Honda Motors: Shifting Into A Higher Gear

| About: Honda Motor (HMC)

Summary

US Auto Sales were weak in March, but Honda managed to keep its own sales broadly flat, thanks to strong sales of its popular CR-V compact SUV.

Honda is expecting a solid year, with profits for the year ending in March set to climb by 59% from a year earlier.

Profit increases will be driven by Honda management’s focus on reducing its operating leverage and value-engineering its vehicles.

Our price target of $39 for Honda reflects these considerations and would give investors a total return of close to 35% over the next 12 to 18 months.

Analysis

US Auto Sales Fell in March, but Honda Kept Afloat

The latest reports for the auto industry's sales came in shy of Wall Street expectations. U.S. automakers' annualized sales figures suggest that they sold between 16.5 and 16.6 million "light" vehicles (i.e. cars and light-duty trucks, including crossovers and SUVs) in March, or around 800 thousand vehicles shy of the estimate of 17.3 million.

The drop came even as the industry engaged in heavier discounting - even on vehicles that had previously required little by way of discounts - sometimes as much as $500 more than a year earlier.

Even so, Honda (NYSE:HMC) managed to keep its sales relatively flat - falling just 0.7% in March compared to the 1.6% drop for the industry as a whole. Honda was kept afloat by a near-tripling in the sales of its imported vehicles (equivalent to about 8,500 more vehicles compared to last year) as well as sales of US-assembled sports utility and crossover vehicles (like its popular CR-V), which added 8% in March.

Recent Performance and Dividend

Despite the negative tone for automakers, Honda has had a relatively good 2017, with its shares adding about 1.5% in the year-to-date. This is superior to the performance of industry titans such as GM and Ford (NYSE:F), which have seen their shares drop by 1.6% and 6.3%, respectively, in 2017. Honda's share price has been aided, no doubt, by its recent spate of strong results: The company has exceeded expectations in each of the last two quarters.

Another thing that makes Honda attractive is its 2.8% dividend yield, which is better than the average yield of the S&P 500 but trails the yields of giants like GM and Ford, which both pay a dividend north of 4%. Even so, Honda's dividends are at their highest level in the last decade and Honda management's current goal is to pay around 30% of the year's profits as dividends.

The one caveat for investors interested in Honda is that its shares are ADRs (although they've been listed on the NYSE since 1977 and has had ADRs since 1962), and its dividends are declared in Japanese yen. In that regard, there is some currency risk as the dollar has had a volatile ride with yen in the last year.

CR-V to the Rescue

As we mentioned earlier, Honda managed to keep its numbers close to flat in March, thanks to sales of imports and strong sales of its US-assembled SUVs and crossovers. The CR-V, in particular, was very strong, as Honda sold close to 33,000 units in March - for an annual gain of nearly 23%.

The CR-V's record sales in March helped Honda overcome the nearly 9% decline in its car sales for the period. In fact, its approximately 6,100-unit gain alone was almost enough to overcome the 6,400 decline in Honda's car sales. This isn't surprising, given that Honda continues to ship the latest in-dash systems such Android Auto and Apple CarPlay on CR-V models, effectively giving these vehicles an "added value" push ahead of other vehicles. It also helps that the CR-V continues to be the top-rated compact SUV for the U.S. market and that it has received superlative ratings from respected consumer magazines such as Car and Driver.

In fact, of the top 20 vehicles sold in March, the CR-V trailed just Nissan (OTCPK:NSANY) in year-over-year sales with 23% unit-sales growth and is among the Top 5 in vehicles sold in the year to date, ahead of Toyota's (NYSE:TM) ubiquitous Camry sedan. Clearly, the CR-V ticks consumers' boxes with its versatility, value for money and driver satisfaction.

Global Profits on the Rise

Of course, Honda is an international entity, so U.S. sales are only part of the picture. Fortunately for Honda investors, it looks as though Fiscal 2017 (which ended in March) will see a strong resurgence.

Honda's guidance is for its earnings per share to rise by 58%, from JPY191 to JPY302. At the relevant market exchange rates, this translates to a rise of 59% from $1.70 to $2.71 per share. Honda anticipates this increase despite a 5.5% decline in revenues, so Honda will have a margin expansion - from just 3.4% to 5.7% - to thank for its expected profit surge.

While the headline margin number's climb might seem slight, on a relative basis, this translates to a 68% margin improvement and is driven by Honda's efforts to value-engineer its vehicles (by reducing raw materials prices) as well as trim its overhead (by decreasing its product-warranty expenses). These two areas of cost improvement should more than offset Honda's significant currency drag and allow it to attain its profit targets.

Conclusion

Honda's profit climb for Fiscal 2017 dwarfs that expected for both GM and Ford, which are both expected to see earnings contractions this year. It should also be noted that Honda's anticipated earnings improvement is superior to that of the S&P 500, which is only expected to deliver earnings growth of 16% this year. Honda's fiscal year isn't perfectly aligned with the market since its fiscal year ends in March but if we go by our earnings estimates of $3.11 per share this year (which is in line with the consensus) and $2.72 next year, we get a blended growth rate of 44% for the comparable period. In that sense, Honda is in a different paradigm compared to its peers and deserves a multiple closer to the broader market.

Honda is currently trading at 9.5 times its trailing earnings, compared to 18.3 times for the S&P 500. We believe that Honda, considering its expected performance, should be trading at about 12.5 times its forward earnings, which would give consideration to its better-than-average industry performance as well as the risks facing the auto sector.

This, in turn, translates to a target price of $39 per share, which represents upside of 31.6% for shareholders - and with Honda's dividend yield of 2.8%, investors could be looking at a total return of close to 35%.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in HMC over 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.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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