DBRS Confirms Honda Motor Co., Ltd. at A (high) and R-1 (middle), Trend Remains Stable

DBRS has today confirmed the long- and short-term ratings of Honda Motor Co., Ltd. (Honda or the Company) and its related companies at A (high) and R-1 (middle), respectively. The confirmation reflects the Company’s strong business profile, with its core automotive models very well positioned to benefit from the structural shift worldwide toward more fuel-efficient vehicles. DBRS also notes that Honda enjoys modest diversification benefits from its motorcycles segment (where the Company is a global leader) and financial services operations. The trend on the ratings is Stable. While DBRS recognizes that the Company is currently undergoing substantial growth and investment activities that will persist over the next few years, the elevated level of investments is expected to be sufficiently offset by projected strong sales and solid cash flow generation, with the Company’s credit metrics and financial risk profile remaining well commensurate with the assigned ratings.

Honda’s results in fiscal 2013 (F2013, ending March 31, 2013) were much improved year over year, with the operating earnings of the Company’s industrial operations attaining their highest level since F2008. The stronger financial results essentially incorporate the recovery of Honda’s production capabilities, which were previously significantly affected by the Great East Japan Earthquake and subsequent flooding in Thailand. Higher automotive revenues were also a function of generally favourable global industry conditions (with the exception of Europe, to which, however, Honda’s exposure is relatively low). Of particular significance, this included Honda’s two major automotive markets, the United States and Japan (which together typically account for close to two-thirds of the Company’s total vehicle sales). In the United States, industry volumes increased year over year, in line with the nation’s ongoing automotive recovery, while in Japan, vehicle sales benefitted from higher economic activity (following the previous natural disasters) and government incentives in effect through the first half of F2013.

Through the first half of F2014, the Company’s financial results continued to improve year over year as ongoing unit sales increases were bolstered by positive foreign exchange effects given the depreciation of the Japanese yen. DBRS notes, however, that while Honda stands to benefit from the progressive weakening of its native currency, it is relatively less exposed in this regard vis-à-vis its Japanese peers, with the Company’s domestic production currently estimated to represent less than 25% of global production. Moreover, in North America, taking into account production capacity increases planned in the near term (the most significant being the new Mexican plant slated to open later this year), the Company estimates that more than 90% of cars sold in the United States would be manufactured in North America, with the region also likely serving as an export base to other markets.

DBRS notes that Honda is presently undergoing a phase of substantial investment and growth activities, with the Company expected to incur significantly higher capital expenditures and research and developmental (R&D) expenses (relative to historical norms) over the next few years. Through planned capacity increases in Asia and the Americas, the Company estimates that its production capacity by year-end 2015 will total more than 5.5 million units. DBRS observes that such growth objectives are of particular importance to Honda, with automotive original equipment manufacturers (OEMs) being under increasing pressure to attain sufficient scale to effectively compete in the industry, where escalating costs linked with product development and tightening emissions legislation render it all the more challenging for modestly sized auto companies to remain viable over the medium-to-long term.

Apart from the significant increase in production capacity, the Company’s investments will also result in technological advances, with Honda significantly expanding its powertrain offerings to include a new range of gasoline (as well as diesel) engines, new continuously variable transmissions and an enhanced hybrid line up. The Company’s competitive position is expected to be well defended by launches/revisions of some core models, the most significant being the new Fit and its derivative small crossover utility vehicle model to be launched later this year. Honda will also look to increasingly coordinate new model introductions on a global basis, with such practices bolstering large volume production, thereby resulting in cost reductions and enhanced unit margins through scale efficiencies and global sourcing.

Notwithstanding the Company’s elevated investment objectives over the medium term, DBRS notes that the planned outlays are expected to be essentially internally funded by cash flow generation, which is forecast to be solid, in line with ongoing sales growth. The projected sales increases reflect generally favourable global market conditions, with industry volumes likely increasing across all major market regions except for Japan (which is likely to remain at essentially flat levels). Moreover, as previously mentioned, Honda’s product cadence is expected to be strong with the Company’s heightened focus on compact vehicles bolstering its competitive position primarily in emerging markets, which are likely to represent the majority of global industry growth going forward.

DBRS expects the ratings to be constant over the near-to-medium term, with forecasted earnings growth and cash flow generation maintaining Honda’s credit metrics at solid levels notwithstanding the Company’s elevated investment plans. However, in the event that Honda were to incur significantly negative free cash flow as a result of weaker-than-anticipated earnings, this could potentially result in negative rating implications, although this is considered unlikely by DBRS.
 
Notes:
The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Companies in the Automotive Manufacturing Industry (August 2013), which can be found on our web site under Methodologies.