In this article, let's take a look at Honda Motor Co Ltd (HMC, Financial), a $63.06 billion market cap company, which is one of the world's largest automobile manufacturers, and is the largest manufacturer of motorcycles, which operates in an industry that is so cyclical that in bad times even the best automakers could have problems.
The Macro
The industry continues to be capital-intensive, but barriers to entry are not as high as in the past. Due to strong competition, it is very difficult for a company to gain a sustainable advantage. Further, competitors from China and India are a threat even in the U.S. market. We have to mention that South Korea's Hyundai is nowadays a great competitor.
One of the major risks the firm faces is an increase in steel prices that would generate negative consequences to Honda´s profits. One possible (and partial) solution is to use more common-size vehicle platforms to reduce costs.
The weak dollar is no more a problem, since that currency strengthened considerably against the yen. Honda´s profits could be hurt by a strong yen if Japanese monetary policy is unsuccessful.
U.S. and International Markets
The company's production operations are conducted in 30 separate factories; four of them are in Japan. The rest are located in the U.S., Canada, the U.K., France, Italy, Spain, India, Pakistan, the Philippines, Thailand, Vietnam, Brazil and Mexico.
Honda has the largest exposure to the North American market. Last year, the firm produced 94% of its vehicles sold in the U.S. in North America. What we are saying is that it is better positioned than its rival Toyota Motor Corporation (TM, Financial), with only 70%, to withstand a “strong yen”.
Although higher volume in the U.S. and abroad versus 2013 will help corporate profits and cash flows, I think it´s crucial to expand businesses outside the traditional markets (Japan, North America, and Europe) and try to produce where they sell in order to mitigate exchange risk. Emerging markets continue to be regions for growing sales.
Revenues, Margins and Profitability
Looking at profitability, the revenue growth (41.32%) has outpaced the industry average. Earnings per share tremendously increased in the most recent quarter compared to the same quarter a year ago ($0.97 vs $0.3).
During the past fiscal year, the company increased its bottom line by earning $3.10 vs $2.17 in the prior year. This year, Wall Street expects an improvement in earnings ($3.60 vs $3.10). On Tuesday, July 29, 2014, Honda will report its first quarter results. Analysts are expecting a profit of 79 cents a share, up from 69 cents a year ago. (To be honest, I think it will beat the consensus).
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| HMC | Honda | 9.7 |
| NSANY | Nissan Motor Co. Ltd | 8.87 |
| TM | Toyota | 12.6 |
| Industry Median | 10.05 |
The company has a current ROE of 9.7% which is higher than the one exhibit by Nissan Motor Co. Ltd (NSANY, Financial), but lower than industry median and Toyota´s ratio. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 11.2x, trading at a discount compared to an average of 17.4x for the industry. To use another metric, its price-to-book ratio of 1.1x indicates a discount versus the industry average of 1.6x while the price-to-sales ratio of 0.5x is below the industry average of 0.7x. All the ratios indicate that the stock is relatively undervalued and seems to be an attractive investment relative to its peers.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $13.895, which represents a 6.7% compound annual growth rate (CAGR). Further, 3M has demonstrated a pattern of positive earnings per share growth over the past years.
Final Comment
As outlined in the article, in the last years, the world has a weaker yen against the dollar while the U.S. is recovering from recession and demand for light vehicles seems to be a key driver for the company.
Apart from all the reason we have already analyze, valuation is another key reason to considering Honda as an investment. So in this opportunity, I would recommend fundamental investors to consider this attractive option for their long-term portfolios.
Hedge fund gurus like Jim Simons (Trades, Portfolio) and Charles Brandes (Trades, Portfolio) added this stock to their portfolios in the first quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
