Can Honda Motor Co. Grow Without the Yen Effect?

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Japanese automaker Honda reported respectable numbers in the fiscal year ended March, with both revenue and profit thriving from the weak yen. But as its effect wanes, how's the company placed to perform over the coming quarters? True, Honda is working hard to control cost and also planning new vehicle launches to maintain its sales momentum, but is that enough?

Takeaways from the yearly performance
Honda reported revenue of 11.8 trillion yen ($116 billion at current exchange rates) for the fiscal year ended March 2014, up 19.9% from last year. The automobile and motorcycle segments posted unit sales growth of 7.7% and 9.9%, respectively, while the power products business dipped 0.6%. 

Auto sales got a boost from Asia, with volumes rising 18.2% year over year to 818,000 units in Japan and 14.6% to 1.2 million units elsewhere. In Japan, buyers lapped up the remodeled Fit that was launched in September, while the N-series' N-WGN, the compact SUV Vezel, and the fully refurbished Odyssey found takers as well. Sales also leaped as customers hurriedly bought vehicles in March to dodge an 8% sales tax that began in April. 

Honda Odyssey. Source: Honda Motor Co.

India was the other bright spot, with volumes up 83% to 134,339 units, owing to the popularity of the compact sedans, the Amaze and the City. In North America sales grew 1.5% to 1.8 million units, and Europe remained flat at 169,000 units.

Asia dominated the motorcycle segment with 14% year-over-year volume growth during the fiscal year. The CB Shine and Active models sold big in India, and the former became the best-selling 125cc motorcycle in the world, recording 3 million units sold.

Japanese Prime Minister Shinzo Abe's economic policies paid off as a weaker yen brought home a net profit of 574.1 billion yen ($5.65 billion), up 56.4% from previous year. Operating income of 750.2 billion yen ($7.38 billion) was 37.7% higher than fiscal 2013 driven by the higher sales and favorable currency. Though operating expenses rose during the year, it was more than compensated by the increased sales volume and favorable model mix.

Cash from operating activities was 1.2 trillion yen ($11.8 billion), an improvement from the previous fiscal year's 800.7 billion yen. But free cash flow generation plunged further to 479.5 billion yen ($4.72 billion) as the company spent heavily on capex.

Fiscal year 2014 was good for Japanese carmakers primarily due to the benefits available to them thanks to currency exchange rates. Honda's average conversion rate was 100 yen per dollar compared with 83 yen per dollar in fiscal year 2013, which increased the amount of overseas profits when converted to yen. But in fiscal 2015, the company expects the yen to remain stable. Without factoring in the benefits from the currency exchange rates, it has forecast only a modest 3.6% growth in net income to 595 billion yen for fiscal year 2015, no match for this year's bumper profits.

The company's also facing stiff competition in the U.S. auto industry -- its largest market accounting for 40% of total sales. In the last four months, sales of Honda vehicles in the U.S. were down 3.3% to 405,740 units despite the heavy incentives that it's offering. Bloomberg reports that Honda's incentives increased 42% year over year to $2,010 in the first quarter of 2014, way ahead of the 7.4% increase recorded by the industry. 

Honda expects its sales volume to remain flat at 1.8 million units in North America in fiscal year 2015. It's hoping that sales in Japan (172,000 units) and the rest of Asia (304,000 units) will compensate for this weakness in its largest market. This could take Honda's overall sales to 4.8 million units from the current level of 4.3 million units; yet its target of 6 million vehicle sales by 2016-2017 still remains a distant dream. 

Time-tested strategies
On a positive note, Honda understands that unveiling fresh cars is crucial for pushing sales, while keeping costs under control is essential for boosting profitability, and it's working hard on both of these factors.

In fiscal year 2014, it successfully launched the third-generation Honda Fit in Japan and China (in India it is labeled the Jazz). Soon the new Fit will make its appearance in North America together with the compact SUV -- the HR-V -- that sells as the Vezel in Japan. In China, Honda also launched the Crider and Jade models, and plans to roll out nine new or remodeled cars over the next two years to bolster sales and increase market share. 

Honda Fit. Source: Honda Motor Co.

Also, the carmaker has deployed several methods on the cost reduction front. These include sharing platforms among models to improve efficiency and lower development costs, and reducing the production cost of hybrids, which are generally higher than costs associated with producing conventional cars. The company also reduced its pension benefit from January, and has even implemented lean production in its manufacturing processes.

It achieved cost savings of 15 billion yen ($147.5 million) in fiscal year 2014 and is trying to continue the momentum. While cost savings will not give a similar boost to earnings as the currency exchange rate benefits, it will definitely aid profitability in the future.

Foolish takeaway
Honda did well in fiscal year 2014, but sustaining its growth rate could be difficult once the benefits from currency exchange rates moderate. It's also in bit of a rut in the U.S. and needs to accelerate sales. But management is aware of the challenges, and is aggressively cutting costs and bringing out new models to generate sustainable growth.

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