After a significant decline from last year’s peak, Honda (NYSE: HMC) releases strong upside potential derived from a discounted cash flow model. Despite temporary headwinds like pandemic-caused production shutdowns and high inflation environment, HMC improved operational efficiency and reassured its inventors that their margins will remain under control and continue to grow. The stock demonstrates a powerful catalyst just waiting to materialize, making it an excellent buy in the current weakness.
HMC has been around for over 73 years and is one of the major players in the global automotive industry. It operates through 4 separate reportable segments: Motorcycle, Automotive, Financial Services, Life Creation and Other Business Activities. This makes the company’s product portfolio diverse and broad enough to meet potential changes in demand for from cars to motorcycles due to the current fuel cost hike triggered by the war between Russia and Ukraine.
Currently, HMC is suffering from an economic downturn due to the pandemic, which was triggered by high inflation and shortages of semiconductors. As a result, the company was unable to sustain pre-pandemic revenue growth, and in its third quarter 2022 report, the company reported total revenue of 124,250.1 million, which is still lower than its fiscal 2020 revenue of $138,871.1 million. In fact, the company has seen declining revenue since the start of the quarter, which amounted to $32,049.4 million, down 2.19% from the $36,525.7 million recorded in the same quarter last year. This is mainly due to the slowdown in its sales in North America and Europe, both of which are experiencing a temporary period of high inflation which is affecting demand from their respective customers.
However, despite the uncertainties of the economic recovery in this fiscal year, management provided a strong outlook for its revenue for this fiscal year 2022, amounting to 14,550 billion yen (127,408.06 million dollars). ; USD/JPY exchange rate = 114.2), which is expected to beat its ¥13,170 billion ($118,943.7 million) recorded in fiscal 2021. This is based on the assumption of a continued pandemic recovery, particularly in North America, and from May of last year to the present we have seen a continued decline in new covid cases around the world.
HMC has two positive catalysts:
- Its solid path to electrification in the United States and its strong R&D spending outlook of 8 trillion yen ($64 billion). One of the challenges Honda is currently facing is its competitive environment and its slow transition to battery electric vehicles. It’s been a while since the company provided an outlook on its electrification initiative, the previous one being in October last year, talking about its plan to develop 10 electric vehicle models over the next 5 years. in China which will be called the “e:N series”. They recently announced an update to their electrification strategy and this time it includes a plan to dedicate an electric vehicle production line in the United States, which will strengthen their American operationwhich currently accounts for 50% of its total revenue in the third quarter of 2022. It is one of management’s few strong catalysts following the phasing out of their all-electric Honda Claritywhich was the only Honda-branded electric vehicle available in the United States to be obsolete in terms of EPA-estimated range compared to its peers ranging from 300 EPA miles. The company’s recent announcement highlighted several noteworthy numbers that will help rejuvenate its aging product portfolio. One is their long-term goal of launching 30 electric vehicle models globally and another is their goal of manufacturing 2 million units per year by 2030.
- Their plan to introduce two sporty electric vehicle models globally with “distinctive” features. In my opinion, this will help the company reintroduce its electric brand in the United States. Management has also hinted at its intention to form a joint venture with Sony Group (NYSE: SONY) to help the company achieve its long-term goal of developing high-value electric vehicles. A fruitful conversation between the two companies, combined with Sony’s expertise in entertainment technology, will usher in a new, perhaps challenging era of mobility. You’re here (NASDAQ: TSLA).
Hampered by temporary headwinds
Despite temporary headwinds such as production shutdowns due to flooding, the Omicron wave and continued shortages of semiconductors, management assures investors that their forecast for automotive unit sales for fiscal year 2022 of 4 200,000 units remain unchanged.
For the next fiscal year, we expect the impact of the semiconductor shortage to persist, but we are working to further strengthen the business foundations of profitability we have built and ensure we are well prepared for the future. and [relating] for continued growth. Source: Third quarter 2022 earnings call
However, the total revenue forecast for FY2022 is questioned and revised by management to 14.55 trillion yen ($127,408.06 million) from 15.2 trillion yen ($143,518.08 million). dollars; USD/JPY exchange rate = 105.91) billion in Q4 2021, making it still below pre-pandemic levels.
Despite the downward revision to revenue, management raised its operating profit outlook to 800 billion yen ($7,005.25 million; USD/JPY exchange rate=114.2) from 660 billion yen ($6,231.71 million; USD/JPY exchange rate=105.91), due to cost reduction initiatives aligned with the company’s long-term goal of improving its structure of profits. As shown in the graph above, HMC is actually improving its OPEX spend relative to its total revenue, which resulted in a higher operating margin of 6.19% compared to 5.01% the previous financial year and 4.24% for the 2020 financial year.
Potential Wave 2
HMC is currently printing a potential bullish flag pattern as shown in the chart above. Consolidation above $23, in my view, will provide investors and traders with a good entry point. In this scenario, I expect HMC to complete its corrective wave C before initiating an impulse wave 3 and likely challenge its current 52-week high of $33.42. However, if the price falls below $19, this count becomes invalid. This counting method is based on the Elliott wave theory, which predicts that the market will initiate a rally after the completion of its corrective waves. Looking at its simple moving averages, it demonstrates strong bearish sentiment as the current price is trading below its three SMAs. This is consistent with the fact that its MACD indicator is currently in negative territory.
Strong upside potential despite a conservative outlook
By estimating a fair price of $35.89 using a discounted cash flow model and averaging with the result an implied fair price of $12.37 x P/E of 33.7 $, I arrived at a fair average price of $34.81 with 34% upside potential. In my model, I assumed a conservative exchange rate of 1 USD = 128.4 JPY from its 200-day average of 114.2 JPY. I have also assumed below its industry median multiple of the P/E ratio of 13.40x and the EV/EBITDA ratio of 9.37x.
I completed my DCF model using an expert projection. I mirrored management’s outlook for its 2022 fiscal year and projected it to 17,400,870 million yen ($152,371.89 million; USD/JPY exchange rate=114.2) by the end of the model. In my opinion, it is possible that the company will continue to expand its production both in China and in the United States and with its high R&D budget, I think the company is on track to produce 2 million units per year. Despite its current operating margin outlook, I’ve modeled it below what management expects as tension between Russia and Ukraine. intensifies, which may temporarily affect the cost of the company’s inputs, such as steel, and expects it to reach a conservative rate of 5.9%. I also assumed a conservative discount rate of 10% to complement my DCF model, which is aligned with current market sentiment.
After a significant decline from its peak last year, Honda is creating better upside potential that outweighs current risks. It has maintained a liquid balance sheet and has actually delivered improved metrics with its current record ratio of 1.38x and its record debt-to-equity ratio of 0.78x, despite temporary headwinds. Additionally, in addition to its improved efficiency, HMC ended its third quarter of 2022 with a trailing FCF margin improvement of 4.88%, up from its 5-year average of 3.60% and benefiting from positive growth in its EPS this financial year 2022 to be ¥389.54 ($3.41; USD/JPY exchange rate = 114.2) versus ¥380.75 ($3.44) in the prior fiscal year, compared to ¥345.99 ($2.42) in fiscal 2020 and from ¥260.13 ($3.12) recorded in the fiscal year 2019. With successfully managed margins and strong catalysts waiting to be realized, HMC is a strong stock in the current high inflationary environment and is a buy at today’s price.
Thanks for reading and good luck!