2015 Will Be A Transition Year For Honda

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Japanese auto maker Honda Motors (NYSE:HMC) is undergoing a significant change in 2015. The company’s CEO Takanobu Ito resigned and is being replaced by Takahiro Hachigo. [1] Ito had done a lot to change the way the company operated and had set a target of six million unit sales per year by 2017. However, following a disappointing 2014 and a reported 5% sales drop in the U.S., Honda’s biggest market, the company has given up on that goal. Ito strived to bring the company to its current state and his resignation came as a surprise to many industry watchers since his planned changes were just about coming into effect. Under Ito, Honda’s operations in its six major operating regions became autonomous and accountable. The company localized production, development, and purchasing, allowing each regional operating division to have an individual approach to its market. But two major car recall incidents – one related to Takata Corporation’s flawed air bags, the other related to the faulty redesigned Fit – threw a spanner in the works,  and now the company is having to reset its overall strategy. In our note below, we take a look at the direction we expect the company to take in the coming years.

We have a $41 price estimate for Honda Motors, which is about 15% above the current market price.

Streamlining Operations

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Hachigo is the first Honda CEO who did not head the company’s R&D division and is a non-director. We expect the company to simplify its operations under his leadership. In 2014, the Japanese auto maker had to recall 60 million vehicles because of two reasons: first, due to the flawed air bags provided by Takata Corporation and, second, due to a faulty hybrid system in the redesigned Fit. The Fit had to be repeatedly recalled and one of the recalls, though mainly concerning Japan, ended up delaying the launch of the vehicle in the U.S., and as a result affected sales. The outgoing CEO Ito admitted that part of the problem in the case of Fit was the aggressive sales targets set by the company for the vehicle. Quality suffered as the company focused on quantity. Furthermore, the company also withdrew its target of selling six million vehicles by 2017. The company is not expected to announce a new target anytime soon.

For now, it appears the company is looking to trim the fat from its operations. The Japanese auto maker is planning to cut back on the number of model variants and focus on improving the quality of the remaining models. The company has stated that it plans to cut the number of model variants by 20% over the next couple of years and also add a number of quality checks to the production process of the remaining vehicles. The first glimpse of this additional focus on quality will be visible with the new CR-V for Europe which will feature a predictive cruise control system called Intelligent Adaptive Cruise Control (i-ACC) that helps predict the movement of other vehicles on the road and helps the driver to react quickly, thus lowering the chances of an accident.

U.S. Auto Market Slow Down

In March 2015, sales in the U.S. auto market grew by only 0.5% leading to fears that growth in the second biggest car market in the world might be slowing down. [2] The March growth slowdown was a result of two factors – 1) base effects: the market had been growing at a high pace for a while now and people cannot go on buying cars at the same rate forever; and 2) weather related issues that affected the supply chain delaying sales. Honda itself reported a drop of 5% in March, and this might be excusable for the two reasons mentioned above, especially as the company posted gains of 11.5% and 5% in the first two months of the year previously. [3] However, base effects are real and growth will slow down, if not just so rapidly. This means that competition among car makers will increase and put a squeeze on profitability. Around 68% of Honda’s sales in the North American car market come from just three models – Accord, Civic, and CR-V. The company rolled out a redesigned version of the CR-V in September last year and sales have been growing because of the new introduction, as well as the general uptrend in SUV sales in the U.S. auto market. Honda is also set to release a new sportier version of the Civic in the second half of this year. The company is hoping the new model launch can give it an edge over the competition.

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Notes:
  1. Honda CEO to step down, replaced by low-profile engineer, Reuters, February 2015 []
  2. U.S. Auto Sales Lost Steam In March, Forbes, April 2015 []
  3. American Honda Reports March 2015 Sales Results, Honda, April 2015 []