Morningstar DBRS Confirms Honda at A (high); Trends Remain Stable

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating of Honda Motor Co., Ltd. (Honda or the Company) at A (high). Concurrently, Morningstar DBRS confirmed the Senior Unsecured Debentures and Commercial Paper credit ratings of Honda Canada Finance Inc. at A (high) and R-1 (middle), respectively. The trends on all credit ratings remain Stable.

KEY CREDIT RATING CONSIDERATIONS
The confirmation of the credit ratings reflects Honda’s sound business risk assessment (BRA) as an automotive original equipment manufacturer (OEM) of moderate scale, albeit with strong technological capabilities. Moreover, recent financial earnings performance has been bolstered by the stronger earnings of the Company’s Automobile segment in line with ongoing firm demand (notably in North America) amid a recovery in production volumes enabled by the progressive improvement in the global semiconductor shortage. Moreover, Honda’s ratings remain underpinned by its robust financial risk assessment (FRA), with the Company’s industrial operations having a sizable net cash position (i.e., industrial cash balances exceeding indebtedness) and substantial available liquidity.

CREDIT RATING DRIVERS
Consistent with the Stable trends on the credit ratings, Morningstar DBRS expects Honda’s ratings to remain constant over the near to medium term. Morningstar DBRS sees limited potential for positive rating actions given the high level of the Company’s current credit ratings (compared with the industry average), further noting Honda’s moderate scale relative to the world’s largest OEMs. Conversely, future earnings underperformance and an associated cash burn resulting in a meaningful weaking of credit metrics could potentially lead to negative rating actions, although Morningstar DBRS considers this scenario rather unlikely.

EARNINGS OUTLOOK
For fiscal 2024 (F2024, ending March 31, 2024), Morningstar DBRS expects Honda's earnings to trend significantly higher year over year (YOY) with profitability being bolstered by volume growth, favourable product mix, and pricing (in addition to slightly positive foreign exchange effects), partly offset by cost increases, including higher warranty expenses. The Company is targeting increased efficiencies in its Automobile operations through its Honda Architecture initiative, capacity reductions, and more streamlined model allocation/trim variations. Consistent with its peers, Honda plans to progressively expand its electric vehicle offerings in line with tightening emissions regulations across most global jurisdictions. As such, while Morningstar DBRS expects the Company's earnings to benefit from business growth (unit sales and product mix) and planned efficiencies, this will likely be partly offset by the higher development costs related to the progressive electrification of its products.

FINANCIAL OUTLOOK
Morningstar DBRS anticipates that Honda’s cash flow from operations in F2024 will materially increase YOY amid improved earnings (and slightly firmer depreciation levels). Moreover, the Company forecasts capital expenditures (capex) to contract modestly YOY and approximate JPY 440 billion. Dividend payments for F2024 are slated to moderately increase YOY and slightly exceed JPY 240 billion. As such, gross free cash flow (FCF) in F2024 is expected to considerably strengthen YOY and remain substantially positive. Moreover, Morningstar DBRS estimates that FCF will remain supported beyond F2024 and over the medium term as cash generation should continue to outpace capex and dividend payments, in line with projected ongoing earnings growth.

CREDIT RATING RATIONALE
Honda’s credit ratings are supported by its solid market position in key markets, notably the United States and Japan, with the Company’s core nameplates also being highly established in their respective vehicle segment categories. Moreover, the Motorcycle and Financial Services businesses provide meaningful diversification benefits. The credit ratings also reflect Honda’s highly conservative financial policy, with Honda’s FRA and associated credit metrics remaining strong and well commensurate with the current credit ratings.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
Morningstar DBRS considered that the E factor, specifically costs relating to carbon dioxide (CO2) and greenhouse gas emissions, represents a relevant factor as Honda is subject to a wide range of environmental compliance requirements relating to CO2, fuel efficiency, emissions control, and other factors. In the event the Company cannot comply with applicable regulations, significant penalties and reputational harm could result. Moreover, such risks could significantly affect Honda’s mid- and long-term initiatives, particularly regarding further electrification of its products. Accordingly, Honda is targeting research and development expenses and investments of JPY 5 trillion in electrification and software over the next 10 years (from F2022).

There were no Social or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of Honda, the relative weighting of the BRA factors listed in the Automotive Manufacturing section of the methodology was approximately equal.

(B) Weighting of FRA Factors
In the analysis of Honda, the relative weighting of the FRA factors listed in the Automotive Manufacturing section of the methodology was approximately equal.

(C) Weighting of the BRA and the FRA
In the analysis of Honda, the BRA carries greater weight than the FRA.

Notes:
All figures are in Japanese yen unless otherwise noted.

Morningstar DBRS applied the following principal methodologies:
-- Global Methodology for Rating Companies in the Automotive Manufacturing and Supplier Industries (October 11, 2023), https://dbrs.morningstar.com/research/421716
-- DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support (March 28, 2023), https://dbrs.morningstar.com/research/411694

The following methodology has also been applied:
-- DBRS Morningstar Global Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (February 24, 2023), https://dbrs.morningstar.com/research/410196

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/397223.

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 under Related Documents or by contacting us at [email protected].

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at [email protected].

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577