HYMTF - Honda Motor: Stable Prospects But Auto Segment A Question Mark

2023-09-25 10:45:22 ET

Summary

• Q1 2024: Revenues and profits up, and margins increase.
• New EV motorcycle plan may help support earnings growth and defend market share.
• Anticipated EV launch may stem market share losses, but Honda is up against arguably stronger competitors.

Prospects for Honda Motor's ( HMC ) cash cow - motorcycles - appear stable, however, prospects for their automobile segment are uncertain due to stiff competition and Honda being a latecomer to the EV game. Their valuation appears fair, assuming modest automobile segment profitability.

Company overview

Honda Motor develops, manufactures, and markets motorcycles, automobiles, and power products around the world.

The company has four business segments:

Motorcycle Business: Engaged in the design, manufacture, and marketing of a wide range of motorcycles and relevant parts. This is Honda's third-biggest segment by revenues (accounting for 16% of revenues in Q1 2024), but is the second biggest in terms of profits (accounting for about 36% of operating profits in Q1 2024) and is among Honda's most profitable business segment in terms of margins (with segment margins of 18.9% in Q1 2024 and 16.7% in FY2023 ended March 2023).

Automobile Business: Engaged in the design, manufacture, and marketing of automobiles and relevant parts. This is Honda's biggest segment by revenues (accounting for 65% of revenues in Q1 2024). Segment profitability has been among the lowest of all segments over the past few years with margins typically hovering in the low single digits. The segment reported an operating loss in FY2023. Q1 2024 segment operating margins amounted to 5.8%.

Financial Services Business: Engaged in financial services, specifically retail loan and leasing services related to Honda products. This is Honda's second-biggest segment by revenues (accounting for roughly 17% of revenues). As of Q1 2024, the segment contributed 17% to Honda's operating profits.

Power Products and Other Businesses: Engaged in the manufacture and marketing of power products and relevant parts. This is Honda's smallest segment by revenues and profits (less than 3% share of total revenues and less than 2% share of total operating profits in Q1 2024). It is also one of the lowest-margin business segments with a segment margin of 4% as of Q1 2024.

Q1 2024: Revenues and profits increase by double digits, margins up

For Q1 2024 (three months ended June 2023), revenues rose 20% YoY to JPY4.6 trillion, helped by a production recovery due to an improvement in semiconductor supplies. The Motorcycle and Automobile business segments reported revenue and profit growth helped by higher sales volumes (Motorcycle unit sales were up 5.2% YoY to 4.473 million units driven by higher sales in Asia and Automobile unit sales increased 10.5% YoY to 901,000 units driven by higher sales in North America) while Financial Services and Power Products reported profit declines.

Operating profit nearly doubled to JPY394.4 billion. Gross margin increased to 21.5% in Q1 2024 compared with 19.9% the same quarter last year, and operating margin increased to 8.5% compared to 5.8% the same quarter last year. Net profits more than doubled to JPY328 billion.

Near term, Honda management forecasts FY2024 revenues to increase 7.6% to JPY18.2 trillion, operating profits to increase 28% to JPY1 trillion, and net profits are projected to rise 22.8% to JPY800 billion. Earnings per share are forecast at JPY163, down from JPY384 last year after factoring in the company's 3-for-1 stock split.

Looking further ahead, market prospects for Honda's biggest earnings generator - motorcycles - are stable. The global motorcycle market is projected to grow in the low-single-digit over the coming years. Honda, the dominant player commanding about a third of the market, should remain a beneficiary. The company has been losing share over the years due to their resistance to electric motorbikes (Honda's 29.1% market share last year is nearly five points lower than their market share in 2016). Honda however launched their electric motorbike model in August 2023 in Japan, Europe, and Indonesia. The launch marks the first of 10 planned electric models Honda aims to launch by 2025, which may help stem market share erosion to rival brands and position Honda to capitalize on the market's growth which is projected at a CAGR of 10% and higher over the coming years.

Honda's Automobile segment's prospects are uncertain. After years of delay and resistance, Honda has finally stepped up their EV game (a market expected to grow by around 16% over the coming years) with plans to launch their new Honda Prologue and Honda Acura EV models in the U.S. next year and another SUV planned for release the year after. The Prologue and Acura are manufactured in the U.S. in partnership with General Motors ( GM ), making them eligible for subsidies under the Inflation Reduction Act (IRA) which may help Honda get off to a strong start considering fellow South Korean rivals Hyundai's IONIQ 5 and Kia's EV6 EV models were not eligible for IRA subsidies, but they managed to make the top 10 selling EVs in the U.S. for the first half of 2023. The timing may also be opportune as a potential interest rate cut next year may stimulate car sales. Honda's new EVs can help stem market share erosion; about 40% of Americans who bought Teslas switched from Japanese cars, primarily Toyota ( TOYOF ) and Honda.

Price-wise, Honda may position themselves between Hyundai ( HYMTF ) and Kia (who generally offer affordable vehicles) and top-selling EV brand Tesla ( TSLA ). However, medium term, Tesla has room to cut prices, and if they do, Honda may struggle to offer a value proposition comparable to Tesla who has years of EV experience and consequently technological superiority (an ICCT report deemed Honda among other Japanese automakers are " laggards " in terms of technology performance and other metrics while Tesla leads), operational advantages including a vertically integrated supply chain and scale advantages, better profitability at the moment (Honda's Automobile business segment typically generates low-single-digit profit margins and their 7% segment margin target by 2026 still trails Tesla's net margins of over 10% currently), and a better balance sheet (Tesla has a negative net debt position while Honda's net debt is more than $28 billion and a relatively high debt to equity of 71). Meanwhile, Chinese automakers like BYD have scale advantages and growing technological advantages (including battery technology), and supply chain advantages (including upstream minerals mining) to dominate the affordable to mid-end of the EV market, leaving Japanese carmakers like Honda squeezed in the middle. The possibility of this segment becoming a drag on overall performance due to competitive pressures cannot be ruled out.

Risks

Better than anticipated automobile segment performance

Given uncertainties over Honda's automobile segment's medium-term performance, it is conservatively assumed (see below) the segment would generate a modest low-single-digit segment margin over the coming two years, far below management's 7% segment margin target by 2026. However, if Honda's automobile segment's profitability improves better than anticipated, the company could be worth significantly more.

Conclusion

Honda Motor has a moderate buy analyst consensus rating while Seeking Alpha's Quant system rates it a strong buy.

Honda Motor's valuation looks inexpensive; with a forward P/E of 9.5, Honda Motor is trading below the sector median of 15 , and below their 5-year average of 10.7.

Taking the following assumptions, Honda Motor's fair value is roughly $61 billion, just slightly higher than their $57 billion market cap currently.

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