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  1. 1. Ticker: HMC Honda Motor Company (HMC) Sector: Consumer Goods Industry: Auto Manufacturing Company Profile Honda Motor Co., Ltd. engages in the development, production, and manufacture of motor products worldwide. The company Recommendation: BUY was founded by Soichiro Honda in 1946 and is based in Tokyo, (Recommended shares: 230) Japan. Honda is not only one of the leading auto-makers, but it is also one of the largest manufacturers of motorcycles, personal Pricing watercraft, and other general purpose engines. The company Closing Price $39.70 (1/30/07) 52-wk High $40.70 (1/24/07) also produces all-terrain vehicles, robotics products, and aircraft 52-wk Low $27.90 (1/30/06) jets. Stop-Loss $ 34.00 (recomm.) Honda’s automobile line consists of cars, trucks, cans, and SUVs. The company offers popular models such as Accord, Civic, Odyssey, Pilot, CR-V, and further models under the Market Data Acura brand. Honda’s motorcycle line consists of sports, Market Cap $144.80B business, and commuter models. The company produces a wide Total assets $90B range of motorcycles ranging from 50 cc to 1800 cc. Trading vol 500,884(3mon avg) In addition to its motor products, Honda offers various financial Valuation services to its customers and dealers. Further, the company EPS (ttm) $1.41 manufactures various power products, including power tillers, P/E (ttm) 27.67 portable generators, grass cutters, water pumps, snow throwers, PEG 1.75 and lawn tractors. Honda sells its products through various Div Yield (0.48) 1.20% water outlets, wholesalers, and independent retail dealers. Market Position and Competition Profitability & Effectiveness (ttm) Honda ranks first in motorcycle sales and sixth in overall ROA 4.9% automobile sales. With a global network of over 450 ROE 16.1% subsidiaries and affiliates accounted for under the equity Profit Margin 4.9% method, Honda develops manufactures and markets a wide Oper Margin 8.85% Gross Margin 28.6% variety of products ranging from small general-purpose engines and scooters to specialty sports cars, to earn the company an outstanding reputation from customers worldwide. Competitors of Honda include a number of companies in the automotive industry of the consumer goods sector. The top competitors are companies such as General Motors Corp., DaimlerChrysler AG, Toyota Motor Corp., Ford Motor Co., and Volkswagon AG. DIRECT COMPETITOR COMPARISON Valerie Chaston
  2. 2. HMC F GM TM Industry Market Cap: 142.32B 15.81B 18.48B 211.78B 15.90B Employees: 144,785 300,000 335,000 285,977 285.98K Qtrly Rev Growth (yoy): 12.50% -8.40% 3.60% 17.30% 3.10% Revenue (ttm): 87.00B 166.13B 206.71B 186.24B 186.24B Gross Margin (ttm): 28.63% 4.48% 0.54% 19.38% 17.67% EBITDA (ttm): 9.98B 8.67B 4.09B 30.27B 20.55B Oper Margins (ttm): 7.54% -3.04% -5.74% 9.59% 3.16% Net Income (ttm): 5.15B -6.82B -9.58B 13.04B 462.40M EPS (ttm): 1.41 -3.723 -17.124 8.06 1.14 P/E (ttm): 27.67 N/A N/A 16.34 18.29 PEG (5 yr expected): 1.75 N/A 1.14 N/A N/A P/S (ttm): 1.64 0.10 0.09 1.14 0.33 F = Ford Motor Co. GM = General Motors Corporation TM = Toyota Motor Corp. Industry = Auto Manufacturers – Major source: Yahoo!Finance The following graph shows that Honda has outperformed Ford and Toyota within the last year. While some company’s have fluctuated and appear inconsistent, especially within the last six months, Honda has continued its steady increase. Honda is largely a manufacturer of automobiles, but also manufactures a variety of motor related goods. The company has a history of consistent growth. In fact, Honda posted a record profit for the fifth straight year for the fiscal year ending March 31, 2006. This big jump was mostly attributed to a boost in the company’s US sales, an area where many automakers have been 2
  3. 3. lagging. Additionally, Honda has met with success in their domestic market (Japan) and other areas globally including Europe and Asia. Furthermore, Honda has recently begun to further pursue the China market realizing the growth potential possible. Honda is an industry leader in hybrid technology and production. The company manufacturers hybrid vehicles of all kinds and continues to pursue new technology. Very recently, Honda announced that it would make a push for ethanol powered vehicles as the price of oil remains high. Honda’s record profit for 2005, coupled with the unveiling of a $1.3 billion global expansion plan is the reason for the high share price jump in May 2006. Like most automobile manufacturers, Honda moves almost parallel to the S&P 500. This is most likely due to the fact that as the economy is doing better, consumers have more money and are more likely to purchase automobiles. Nevertheless, over the past year Honda has more than doubled the performance of the S&P 500. Looking at a graph over a five-year span reveals that Honda dominated the S&P 500. Even within the last six months, the company has shown nearly a 10% increase over the medium. Economic and Industry Environment Honda’s operating environment in fiscal 2006 was characterized by growing concern about soaring crude oil prices in various world regions. The U.S. economy was strong, benefiting from rising personal consumption and improved employment numbers, and the European economy posted a moderate recovery. Economies in Asia continued to record strong growth, especially in China and India. In Japan, the economy recovered modestly, supported by increasing personal consumption and capital expenditures and a turnaround in exports. 3
  4. 4. In this operating environment, Honda strove to solidify its corporate foundation in order to meet the needs of customers and society more swiftly and accurately. With respect to R&D, Honda actively developed technologies aimed at enhancing safety and minimizing environmental impact, as well as advanced technologies designed to boost the attractiveness of its products. On the production side, Honda strengthened its manufacturing foundation and expanded capacity at its Asian production facilities and its affiliates accounted for under the equity method. Additionally, Honda started construction of a new transmission plant in the United States and a production facility in Asia. Regarding sales, Honda aggressively launched products offering new levels of value and delivered offerings with global appeal. Also, the company worked to consolidate its automobile sales channels in Japan, upgraded its product lineup, and strengthened its sales system. Despite the fact that many large companies have problems with overcapacity and low profitability, the automotive industry maintains very strong influence and importance. The industry also provides well-paying jobs with good benefits, has heavy linkages with supplier industries (which gives it a huge role in economic development), and has a strong political influence. The automotive production industry is more than a hundred years old. Vehicle volumes, efficiency, safety, features, and choice have grown steadily throughout the industry’s history. However, there have been some setbacks in this industry. Worldwide, average margins have fallen from 20% in the 1920s to 5% now, with many companies losing money. The poor profitability performance is reflected in the industry’s market capitalization. Despite its huge revenues and employment, the automotive industry accounts for only 1.6% of the stock market in Europe, and 0.6% in the U.S. There is a big contrast between the industry’s lackluster financial success and its oversized social role, share of employment and political influence. These facts mask a wide range of operational and financial performance. Toyota, the most successful large auto company, has a market value 15 times larger than General Motors. Top Automotive Assembly Companies Vehicle Sales Per Year (Millions) Revenues ($US Billions) General Motors 9.17 192.6 Toyota 7.97 182.9 Ford 6.82 177.1 Volkswagen 5.24 119.1 DaimlerChrysler 3.85 187.5 Nissan 3.51 82.0 PSA/Peugeot Citroen 3.39 70.4 Hyundai Automotive 3.28 38.5 Honda 3.24 80.5 Renault 2.53 51.7 4
  5. 5. Source: Annual reports The overall performance of the industry can be traced to overcapacity and mature markets in developed countries. In the U.S., Europe, and Japan, which account for 80% of world sales, growth has been stalling for many years. The natural response to slowing growth and increasing productivity is to reduce capacity. However, existing plants are very painful to scrap. Mass production presents a strong cost advantage, which has traditionally encouraged very large and expensive plants. The result is excess capacity worldwide. Even continuing consolidation in the industry is not resulting in capacity reduction. Focusing on the U.S., the “Big 3” (General Motors, Ford, and Chrysler) automakers have been losing market share for three decades, and new plans by non-U.S. companies have increased capacity and competition. The two largest domestic U.S companies are losing money as well as market share. This is not a sustainable situation and the industry is in for a very big change. Risks: There are several risks factors in the auto manufacturing industry that are related to Honda. Two such risks associated with this industry include the adverse effects of market conditions. A continued economic slowdown, recession, or sustained loss of consumer confidence in the auto manufacturing markets, which may be caused by rising fuel prices or other factors, could trigger a decline in demand for automobiles, motorcycles, and power products that may adversely affect Honda’s operations. Additionally, prices for automobiles, motorcycles, and power products can be volatile. The volatility is caused by many factors, including increasingly fierce competition, short-term fluctuations in demand from underlying economic conditions, changes in import regulations, shortages of certain supplies, high material prices and sales incentives by Honda or other manufacturers or dealers. Several other possible risks include the following:  Operations subject to currency fluctuations  Hedging of currency and interest rate risk exposes Honda to other risks  Operations subject to extensive environmental and other governmental regulations  Operations reliant on the protection and preservation of its intellectual property  The company’s financial service business conducts business under highly competitive conditions in an industry with inherent risks  Operations reliant on various suppliers for the provision of certain raw materials and components  The company conducts its operations in various regions of the world Current Events: In recent news, it has been reported that Honda has set all-time annual records for worldwide and overseas auto production for 2006. For the tenth consecutive year, since 1997, worldwide production increased from the previous year. This was due mainly to increased production in North America and Asia. Honda’s net sales for the fiscal year of 2006, ended March 31, 2006, amounted to about $84 million, up 14.5% from the previous fiscal year. Of this amount, domestic new sales decreased by 0.3%, while overseas net sales increased by 18.2%. Valuation: 5
  6. 6. The first step in the valuation of Honda was to calculate the appropriate market capitalization rate. This was calculated using the CAPM formula. This formula is represented by the following equation: Market Capitalization Rate = Risk-free Rate + Beta (Market Return – Risk-free Rate) The beta of 1.04 was acquired from Yahoo!Finance. The market return that I will use is 9%, which was calculated from the S&P 500 30-day average return. Additionally, the risk-free rate from the 30-day Treasury bill will be used and is 4.98%. Market Capitalization Rate = 4.98% + 1.04(9% - 4.98%) = 9.16% a.) Owner’s Earnings Valuation Model To evaluate Honda, I first used the Owner’s Earnings Discount Model. This is a simplified way to get a general valuation. I used a simplified model that goes along with the teachings of investment guru Warren Buffett. This is displayed in Appendix A. I used the discount rate previously calculated above (9.16%). Analyst predicted a growth rate of 7.0%, which was used as the first-stage growth rate in the model. An additional growth rate of 3.0% was applied for the growth of the firm beyond ten years. Thus, the intrinsic value per share was $43.37. This suggests that the stock is undervalued. b.) Gordon Growth Model This is a constant growth model and gives a generalized idea of what the value of the firm would be if this 7.0% rate were applied. In this calculation, the same measures were exercised concerning the market capitalization rate. Also, the earnings per share identified for were $2.70 (identified on the Value Line Investment Survey) and the payout ratio thus calculated was 35%. This model expressed a value of $46.80. This however, should be higher since it is only looking at one constant growth. This is displayed in Appendix B. c.) Two-Stage Dividend Discount Model One again, a growth-rate model was used to calculate the value of Honda’s stock. This model, however, takes into account two stages of growth. Again, the same rates and values apply from the previous models. This model found Honda’s stock price to be valued at $38.55. This is a really close account of the value represented in the market. This is displayed in Appendix C. Financial Analysis: In analyzing the financial statements for Honda, several measures were assed concerning the operations of the company. Sales continue to grow and margins are up from the previous years. Also, the returns to shareholders have been consistently higher. There are four segments that were assessed to gain an insight on Honda’s performance over the past couple years and in relation to the auto-manufacturing industry. Liquidity: 6
  7. 7. Honda’s current and quick ratios, which measure how available assets are to be converted into cash the company could use, show that Honda is liquid. Honda is comparable to the industry and S&P 500, which have a current ratio of 1.1 and quick ratio ranging from 0.8 to 0.9. Profitability: Net sales are on a steady increase and have been for the past decade. Profits are up 15% from the previous year and margins are relatively high compared to the industry. Honda’s gross and profit margins for the quarter show 28.6% and 4.9%, respectfully. This compares to an industry average of 19.4% for gross margin and 4.0% profit margin. Additionally, the returns on equity and assets are in line with the S&P 500 and higher than industry standards. Return on equity is up from the previous year, 15.8% to 16.1% and has been consistently above 15% since for the last five years. Similarly, return on assets has been steadily increasing. The five-year average is about 9%. Long-term Solvency: Honda’s debt-to-equity and leverage ratios are lower than industry standards, with 80% and 2.6. This suggests that, while the firm many be fairly aggressive in financing its growth with debt, it is not meeting the industry average rate. Valuation: Honda’s current price to earnings ratio is 14.4%, this just under the industry average by about 2.0%. A high ratio suggests that investors are expecting higher earnings growth in the future. The PEG ratio is another useful tool for evaluating potential growth of a firm and Honda’s PEG is 1.75. Recommendations: Based on the research, I recommend a BUY position for Honda. It is a strong company that has outperformed the market and the rest of the industry for the past ten years on a consistent basis. In current news, the company has been expanding its operations overseas to prepare for new growth. They company is continuously developing new technology and this future growth seems eminent. Also, the recent release of Honda’s desire to manufacture automobiles that use more efficient and environmentally friendly technology proves that Honda is looking forward. To evaluate the recommended amount of shares to purchase, I suggest we increase the portfolio weight of Honda’s stock to 1.0%. This would mean adding an additional 230 shares to the fund. Honda is one of the top performers in the consumer goods sector and, according to analysts, its earnings estimates for the current year are expected to increase by about 14%. Below are a few charts comparing Honda’s stock price over the last several years to the 300 SMA. According to this information, it is apparent that Honda’s stock price is well above this standard and continues to increase. 7
  8. 8. HMC – 1 Year HMC – Default Style 8
  9. 9. Based on this information, the recommendation for a stop-loss price is $34.00. To calculate the amount of risk involved with this price, I used the Risk to Capital equation: (Current share price – Stop Loss price)*Shares/IFM Total Value I quickly calculated that the $34.00 stop-loss price would produce a risk to capital of 0.04%. This is in line with the current position of the committee to keep this risk under 1%. In closing, Honda’s performance is stable. Considering the factors discussed in this report, it is beneficial to add more equity to our fund. *sources for this analysis include: Honda 2006 Annual Report,ticker__HMC--/free-co-fin-stockquote.xhtml MSN Money Yahoo!Finance 9