Honda Motor Stock Upgraded: What You Need to Know

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Honda Motor's (NYSE: HMC) sales last month...weren't great. Honda sold 1.7% fewer cars in the U.S. in January 2018 than it had in the prior-year period, badly lagging the performance of Japanese rivals Toyota and Nissan. This followed an uninspiring performance in 2017, which saw Honda sales decline in five months of the year.

And yet, three days ago, analysts from JPMorgan met with Honda management. Today, JPMorgan announced that it's upgrading Honda stock. Coincidence?

I think not. Here's what you need to know.

Upgrading Honda Motor

This morning, JPMorgan upgraded shares of Honda from neutral to overweight. The banker predicted that Honda will enjoy "better profitability" this year on automobile sales, reports (subscription required), while the motorcycles market is about to shift into "structural growth" mode.

Test-driving the logic

Admittedly, that seems like a strange prediction for JPMorgan to be making in a week that saw Honda announce a 350,000-car recall in China, citing an issue with its engines failing to properly evaporate uncombusted fuel in cold weather. Recalls can ding profits, and a 350,000-car recall is about three months' worth of Chinese sales for Honda -- a not insignificant size.

Still, it's worth pointing out that Honda itself doesn't see any huge issue with Chinese sales. In fact, Honda grew its Chinese sales by more than 15% last year. And earlier this month, the company predicted that China will soon overtake the U.S. as its largest market. Partly as a result of its success in China, Honda raised its guidance to predict it will earn a $7.1 billion operating profit this fiscal year.

Incorporating this prediction into their models, analysts on average now predict that Honda will report 2018 earnings of $5.40 per share, according to estimates collected by S&P Global Market Intelligence. If that's correct, it suggests that Honda Motor stock could be a real bargain at today's price of less than $36 per share -- just 6.6 times current-year earnings.

With analysts projecting a long-term earnings growth rate of 5.7% for Honda, and Honda stock yielding a very respectable 2.7% dividend, 6.6 times earnings doesn't seem a very high price at all to pay for one of the world's most respected automakers.

Did anyone catch the number of that motorcycle?

And yet, if you ask me, the most important nugget of information in JPMorgan's note on Honda this morning, is what it might bode for another company entirely: Harley-Davidson (NYSE: HOG).

Harley had a rough time of things in 2017, with sales down 4% internationally and down an even steeper 11% in the all-important U.S. market. The company predicted that its motorcycle shipments will decline a further 4% globally in 2018, hurting production efficiency and shaving as much as 300 basis points off of its profit margin -- which Harley says could fall as low as 9.5% this year.

That's a grave prediction, and helps to explain why, even if Honda's stock is lagging the S&P 500 by a few percentage points over the past year, Harley-Davidson's stock is down much more -- falling 15.5% over the past 12 months, and trailing the S&P more than 30 percentage points. And yet, if JPMorgan is right and there's "structural growth" in the future for motorcycle makers like Honda, then that's even more important to know for investors in Harley-Davidson (which sells almost nothing but motorcycles) than it is for investors in Honda (which sells mostly cars).

The upshot for investors

When you get right down to it, I can't quite bring myself to recommend Harley-Davidson stock over Honda Motor stock. Harley may have a future, and Harley may sell for an undemanding 15.6 times earnings, but Honda looks downright cheap at just 6.6 times earnings. Still, in a market that seems to have little good to say about Harley-Davidson lately, JPMorgan's upgrade of Honda still holds out hope that there's still a future for one of Honda's biggest rivals in motorcycles.

If you're invested in Harley, that's welcome news, and a little something reassuring to hold onto on days when all the news is bad.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.