Honda (HMC, Financial) has had a pretty rough year. Over the past 10 months, the company has seen its operating income slashed due to climbing research and development expenses, domestic sales have plummeted by 13.5%, and it’s lost billions of dollars in recalls.
Yet after months of chaos, it appears as though things are finally back on track for Honda – in fact, things are actually better than ever. Whether that success is actually sustainable remains to be seen.
This has been a big week at Honda. First, its board finally agreed to sever ties with Takata (TKTDY, Financial), the dodgy airbag manufacturer that’s landed a lot of people in hot water. Thanks to a set of explosive airbag filters, Honda has been forced to issue major recalls on some of its top-selling models – which will ultimately cost the company around $2.29 billion (1.9% of its full-year revenue). Bearing in mind that Honda was Takata’s top customer, shares in the airbag company have since plummeted by one-fifth. Honda, on the other hand, is perceived to have shed some toxic dead weight and taken a progressive step forward. Things are looking up.
In fact, CEO Takahiro Hachigo demonstrated just how much things are looking up on Wednesday when he unveiled the company’s shock Q2 results for the 2016 year. Nobody expected Honda to deliver anything special this week – but against all odds, the company actually killed it.
Net profit rose to $1.05 billion (127.7 billion yen) in the quarter ending Sept. 30, driven almost entirely by gains in North America and some favorable exchange-rate shifts across the board. Sales in the U.S. and Canada shot up by 9% to around 437,000 – primarily on the strength of Honda’s popular CR-V and HR-V. Meanwhile, sales in Asia (apart from Japan) rose 15.8%. The bulk of that growth came out of China, where there appears to be an ever-surging demand for crossover SUVs. Honda’s motorcycles unit reported a relatively stagnant quarter, with net sales inching forward by about 0.5%.
Given the weak state of the yen and what should have been a devastating set of recalls, Honda has enjoyed an incredible quarter. The company has even upped its full-year revenue forecast from 14.5 trillion yen to 14.6 trillion yen, and a lot of analysts are recommending investors take advantage of a recent price dip and start hoarding shares now.
But if you look at some of Honda’s other business interests, the picture isn’t so perfect – and it’s not difficult to see why share prices have taken a tumble in recent weeks.
Thanks to gains in North America and China, Honda is sitting pretty this quarter. But to be honest, those gains have only just been able to offset losses elsewhere. Developing markets are costing Honda big time – and Indonesia is the primary culprit. Over the past year or so, Honda has funneled a lot of its time and energy into cracking the Indonesian market, where Toyota has always reigned supreme. According to industry experts, sales in the Southeast Asian country are expected to jump 10% year over year like clockwork until 2020.
Honda has done its best to steal some of that market share by rolling out a couple of sleek new SUV models designed specifically for that market. Buyers are already proving receptive, and Honda’s sales volume is definitely on the rise.
The problem is that 10% hike in demand analysts were predicting isn’t going to materialize. In the first nine months of 2015, we’ve only seen a 2.7% sales increase across the industry – and with the Indonesian rupiah depreciating faster against the dollar than the yen, it's become far too costly for Honda to import vehicles and parts into the country. In short: Indonesia has turned out to be a major flop – and it’s these sort of flops that are ultimately hurting Honda’s growth potential.
In Wednesday’s Q2 report, the company posted a 2.5% year-over-year decline in operating profit, which officers blamed on currency values and rising SG&A expenses. That’s admittedly not a huge loss; however, if you take a look at the leaps and bounds Honda’s top competitors have made in Q2, Honda is definitely way behind the pack in terms of operating profit. At this point, it might not be able to catch up.
On Thursday, Toyota posted a $5.02 billion net profit for July to September – its highest ever Q2 result and a 14% year-over-year increase. It also set a quarterly operating profit record, despite forecasting a full-year sales slump. Meanwhile, Nissan’s (NSANY, Financial) relative lack of investment in emerging economies played to its distinct advantage, with the company skating past analyst estimates with an operating profit of $1.20 billion.
With the Chinese economy still on the fritz, Nissan, Toyota (TM, Financial) and Honda are all going to rely exclusively on U.S. sales to post any sort of measurable growth for the full year. The problem for Honda is that industry experts don’t think the company can manufacture enough units to meet rising demand for SUVs and steal business from Toyota, Nissan and stronger domestic competitors. Thanks to losses in emerging economies, Honda’s midterm success ultimately depends on big North American sales – and unless the company can sink big money toward increasing production there, a major sales jump simply is not in the cards.
So, where does that leave Honda? Doing substantially better than it should be, actually. Right now, the company is still trading at some 11.3 times the value of its forward earnings, which is pretty expensive compared to shares in its better performing competitors, Toyota and Nissan. These two companies are facing less risk in undeveloped markets, and have both got a far more consolidated presence in North America. Consequently, Honda might not be the safest long-term investment. It’s certainly not the cheapest, anyway.
