Honda Motor Company (HMC)

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Honda Motor Company (NYSE: HMC), headquartered in Japan, is the world's fifth largest automaker and first largest motorcycle producer by FY2009 sales.^[1]

With about 180,000 employees worldwide, the firm operates in four main segments: Motorcycles, Automobiles, Financial Services, and Power Products and Other Businesses.^[2] North America is Honda's largest market in the automobile segment, accounting for about 1.5 million of Honda's 3.5 million car sales in FY2009.^[3]

A variety of factors impact Honda's earnings, ranging from U.S. legislation, the housing market, and commodities prices to exchange rates, emerging markets, and an aging Japanese population.^[4] Honda's fuel efficient fleet of small cars and motorcycles, provided it with a relative advantage compared to some its more SUV focused competitors, as fuel prices spiked through 2008, when Honda's sales fell only 3.2%. ^[5][6] The company did not perform as well in its North American auto-business in FY2009, where auto sales decreased by 19.1% as global demand for automobiles plummeted.^[7]

Company Overview

Honda employs approximately 180,000 employees who work at 35 major manufacturing facilities located throughout Argentina, Brazil, Mexico, the USA, Canada, Japan, Thailand, Vietnam, Indonesia, the Philippines, Malaysia, Pakistan, India, China, Taiwan, Turkey, Spain, Italy, France, and the U.K.^[8] Honda's conslidated revenue for FY2009 of 10,011.2 billion ¥ makes it one of the world's largest 100 companies by revenue. Although Honda is one of the largest companies in Japan, it still trails behind its perennial leader Toyota Motor (TM).^[9] The company operates in four main segments: Motorcycle Business, Automobile Business, Financial Services Business, and Power Product & Other Business.

Source:Honda 2009 Annual Report: Financial Highlights^[10]

Q2 FY2010 Summary

Honda reported 54.2 billion yen profit in the second reporting quarter of FY2010, a 56% decline compared to second quarter of FY2009.^[11] Honda attributes its decreases in profits as mainly affected by a fall in vehicle sales and yen's appreciation against the U.S. dollar. However, Honda raised its stakes from previous estimates and expects to sell 3.4 million vehicles for fiscal 2010, spurred by a 15% rise in sales in Japan and a 27% rise in China.^[12] As a result, Honda nearly tripled its net profit forecast for fiscal 2009, from 55 billion¥ to 115 billion¥.^[13] Honda has been able to resist the auto industry downturn better than other major automakers mainly due to its profitable motorcycle business (See Business Segments). Furthermore, Honda was also able to succeed in resisting the global economic slump better than its rivals because Honda focuses on smaller fuel-efficient models such as hybrid vehicles, which are designated tax-free in Japan.^[14]

Q3 FY2010 Summary

Honda posted a profit of ¥134.6 billion (approximately $1.5 billion) for the third reporting quarter of FY2010, a 565.1% increase compared to the third reporting quarter of FY2009.^[15] Consolidated net sales on the other hand was ¥2.2 trillion (approximately $24.3 billion), which was an approximately 11.5% increase.^[16] This factor on the top line was mostly due to unfavorable currency translation effects. As a result, Honda raised its full year profit forecast by 71%, which is sharply due to cost cutting.^[17] Honda may also be benefiting from the recall issue Toyota has been facing, which has forced Toyota to recall more than 8 million cars worldwide.^[18] In the long run, Honda may be able to steal market share from Toyota due to damaged brand image.

The large discrepancy between the top and bottom line is due to aggressive cost cutting. Honda's automobile segment for example was down 2.8% to 914,000 units.^[19] Honda's Motorcycle segment was also down 5% in sales to 2.4 million units.^[20] Japan, in particular, suffered a 22.7% decrease in motorcycle unit sales. Finally, Honda's Power Product and Other segment also declined 11.4% to 988,000 units.^[21]

Q4 FY2010 Earnings Summary

Honda posted a net income of $776 million in the fourth quarter of FY2010 as it came back into the black; the fourth quarter of FY2009 posted a net loss of 179.95 billion yen compared to a net income 72.17 yen this quarter.^[22] Honda attributes its rise in bottom line growth from the strong sales of hybrid and other fuel-efficient vehicles as well as cost-cuts paid off in its fiscal fourth quarter.^[23] This was buttressed by the Japanese tax breaks given to those who purchase "green" models. Honda sold 874,000 vehicles for this fiscal fourth quarter compared to 680,000 a year earlier, a 28.5% increase.^[24]

Honda projects a 27% growth in its net profit on higher vehicle sales in Asia and North America going forward.^[25] In particular, the booming demand in China and India has helped drive car sales. In Honda's motorcycle division, strong sales contributed to a 30 percent sales increase to 2.6 million motorcycles for the quarter.<ref.Honda sees profits and sales ris</ref> As a result, Honda expects annual profits for the year as a whole to be up 10% compared to FY2009.^[26]

Business Segments

Automobiles (76.7% of FY2009 Revenues)

Source:Honda 2008 Annual Report: Summary of Operating Results by Business^[27]

Responsible for the majority of the company's total revenue, the Automobile Business is Honda's lifeline. Automobiles are produced by Honda at two sites in Japan: the Saitama factory and the Suzuka factory. The firm's major production sites overseas are located in Ohio (U.S.A.), Alabama (U.S.A.), Alliston (Canada), Swindon (U.K.) and Ayutthaya (Thailand).^[28] Honda markets its cars under the Honda and Acura brands.The Acura brand is Honda's luxury car brand and is sold only in North America and China.

The United States is Honda's largest automobile market; however, as the economies of the BRIC countries grow rapidly and the traditional mainstays of automobile consumption -North America, Western Europe, and Japan- remain in economic turmoil through 2010, Honda is increasingly relying on the third world to drive growth. For example, while all regions in North America and Europe dropped in sales, Asia and Other Regions grew by 1.14% and 1.37% respectively from FY2008 to FY2009.^[29] Nevertheless, as gas prices climb, Americans and others are turning to Honda's cars, which are typically smaller, low-maintenance and more fuel efficient than its competitors. The company has a limited product line and focuses on low-powered vehicles, with no plans to offer a V81 or bigger engine and diminishing focus on its Acura luxury brand. The firm holds a comparative advantage in hybrid and fuel cell vehicles, such as the Civic and Accord Hybrid models both of which are helping Honda steal business from American car manufacturers. Even some of the company's non-hybrid vehicles achieve fuel efficiency greater than 30 mpg. Honda’s principal automobile products include the following vehicle models:

Motorcycles (14.1% of FY2009 Revenues)

Source:Honda 2008 Annual Report: Summary of Operating Results by Business^[30]

Honda's motorcycle business includes motorcycles, all-terrain vehicles (ATVs) and personal watercraft (PWC).^[31] Honda produces a range of motorcycles, consisting of sports (including trial and moto-cross racing), business and commuter models with engines ranging from 50 cubic centimeters to 1800 cubic centimeters in cylinder displacement. Honda's motorcycles are produced at two sites in Japan, Hamamatsu and Kumamoto, as well as through subsidiaries in the United States, Mexico Italy, Spain, Brazil, Thailand, Vietnam, the Philippines and India.

In fiscal 2009, Honda sold 10.1 million motorcycle units compared to 9.32 million units from fiscal 2008.^[32] These improvements were driven exclusively by growth in emerging markets, which account for about 90% of motorcycle sales, even as revenues and profits stagnating or decreasing in Europe, Japan, and North America.^[32] This was especially true in Asia, where motorcycles are frequently a primary means of transportation. Honda's interaction with asian markets such as China and Indosnesia is unique, as Honda has a local company produce and sell its motorcycle designs, in exchange for a payment for each motorcycle sold.^[32]

The Motorcycle Business is crucial to the company's future growth in emerging markets where many cannot afford cars. As the wealth of these countries increases, so does the people's appetite for cars and other luxury items. The company's motorcycle sales help Honda establish its name brand in developing countries, paving the way for additional car sales in the medium to long run as these economies accumulate wealth.^[33]

Power Product & Other Businesses (3.4% of FY2009 Revenues)

Honda's Power Product & Other Business manufacturers a variety of power products, including power tillers, portable generators, general-purpose engines, grass cutters, outboard engines, water pumps and snow throwers. Its power products also include power carriers, power sprayers, lawn mowers and lawn tractors (riding lawn mowers). Like sales from the Motorcycle Business, sales from the Power Product & Other Business help establish Honda's brand name in emerging markets, giving the company a chance to convert Power Product customers into higher margin car and motorcycle customers in the medium to long run. Total net sales of power products fell 18.5% in fiscal 2009 to ¥343,065 million.^[34] Total unit sales of this reportable segment decreased in FY2009 compared to the previous fiscal year, despite increases in sales of engines for OEM use in construction for Asia and Other Regions.^[35]|right]]

Honda is scheduled to begin production of its first airplane, known as Hondajet, in 2010 - with tentative plans to make about 200 of these aircraft every year thereafter.^[36] Another subsidiary began producing and selling solar cells in 2008.^[37] Management has not articulated how either of these highly capital intensive products play into the company's broader business plan.

Financial Services (5.8% of FY2009 Revenues)

Financial Services offers a variety of financial services to its customers and dealers through finance subsidiaries with the aim of providing sales support for its products. This segment competes against myriad options for its motor customers, including commercial banks and finance and leasing companies.Most of this division's activities are concentrated in more developed markets, as about 97.5% of credit was extended in Europe, North America, and Japan.^[38] In fiscal 2009, revenues from Financial Services Business increased from ¥533.5 billion to ¥582.2 billion.^[39]

Key Trends & Forces

In Lieu of Falling Green-Vehicle Market Share to Toyota, Honda New Strategy is to Promote Low-Cost Hybrids

Given large oil price increases from the trough of around $30/barrel to its current $85/barrel range, fuel efficiency and environmental concerns will likely remain of long-term importance to car buyers. Although Honda was the first company to commercially sell hybrid vehicles in the United States (the Honda Insight), the company quickly fell behind Toyota in sales for alternative fuel vehicles. Over the last decade Toyota has sold considerably more hybrids than Honda. In response, Honda announced an effort to regain its preeminence in the hybrid sector by launching a series of low-cost hybrids models that will be priced to reduce the considerable premium hybrid buyers currently pay for hybrid technology. Honda's new hybrid models will reduce this premium from one to two thousand dollars per vehicle in a bid to recapture buyers from Toyota. Honda plans to introduce a number of new, small hybrid models within a year, beginning with a Fit hybrid that will hit the Japanese market this fall. The company will also begin producing lithium-ion batteries in the second half of this year that will be used in the next generation of the Honda Civic. ^[40]

The Honda FCX Clarity is a hydrogen powered car with twice the efficiency of traditional gas and electric hybrid vehicles. And it doesn't emit greenhouse gases. Honda (HMC) is looking for a way to compete in an auto market that is increasingly focusing on green technology. And with the Clarity, Honda may find itself back in the game (its own gas and electric hybrid attempts were creamed by Toyota). Honda plans to sell 200 FCX Clarity vehicles in the US and Japan between 2009 and 2011.^[41] Right now, though, only a few people can test-lease the Clarity. This is because there aren't many hydrogen fueling stations around. Honda wants to make sure the Clarity's drivers have access to fuel, so the initial offering, here in the United States, is pretty much based in certain parts of California. But if investment in this grows, and if the Clarity finds success, it may be that Honda finds its green motor stock rising.

As Japan Continues to Gray Faster than the U.S., Honda's Advantage is Growing Demand for Luxury Vehicles and Decreased Pressure in Pension Plans

Retiring Customers: A quarter of Honda's sales are concentrated in Japan, where the population is aging: 10% of the population was 65 or older in 1990, and by 2007 that number had doubled.^[42] Aging populations tend to save less, and to spend more on luxury items, such as Toyota's popular Lexus-branded vehicles.^[43] Also, much of Honda's production takes place in Japan, which provides generous national health insurance. Although Honda has to pay for some of its Japanese employees' insurance in the form of higher taxes, American automakers pay for the entirety of their employees' insurance. This has become a competitive advantage to non-U.S. automakers, which have much less of a health insurance burden.

Currency and Commodity Variations Affect Honda's Profits

As a Japanese company, Honda's profits are recorded in Japanese yen, but its sales are denominated in euros, dollars, pounds, Chinese yuan, and many other currencies. Fluctuations in the exchange rate between these currencies and the yen can lead to sometimes large fluctuations in Honda's profits. Honda hedges its exchange rate risk by arranging currency swaps and purchasing futures, but these operations are costly and threaten to cut into the bottom line. In the long run, these effects are even more exacerbated: as the dollar depreciates against the yen, American sales are worth less to Honda, and Hondas are more expensive to consumers. Thus profit per revenue and absolute revenue both fall from depreciating exchange rates. While Honda can hedge out the risk to its profit margins, it cannot easily manage the risk from falling demand. Exchange rates have become a sensitive subject among U.S. legislators, who allege that Japan has kept the yen undervalued to stimulate sales.^[44]

Commodity Price trends also threaten to drive up the cost of both car manufacturing and car ownership.

• Steel: One of the main ingredients in cars is steel, so increases in steel prices reduce Honda's margins. Honda cannot easily substitute another material for steel to reduce its costs, unlike almost any other input into car production, even labor.

• Aluminum also affect the company's margins as this metal is also a significant production input, accounting for around 300 pounds of a new car's weight.

• Oil prices: Increases in the cost of gasoline inflate the day-to-day cost of car ownership. Since consumers buy cars only infrequently, rising oil prices have only a limited impact on year-to-year car sales, but over time they cut into the industry's sales, and force companies to design more fuel-efficient fleets.

Competition

Automobile

Honda's small-car, simple, fuel efficient product line lacks much of the diversity and range of the market share leaders. If Honda is to dominate the world market, it will have to expand its product line, diverging from what it does best - and likely hurting its margins.

Motorcycle

Harley-Davidson maintains a large lead in its dominance in the US Heavyweight Motorcycle market as compared to Honda and others. Unlike Harley, Honda specializes in the full array of motorcycles, ranging from dinky scooters sold primarily in emerging markets to the heavyweights Harley is known for. This means that HOG and Honda's respective sales react differently to economic changes. As Harley's are seldom used as primary transportation, but rather as a recreational vehicle, HOG's sales generally fall off during economic slowdowns as people have less disposable income. On the other hand, especially in emerging markets, Honda's motorcycles serve as a primary transportation method for lower income individuals, meaning that growing wealth can drive consumers to automobiles, which the company hopes will be also made by Honda.

Research indicates that Honda's motorcycle dealerships rank well below both the industry average and Harley-Davidson's number one position for customer satisfaction.^[46]

References

1. ↑ ^{1.0 1.1} Honda Motors 2009 Form 10-K, Page 1
2. ↑ Honda Motors 2009 Form 10-K, Page 79
3. ↑ Honda Motors 2009 Form 10-K, Page 1
4. ↑ Statistical Handbook of Japan, chapter 2
5. ↑ Freep.com: Honda announces deeper production cuts
6. ↑ CNN: Big drop predicted for global auto sales
7. ↑ Honda Motors 2009 Form 10-K, Page 9
8. ↑ Honda Motors 2009 Form 10-K, Page 80
9. ↑ OICA 2007 World Ranking of Manufacturers
10. ↑ Honda Motors 2009 Form 10-K, Page 1
11. ↑ Honda Q2 profit plunges 56%
12. ↑ Honda 'positive' despite fall in profit
13. ↑ Honda raises profit forecasts
14. ↑ Honda raises forecast, avoids loss for first half
15. ↑ Honda Profits Jump to $1.5 Billion - Analyst Blog
16. ↑ Japan indexes slip; Honda gains but Toyota sinks
17. ↑ Honda raises full-year profit outlook by 71%
18. ↑ Nikkei seen range-bound; Toyota, Honda in focus
19. ↑ Honda net up sixfold at $1.49 billion
20. ↑ Honda Profits Jump to $1.5 Billion - Analyst Blog
21. ↑ Honda profits accelerate with six-fold quarterly rise
22. ↑ Honda reports $776 mn profit in Q4
23. ↑ CORRECT:UPDATE: Honda Swings To 4Q Profit, Sees 27% Profit Rise This Fiscal Year
24. ↑ Honda rebounds from loss to post quarterly profit
25. ↑ Honda Motor sees annual profits surge
26. ↑ Honda Motor sees profits surge 95.9 percent
27. ↑ Honda Motors 2009 Form 10-K, Page 2
28. ↑ Honda Motors 2009 Form 10-K, Page 35
29. ↑ Honda Motors 2009 Form 10-K, Page 8
30. ↑ Honda Motors 2008 Form 10-K, Page 44
31. ↑ Honda Motors 2008 Form 10-K, Page 46
32. ↑ ^{32.0 32.1 32.2} Honda Motors 2009 Form 10-K, Page 42
33. ↑ Marketwatch: Honda's Cumulative Global Motorcycle Production Reaches 200 Million Units
34. ↑ Honda Motors 2008 Form 10-K, Page 48
35. ↑ Honda Motors 2009 Form 10-K, Page 11
36. ↑ Honda Motors 2008 Form 10-K, Page 49
37. ↑ Honda Motors 2008 Form 10-K, Page 42
38. ↑ Honda Motors 2009 Form 10-K, Page 42
39. ↑ Honda Motors 2009 Form 10-K, Page 8
40. ↑ http://247wallst.com/2010/07/20/honda-reveals-plans-for-hybrid-all-electric-vehicles-hmc-tm-tsla/
41. ↑ IHT: Carmakers try to guess which way frustrated motorists will turn
42. ↑ Statistical Handbook of Japan, chapter 2
43. ↑ The General Paper: Is an Aging Population Necessarily a Bad Thing
44. ↑ Financial Times: US Congress takes aim at Tokyo over yen
45. ↑ Ford 2009 Form 10-K, Page 51
46. ↑ Biker News Online: Harley Dealers Satisfy Two Years in a Row