With the Japanese government set to deploy a new QE of historical proportions (see The Year of the Central Banks: The Godzilla Atack and the Refugee Camps), it is a good idea to check the numbers on Japanese auto manufacturers. Current US auto sales are at 15.32 million, up 6.20% from a year ago. Last time, I presented my statistical analysis for Toyota (TM) and results were surprisingly good on valuation, even though the stock has advanced substantially in the last 5 months. I'm presenting now the numbers for Honda Motor Corp (HMC).
2013 Accord coupe, source: honda.com
Numbers should always have priority over any subjective analysis. The following image shows a simple quantitative analysis presented in a layer or checklist-type format that I call Plan 21. My research methodology tends to focus more on a future growth analysis rather than solely relying on pure deep-value models. The aim is to have a system that is both straightforward and comprehensive by taking into consideration key elements from the income statement, balance sheet and cash flow statement without loosing attention on the business expansion for coming years.
Only companies with positive EPS (12 trailing months) and positive growth for the current year qualify for the analysis. A glossary for the abbreviations is included at the end of Part II. As a reminder, we always need to be aware that estimates are multi-variable dependent forecasts that carry the inherent risk of future prediction.
Earn=earnings, Rev=revenue, GtY=growth this year, GnY=growth next year, EGnY=earnings growth next year, Ind=industry, EGn5Y=earnings growth next 5 years, Acc=acceleration, Dec=deceleration, CF/S=cashflow per share, FCF/S=free cashflow per share, CCC G=cash conversion cycle growth, Op Margin=operating margin, GVN=growth and value number, GLEN=growth and lean equity number, DCF=discounted cash flow, PT=price target
Honda passed the test with a 77.5% score, or a C+ rating. Any company with a score greater than 70% should deserve further analysis. The company has an impressive 46% earnings estimate growth for next year, its current price is still below DCF analysis (13% discount) and its GVN is a high 4.25.
Just like Toyota, it has a considerable amount of debt (95% debt/equity), but not an alarming level considering the future prospects and the nature of the auto industry. Ford Motor Company (F) as a comparison, has a debt/equity ratio of more than 600%.
Both Toyota and Honda have a C+ rating with very similar final results (76.5% and 77.5% respectively). Toyota is slightly cheaper on DCF analysis than Honda, while Honda has a better balance sheet and much better GVN. I own shares of both companies and also some shares of the iShares MSCI Japan Index Fund (EWJ). I will be watching the market to add more shares to all 3 positions when an appropriate pullback materializes. I was obviously early in my "small correction" hypothesis (see The Warning Signs Keep Accumulating), but I remain cautious. As the stock market (SPY) climbs, weaker inflation expectations are keeping the bond market higher and the commodities major trend to the downside, suggesting that a better buying opportunity will come.
Until later, trade safe.
Parameter Selection and Acceptance Criteria Rationale
There are some non-conventional metrics included in the tables:
Parameter #15 (GVN) is a growth and earnings yield hybrid that takes into consideration the company size, earnings and growth. An acceptable result must be greater than one (1) since that means a better safety margin when compared against an investment grade corporate bond benchmark. The higher the result, the better. I developed the GVN in the spirit of having a more reliable growth-value metric (compared to a 5 year estimated PEG).
Parameter #16 (GLEN) is a growth and balance sheet quality measure. A positive value is required in order to separate the best balance sheets from the rest without ignoring the growth of the company. The higher the result, the better. I created the GLEN in an effort to have a more practical and comprehensive measure than the net current asset value (NCAV).
Additional notes about Plan 21:
Only companies with positive EPS and positive growth for the current year (parameter#1) qualify for the analysis.
Parameters 1 trough 5 have two requirements each. Each requirement is worth 0.5 points.
The acceptance criteria for parameter #2 varies as a function of company size and other considerations. The requirement for revenue differs from the earnings one.
Parameters 3 and 4 are the differences between the stock growth and the growth of the industry and the sector. A negative number means that the growth of the stock is estimated to be smaller than the estimated growth of the industry or the sector.
Acceleration is calculated using only numbers from the previous year, estimated current year and estimated next year. Absolute differences are used, not percentages.
The results reported for ROA, ROE and margins reflect how much the measure of interest will increase or decrease based on estimates (absolute increase/decrease, not growth).
The annual CCC uses the past 2 years for calculation.
DCF uses a 50% safety margin for growth, a 0% long term growth and a 10% discount rate (10% is about the average of the very long-term stock market return, is also about twice the current BAA corporate bond yield and more than twice the AAA yield).
Stocks receive additional credit for DCF discounts greater than 20%.
There are three possible outcomes for the bonus result: 0 points, 0.5 points or 1.0 points. These bonus points are awarded to companies that comply with specific growth and share structure requirements at the moment of evaluation.
Additional disclosure: Any content in this article should not be considered as a recommendation or investment advice given that financial objectives and individual needs of the end user have not been evaluated. Suggestions or tips are for information purposes only and there is no guarantee on stock returns or market performance. All readers must use their prudence and consult their financial advisors before acting on any of the securities or suggestions mentioned or engaging into any other high risk investment. I do not hold any responsibility and can not be held liable for any losses incurred (if any) by acting on the information provided.