Honda Fans' Fears Confirmed by Its Dismal Q3

By Markets Fool.com

Honda Motors' third-quarter results were, as expected, dismal. The Japanese automaker is having a tough time handling airbag issues and falling sales on its home turf. It has cut forecasts for the fiscal year ending March 31 for the second time in a row, indicating that its fundamentals are unlikely to make a U-turn anytime soon.

Continue Reading Below

But is there anything that we're missing? Let's dig in.

Source:StaraBlazkova viaWikimedia Commons.

Revenue growth is decent, but...
Honda reported nice revenue growth of 9% to $27.3 billion (3,289.9 billion yen) in the third quarter, better than the first two quarters. All of its segments -- motorcycle, auto, financial services, and power operating units -- saw growth. However, the improvement was mostly driven by currency tailwinds of a depreciating yen.

Continue Reading Below

Data source: Company press release. Chart by author.

Although revenue in absolute terms looked good, unit sales lagged, particularly in the automobile segment. Sales of motorcycles grew 4.3% to 4.4 million units, while sales of automobiles and power products fell 5% and 1.2%, respectively.

Sales of automobiles, the company's second-largest revenue generator, have struggled to increase. During the first two quarters, total units sold were trending upward, but they dropped about 5% in the third quarter, owing to lower demand in Japan.

Data source: Company press release. Chart by author.

Sales in Japan fell 25% in the quarter compared to the year-ago period. Japan recorded strong sales during the first quarter of fiscal 2015 as people rushed to buy cars before a sales tax increase in April 2014, but since the, sales have decreased.

North American sales were almost flat year over year, though there was a sequential increase -- thanks to the increased demand for the CR-V and Accord. Asian sales were driven by India and Indonesia, partially offset by soft demand in China.

Earnings hit a speed bump
An earnings hit was inevitable, because 9% revenue growth is not enough to bear the massive recall expenses the company has been facing. Net income dropped 15% to $1.1 billion (136.5 billion yen) as operating income fell 22.5% to $1.5 billion (177.2 billion yen) on lower unit sales, unfavorable product mix, and higher expenses. The fall was somewhat cushioned by cost-reduction efforts and yen depreciation.

Data source: Company press release. Chart by author.

As far as the segments go, Honda's motorcycle business proved to be the most profitable once again, with a 55% increase in operating income. But a 50% decline in automobile operating income and an operating loss in the power business pulled the overall operating results down.

Honda's automobile business has recently been plagued by recalls. Almost 5.39 million of its cars have been recalled since last July because of faulty airbags, supplied by Japan-based TakataHonda also recalled over 400,000 hybrid models, including the Fit in Japan, over the past 12 months to fix a software glitch. These recalls made the Japanese behemoth add another level of R&D before putting the models on sale, thus increasing expenses.

Hazy outlook for a near-term turnaround
The company anticipates the recalls to affect the fourth quarter and fiscal 2015 as a whole. Honda has cut its full-year profitability and unit sales forecast yet again.

Total sales in fiscal 2015 are expected to be 4.45 million, down from 4.62 million projected in the second quarter, which was again a revision from 4.83 million forecast during the first quarter. Honda expects sales in Japan to drop by another 100 units, North America by 10 units, and Asia by 60 units from the second-quarter forecast.

The back-to-back recalls have forced Honda to spend more time on validation tests, while delaying new launches in Japan. So Japan will continue to be a pain point.

Honda expects a 4% decline in full-year operating income and a 5.1% fall in net income. However, a weak yen will continue to boost overall revenue growth.

Is there a light at the end of the tunnel?
Honda is sticking to its cost-cutting efforts, which could balance out the growing recall expenses. Notably, in an unparalleled act of accountability, 13 of its top executives, including the president, took a three-month pay cut in the third quarter to absorb the recall cost of the Fit hybrid and other hybrid models.

Honda U.S. exited January with lots of comparatively good news. Sales jumped about 12%, owing to robust sales of the Fit, CR-V, and Pilot. Honda could also continue to benefit from the growing demand of SUVs in the United States. Its Acura luxury brand is also going from strength to strength, led by the RDX crossover and the newly launched TLX sedan.

From April 2014 to January 2015, Honda's American sales reached 1.5 million. If Honda can sustain the momentum in the final two months of its last quarter, toppling its annual sales target of 1.8 million for North America won't be difficult.

Summing up
The fiscal year so far has been marred by recalls, and the sales fall in Japan doesn't help. The two are hurting Honda's financials, but the company is doing well to cut costs and increase R&D investment, which would help avoid more recalls like that on the Fit going forward. The sales turnaround in North America, its biggest market, is a healthy sign and could help it end the year better than anticipated.

The article Honda Fans' Fears Confirmed by Its Dismal Q3 originally appeared on Fool.com.

ICRA Onlineand Eshna Basu have no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.