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Morningstar | Incentives and Foreign Exchange Compress Honda's Fiscal 3Q

Honda's fiscal 2019 third-quarter results showed headwinds from incentives and foreign currency but we don't see enough in the results to merit a fair value estimate change. The company should get a boost in its fiscal fourth quarter numbers and in early fiscal 2020 from the new Passport crossover launching in the U.S. in February. This vehicle gives Honda another crossover to attract customers who want a more aggressive looking vehicle and something sized between the CR-V and Pilot. A Honda North America manager was quoted recently in Automotive News saying not having this vehicle caused Honda to lose 35,000 customers in calendar 2017. The vehicle will be built in Alabama, which will at least partially shield it from possible tariffs on imported vehicles the Trump administration may levy. Management is keeping the dividend forecast for fiscal 2019 at JPY 111 per share and only made modest upward changes to fiscal 2019 guidance relative to the fiscal second quarter release.

Honda's fiscal third quarter operating income fell by 40.2% year over year and we calculate a 25.4% decline excluding a JPY 42 billion currency headwind. Most of the profit headwind excluding exchange came from a negative mix headwind of JPY 57.4 billion and a JPY 15.5 billion increase in research costs. An accounting change to record incentives under IFRS 15 also cost JPY 43.3 billion in operating profit, which Honda recorded within the JPY 57.4 billion headwind. Management also blamed higher incentives to sell the outgoing model year of the CR-V crossover, which we think came from the CR-V needing to remain competitive against a new generation Toyota RAV4 crossover launched in the U.S. late in the quarter. The mix headwind also comes from Honda's U.S. vehicle mix being less skewed to light trucks than most of the industry. Honda's calendar 2018 U.S. light truck mix was 55% compared with 69% for the U.S. industry, evidence for why the Passport launch is well-timed.

Honda could have done a better job disclosing where the currency headwind came from because the largest single line item shown constituting the JPY 42 billion profit hit is an JPY 18.5 billion headwind from "others," which we think could mostly be from Australia. The U.S. dollar strengthening against the Argentine peso was the second largest contributor at JPY 12 billion, evidence of the rampant inflation in Argentina and likely the impact of dollar denominated commodity costs. A similar issue likely played out in Brazil because Honda called out a JPY 7 billion negative total variance from Brazil, Canada, and Mexico. The yen against the dollar actually was a JPY 2 billion tailwind in the quarter but the yen strengthening against other Asian currencies deducted JPY 6.5 billion.