well into the next year. [2] Additionally, considering the slightly higher pricing of the CR-V, rising sales could add a significant amount to the company’s bottom line. The November sales boom alone added more than $200 million to Honda’s bottom line.

However, the effect of increased revenues was offset by an increase in quality related expenses, which meant that operating income in the quarter fell by as much as 50% versus the same quarter  last year, dropping to $634 million. In the first half of fiscal 2015, the company had to recall about 5 million cars in the U.S. and Japan due to faulty airbags provided by the Takata Corporation, and had a hefty lawsuit filed against it by consumers in the U.S.  As a result of the recalls, Honda’s priority has shifted from new model roll-outs, to the management of recalled vehicles. Hence, the lowered forecast for unit sales. Additionally, the handling of the faulty airbags situation by Takata was negative p.r., and Honda was made to look quite bad in comparison to the much swifter handling of a similar airbag problem by U.S. auto maker General Motors. [2]

Chinese Sales Rebound

Since a difficult 12-15 month period starting September 2012, Honda has been optimistic about China. Sales of Japanese automakers had tanked due to a wave of anti-Japan sentiment present across the general public, because of political tensions between the two countries. As the sentiment gradually improved, Honda stepped up its operations in the country by launching  a new R&D center in Guagnzhou, and launching China specific models such as the Crider and the Jade. Unit sales had grown by 31% in the first two months of 2014, but growth fell to 2% in March. However, the trend reversed in the next quarter with sales in China rising by 26% on the back of the introduction of Jade and Crider along with an updated version of the popular Accord. That trend continued into the third quarter. Honda missed its target of 800,000 unit sales in China for 2014 by about 12,000 units, but the figure was that narrow due to a 41% increase in the number of deliveries in the month of December. ((Honda Motors Q3 Financial Results Presentation, Honda Investor Relations)) China accounts for more than a sixth of Honda’s global deliveries.

View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research

Notes:
  1. Honda Motors Investor Relations []
  2. Honda Motors Q3 Financial Results Presentation, Honda Investor Relations [] [] []
  3. Honda Motor Co., Ltd. Reports Consolidated Financial Results For The Fiscal Third Quarter Ended December 31, 2014, Seeking Alpha, January 2015 []
  4. FY15Q1 Results, Honda Investor Relations []