In this article, let's take a look at Honda Motor Co Ltd (HMC, Financial), a $55.31 billion market cap company that 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.
Some risks
The main risk is an increase in steel prices that would generate negative consequences to Honda's profits. One possible solution is to use more common-size vehicle platforms to reduce costs.
Another risk is the exchange rate risk. Although the weak dollar is no more a problem, since that currency strengthened considerably against the yen, the firm's profits could be hurt by a strong yen if Japanese monetary policy is unsuccessful. Last year, the company produced 94% of its vehicles sold in the U.S. in North America. This means that it is better positioned than Toyota (TM, Financial) in a scenario of strong yen.
Further, the fixed costs, when they are big, create a high operating leverage that can make profits volatile to small changes in demand or supply shocks.
Improving regions
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. However, we believe emerging markets are regions for growing sales in the future because we are confident about the strengthening of the global automotive demand.
Revenues, margins and profitability
Looking at profitability, revenue decreased by 14.96 and led earnings per share decreased in the most recent quarter compared to the same quarter a year ago ($0.66 vs $0.68). During the past fiscal year, the company increased its bottom line. It earned $3.10 versus $2.17 in the previous year. This year, Wall Street expects an improvement in earnings ($3.33 versus $3.10).
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 | 10.51 |
| NSANY | Nissan Motor Co. Ltd | 9.91 |
| TM | Toyota | 13.27 |
| Â | Industry Median | 10.16 |
The company has a current ROE of 10.51% which is higher than the one exhibited 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 10.3x, trading at a discount compared to an average of 15.8x for the industry. To use another metric, its price-to-book ratio of 1.0x indicates a discount versus the industry average of 1.43x while the price-to-sales ratio of 0.49x is below the industry average of 0.69x. 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 $10,302, which represents a 0.75% compound annual growth rate (CAGR).
Final comment
The auto-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.
Further, 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 David Dreman (Trades, Portfolio), Jim Simons (Trades, Portfolio) and Charles Brandes (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014, as well as HOTCHKIS & WILEY.
Disclosure: Omar Venerio holds no position in any stocks mentioned
