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Morningstar | Honda's Cost-Cutting Efforts Pay Off in First-Quarter Results

We are not changing our Honda fair value estimate after incorporating its first-quarter fiscal 2019 results into our model. The company posted an 11.2% increase year over year in operating profit (we calculate a 20.7% increase ignoring currency headwinds) to JPY 299.3 billion, resulting from good performance from the motorcycle segment and cost reduction efforts. Foreign exchange took JPY 25.6 billion from operating profit for the quarter with JPY 14 billion of that coming from the dollar against the yen. Honda did not specify another headwind from a variety of currencies for JPY 13.6 billion, but we suspect it is for weaker Brazilian and Argentinian translations against the yen. Motorcycles benefited from new launches in India and overall segment unit volume including joint ventures increased by 13.9%, while segment earnings increased by 16.9% to JPY 92.1 billion and segment operating margin rose by 110 basis points to 16.6%. The auto segment increased operating profit by 8.1% to JPY 151.7 billion boosted by volume and mix from higher Pilot crossover sales in the U.S., the introduction of the Acura RDX crossover, and strong Japanese growth for the N-BOX minicar. Segment margin, however, came in flat at 5.3%, and total company operating margin rose by 10 basis points to 7.4%.

The firm's cost-cutting efforts are going better than management expected, so Honda raised fiscal 2019 operating profit guidance by JPY 10 billion to JPY 710 billion and EPS is now guided at JPY 348.56 per share, up from previous guidance of 322.42. We expect further guidance increases as fiscal 2019 unfolds, so we are leaving our EPS estimate of 396.72 per share in place. We are more optimistic than management because we think Japanese companies tend to be conservative in their guidance and current guidance is based on management expecting the yen to strengthen against the dollar from the current rate of about JPY 112 to JPY 105 in the second half of fiscal 2019, which may not happen.

The Bank of Japan on July 31 said that it will let its current monetary policy, which targets a yield of about zero on 10-year Japanese government bonds, remain in place for "an extended period of time" per BOJ governor Haruhiko Kuroda at a news conference. This policy when combined with the U.S. Federal Reserve recently raising its interest rate target suggests to us that Honda's assumptions for its guidance may be far too strong of a yen against the dollar, so upside to its guidance is possible in our opinion. Steel and aluminum tariffs in America could be a negative surprise later in fiscal 2019 but so far management is saying the tariffs have not had a significant impact to results. Honda sources about 90% of its steel and aluminum for the U.S. market from the United States.

Honda will also be fighting the ramifications of a flooded plant in Central Mexico that makes the HR-V small crossover and the Fit subcompact car. The plant shut down after heavy rain on June 28 and management does not expect assembly to resume until mid-November. Americans love light-truck models, with these vehicles making up nearly 70% of unit sales each month for the industry, so we are not concerned about lost Fit production but the HR-V loss is bad timing. HR-V sales so far in calendar 2018 are down in the U.S. by 2.3%. A small number of Fit cars also are exported from Japan to the U.S., but all HR-V North American sales are manufactured at this Mexican plant in Celaya. Honda's guidance includes the impact of this shutdown, which it estimates at about a JPY 50 billion-headwind relative to fiscal 2018 operating profit.