Honda’s quarterly earnings for the March-June 2011 period revealed the full extent of damage caused by the tragic earthquake in Japan that occurred on March 11, 2011.
In the prior quarter, net income declined 38% year-over-year (yoy) caused by increasing SG&A costs following the earthquake. In the latest quarter, net income slumped 88% yoy as the resulting auto supply chain disruption resulted in Honda’s revenue falling more than what the company could have saved through cost controls.
Honda’s vehicle sales and automotive revenues dropped significantly. Now even as Honda tries to recover from the Japanese disaster, the company is facing the specter of a global economic slowdown which will hurt its sales recovery in the near and medium term. Honda mainly competes with BMW, GM, Daimler, Audi, Ford, Toyota and others.
Our $34 price estimate for Honda stock is about 10% above the current market price.
Revenues dip faster than costs
Honda’s fiscal first quarter ended June 2011 experienced a total revenue decline of 27% yoy primarily as a result of plummeting automobile sales, which declined nearly 40% yoy. The earthquake hit Tohoku, Japan’s main automobile production center and caused severe disruptions in the automobile parts supply chain. This led to a fall in Honda’s car production and thus led to a decline in the company’s inventory levels. Even though the firm was able to control costs by reducing R&D and Selling, General & Administrative expenses, its fixed costs per unit increased due to a drop in production.
Deteriorating global economic environment – a major hurdle for Honda’s sales recovery
As Honda and many of its suppliers try to recover from the disruptions caused by the earthquake, the slowdown in global business activity is likely to impede the company’s sales recovery. In the U.S., growth in consumer spending and capital expenditures remains sluggish while high unemployment continues to plague the recovery. In addition, the government has been strained by its ability to provide fiscal stimulus as a result of rising market concerns over its debt levels and the recent S&P downgrade of U.S. debt. These issues will likely impact business and consumer confidence and continue to weigh on U.S. automobile sales in the short term.
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Fears of a slowdown have been exacerbated as a result of the continuing sovereign debt problems in Europe which is spreading beyond Greece to other euro-zone economies such as Span and Italy. Weakness in Europe is expected to negatively impact auto sales in the region as well.
A slowdown in the U.S. economic growth will also hurt many export reliant Asian economies. The economic expansion that was underway in several emerging markets of Asia is moderating as a result of high inflation and the resulting tightening of monetary policy through higher interest rates. In July 2011, car sales in India dropped for the first time in 30 months while China’s vehicle sales growth moderated to 6.7%. 
These factors will likely impede growth in the overall automotive market thereby impacting Honda’s sales.
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