Earnings Review: Honda Profits Fall On High Quality Costs And Negative Impact Of FX Fluctuations

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Honda Motor

Honda Motors (NYSE:HMC) announced its earnings for the full fiscal year 2015 on Tuesday, April 28. The company reported a 17.2% drop in net income compared to the last fiscal 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, and weak car sales in the U.S. and Japan. Total revenues for the year fell by about 3%, but the fall is attributable to the decline in the value of the yen compared to the U.S. dollar. On a constant currency basis, net sales grew by 6.8% for the year. Operating income decreased by 13.1% due to an increase in SG&A expenses, including quality related costs, as well as the negative impact  on income from volume and model mix despite a cost reduction contribution and positive favorable foreign currency effects. The Japanese auto maker forecast a minuscule 0.4% increase in net profit for the full fiscal year 2016, stating that gains from vehicle sales growth would most likely be offset by higher quality related costs and currency losses. (Honda Motors Investor Relations))

The Japan-based automaker sold roughly  4.36 million cars in the year, roughly the same level as last year’s 4.32 million. [1]  The company attributed this decline in sales volume to the negative impact of the economic situation in Japan and weaker than expected sales in the U.S.  Following the results, Honda forecast 4.75 million vehicle sales for the fiscal year 2016.

We have a $41 price estimate for Honda Motors, which is about 20% above the current market price. We are in the process of revising our estimates in order to incorporate the latest earnings.

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Sales in Japan and North America Decline

During the third quarter, Honda’s sales fell by 3% in Japan compared to last year’s sales. 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. In the final three 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))

North America Sales Sluggish

North America is Honda’s biggest market and it accounts for more than 40% of the unit sales. During the year, sales in the U.S. for the Japanese automaker grew by 7.6%. 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 half of fiscal 2015. 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]

However, the effect of increased revenues was offset by an increase in quality related expenses. 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]

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Notes:
  1. Honda Motors FY15 Results Presentation, Honda Investor Relations []
  2. Ref: 2 [] []