Honda Motors: Stock To Drive Higher On Key Conditions

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 |  About: Honda Motor Co., Ltd. (HMC)
by: David Zanoni

Honda Motors (NYSE:HMC) has a few positive things going for it that are likely to drive the stock higher over the next few years. The maker of autos, motorcycles, and power products is experiencing a perfect storm of conditions that should benefit its business and contribute to higher earnings growth to catalyze the stock. Honda's products are a great value for consumers as the company offers quality and reliability at affordable prices.

Attractive Valuation

At first glance, the trailing P/E ratio of 16 and the forward P/E of 14 do not look all that intriguing. However, Honda has a PEG ratio of only 0.73, a price to sales ratio of 0.59, and a price to book ratio of 1.17. With the PEG and price to sales ratios under 1 and the price to book ratio under 2, Honda is undervalued.

The company became undervalued as a result of the financial crisis in 2008 as the auto industry is cyclical. Honda also took a hit after the earthquake in Japan in 2011. The stock has made a recovery, but still remains attractively valued.

Falling Yen

Japan has made efforts to stimulate its economy with its most recent effort being a massive quantitative easing program. Japan's new QE program is 60% larger than the one being implemented in the United States. The goal is to transform the economy from a deflationary environment to a 2% inflation rate. This process reduces the value of the yen. This past fall, one U.S. dollar bought less than 80 yen. Currently, one dollar buys about 100 yen. The falling yen makes Japanese products cheaper for those in other countries such as the United States. This will help Japan export more goods and positively contribute to the country's economy. Honda is set to benefit as its cars, motorcycles, and generators become cheaper to purchase in other countries. Honda will make about $2,000 more per vehicle when the yen depreciates from 78 to 100 yen per dollar. This will translate into higher revenue and earnings for the company.

Market Conditions

There are currently a few favorable factors contributing to the success of automakers. The average age of a car or truck on the road reached 10.8 years last year as many consumers held off on purchasing a new vehicle. Eventually, consumers will need to upgrade these aging vehicles, which should translate into growing vehicle sales. With Honda consistently ranked high for reliability, many consumers will remain brand loyal and choose a new Honda model. Honda should also pick up some new customers who are seeking value and reliability as they see high marks for the company during their car-buying research.

The low interest rate environment is great for car buyers. Deals such as 0.9% financing occasionally surface for Honda's vehicles. These deals save consumers a significant amount of money in interest over the life of the loan. Even the current average auto loan for new vehicles of 2.45% is historically low and enticing for buyers.

Gross Margins

Honda has a gross margin that is higher than the industry average. Let's take a look at a comparison chart:

Company

Gross Margin

Honda

26%

Toyota (NYSE:TM)

16%

Ford (NYSE:F)

14%

General Motors (NYSE:GM)

10%

Nissan (OTCPK:NSANY)

17%

Industry

22%

Click to enlarge

This shows that Honda retains more of its sales money as gross profit as compared to the other automakers.

Relatively Moderate Risk

The auto business is cyclical and is subject to the risk of an economic slowdown. If a recession were to hit in the U.S. and other large nations, more consumers will hold onto their older vehicles and wait to purchase new ones. However, the U.S. housing market is making gains, the U.S. unemployment rate is falling, and the risk of an European collapse has subsided. Conditions are looking more towards the positive side, indicating continued prosperity.

Aggressive Outlook

Honda is expected to grow earnings annually at 28.75% for the next five years. This growth should allow the stock to triple in five years. Investors should also take into consideration the fact that Honda pays a dividend of 2.3%. This is icing on the cake. This means that investors have the potential of earning a CAGR of 31%. Using a 31% CAGR, a $10,000 investment in Honda stock with dividends reinvested, should be worth over $37,000 in five years and more than quadruple in six years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.