Can This Automaker Race Towards Its Goal?

Gaurav is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Yes! Honda (NYSE: HMC) will be returning to Formula One again after a long absence. It will supply engines to its former F1 partner, McLaren Automotive. So racing fans can expect to witness the magic of the powerful Honda engines once again in 2015.

Now that Honda has delivered the good news to sports lovers, does it have some equally satisfying news for its investors? The company has certainly stepped up its performance in fiscal 2013, growing its sales by 24.3% and improving its EBIT by 90%. This comes after a horrible 2012, when it slumped on account of a Japanese earthquake and Thai floods. And now, Honda has set a steeper target for itself in fiscal 2014 aiming for revenue growth of 22.5% and a huge 59.5% increase in EBIT.

Let us look at some key drivers that will make this happen.

Good demand in North America

North America is Honda’s largest market, accounting for around 40% of sales. The company is witnessing good demand here. In fact, its May sales figures were quite a surprise for market experts. Edmunds.com had predicted Honda’s auto sales would increase by 1.7% y-o-y, but the company reported a much better 4.5% growth.

Honda Accord is witnessing good sales gains. Of course, gone are the days when the mid-size segment was completely ruled by the Toyota (NYSE: TM) Camry and Honda Accord, as both these cars have met their match in the Nissan (NASDAQOTH: NSANY.PK) Altima and Ford Fusion.

But so far Accord still holds the second spot in the mid-size race, selling around 155,183 cars. This is a good 22.9% increase over the first five months of 2012. Camry is still doing well with 171,756 units sold, despite its 5.5% y-o-y decline. Altima holds the third spot with 140,883 units, a 4.1% increase over last year.

Meanwhile, demand for Honda CR-V trucks have picked up, with sales up 8.4% in May.

Honda is also trying to boost its Acura luxury division, which is witnessing a slowdown. The company has earmarked $1 billion to roll out new models for RLX, the MDX sport wagon, and the NSX super sports car. The NSX will carry a price tag of around $100,000.

Toyota and Nissan are also stepping up their games in the US market. Toyota has just unveiled the remodeled Corolla with a much more youthful look. The car will reach the dealers later this year. The company has also increased its incentives to woo buyers. Its May sales were up 2%.

Nissan has taken an aggressive pricing strategy, riding on the strength of a weaker Yen and cutting prices for seven of its cars. Immediately in May its sales jumped 22%.

Favorable currency impact

Devaluation of the Yen has given a solid boost to Japanese manufacturers, who thrive on exports. The weaker currency lowers Japanese manufacturing costs, allowing manufacturers to lower prices. On the other hand, profits earned in stronger currencies boost financial performance.

Honda, which has around 25% of its manufacturing capacity in Japan, also stands to gain from this. In fiscal 2013, the average conversion rate was 83 Yen per dollar against 79 Yen per dollar in the prior year. The impact would be much greater this year with the company expecting 95 Yen per dollar. The currency situation will play a key role in achieving the company’s targeted 59.5% EBIT increase. Toyota has also guided for profits above 40%, while Nissan is looking at increasing its net income by 22.8%.

In order to leverage the currency situation, Honda will open a new domestic plant after 50 long years in July. The company, like most of its peers, had been building plants in overseas markets, but now this is about to change. The new plant will have an annual capacity of 250,000 vehicles and is likely to produce the Fit for domestic sales.

Improvements in China

Although a little preliminary, it looks like the tension in China over territorial disputes with Japan is easing. All the three big Japanese automakers have reported sales gains in May.

Toyota has reported a 0.4% y-o-y increase in number of vehicles sold in China in May, while Nissan reported a 2% increase. However, most impressive was Honda’s 4.6%, rise although it came from a relatively smaller base. Honda makes roughly half of Nissan’s production.

China is the world’s biggest automotive market and presents a huge opportunity. It is estimated that car ownership rate is around 91 vehicles per 1,000 people, compared to 850 vehicles per 1,000 people in the US and 600 to 800 per 1,000 people in Europe.

China is a key market for Honda, and the company is adding capacity to cater to the rising demand there. It is building a new plant that will start operations from 2015 and have an annual capacity of 120,000 units. This will eventually be doubled to 240,000 units.

Toyota will also breathe a little easy now given that it was banking on China to become its third one-million unit market. Its plans had come to an abrupt halt when tensions sparked last year. For this year, if things go as planned, Toyota intends to sell around 900,000 vehicles in this market. Nissan predicts 16% higher sales through the year.

Concluding thoughts

Honda definitely stands to gain from the good demand in the US markets. The recovery in China will also be a key factor for driving sales. But the most significant factor is the favorable currency situation which is making Japanese stocks hot favorites of investors. Even if there is some intermittent volatility, currency will continue to be a big boon. Honda looks poised for some very strong financial performances over the coming quarters.

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Gaurav Basu has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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