Honda Motor

Honda’s fiscal first-quarter consolidated revenue grew 14% year on year, with automobile revenue up 10% and motorcycles up 20%. Automobile margin returned to a positive 5% due to reduced tariffs and favorable currency effects, while sales and profitability for the China unit remained sluggish.

Why it matters: While the automobile segment's operating profit returned to positive JPY 192 billion, the turnaround was primarily driven by noncore factors such as tariffs and a weaker yen, while rising incentives and inflationary costs will continue to cloud the underlying business, in our view. Management guided for JPY 520 billion in costs for the electric vehicle strategy shift in fiscal 2027, bringing the total EV write-down to JPY 2 trillion. We believe the more-than-doubling operating profit with record motorcycle profitability in the first quarter provides a safety net as Honda absorbs the pain. The pivot back to hybrids from EVs signals a tactical retreat in view of demand slowdown, and the outlook depends largely on US hybrid demand by 2030, in our view. However, we think delaying EV development risks leaving Honda behind China automakers in the long-term global EV race.

The bottom line: We maintain our fair value estimates of JPY 1,550 (USD 32). Shares are now fairly valued in 3-star territory. The capital destruction from EV restructuring and uncertainty in the Middle East, affecting sales and material costs, will limit near-term upside, in our view.

Between the lines: Management raised its fiscal-year revenue forecast to JPY 24.2 trillion and operating profit to JPY 650 billion, but only to reflect the assumption of JPY 155/USD from the previous JPY 145/USD exchange rate. Meanwhile, the core business outlook is unchanged, notwithstanding a favorable volume and pricing impact and improved profitability in the first quarter. In our view, this indicates that elevated promotional incentives and input cost pressure remain key headwinds capping margin expansion.

The automotive segment recorded an operating profit of JPY 192 billion from a JPY 30 billion loss a year ago. The profit turnaround was primarily driven by noncore factors, with a reduced tariff impact, favorable currency effects, and absence of EV-related impairment losses offsetting rising incentives and input cost pressures. However, the elevated incentives in the US market make us remain cautious on the near-term automotive demand outlook given headwinds to consumer affordability. The company saw improving sales across major markets in Japan and North America; the China market remains challenging. Honda's China automotive retail volume fell another 47% to 83,683 units during the fiscal quarter, which led to Honda’s global retail unit sales down 6% to 786,000 units. Due to intense competition and the declining internal combustion vehicle market, we expect the firm’s China business will continue to face sales and profitability pressure for the rest of the year.

The motorcycle segment posted decent volume growth in key markets driven by strong sales in India and Brazil, with total unit sales up 10% year on year and revenue up 20%. As a result, motorcycle segment operating income grew by 24% year on year to JPY 234 billion and operating margin expanded by 60 basis points to 20.5%. The record-high quarter was helped by a JPY 29 billion currency tailwind, JPY 20 billion volume and mix benefits, and JPY 13 billion pricing contribution, which offset rising raw material costs.

Our fair value estimate for the US-traded ADRs of Honda is USD 32, which implies a fiscal 2028 price/earnings ratio of 11 times. For fiscal 2027 guidance, management forecast 11% consolidated revenue growth to JPY 24.2 trillion and operating profit at JPY 650 billion, as the impact of a favorable exchange rate, positive volume, and pricing offsets its EV project write-off, tariffs, higher incentives, and inflationary costs. Global automotive retail volume was guided to reach 3.4 million, flat year on year, with 6% growth in North America offsetting the decline in China.

Our Stage I forecast assumes a 3% revenue compound annual growth rate over our forecast period, excluding the captive finance arm, driven by an expansion in volumes and the average selling price. We project the firm's operating margin, excluding the finance arm and China joint venture equity income, will average 2.3% during our Stage I forecast as we incorporate the impact from the 25% US tariff on imported vehicles. In addition, competition continues to intensify for Honda, which may make margin expansion more difficult than in the past, so our midcycle operating margin (excluding financial services) is 2.7%. During the past decade, Honda's operating margin has had a high, low, and median of 6.4% (2024), 2.4% (2016), and 3.8%, respectively. In fiscal 2026, Honda sold 3.4 million automobiles, including joint-venture sales, while the largest automakers typically sell about 10 million units a year. With the global auto industry becoming increasingly competitive, we see margin expansion challenges ahead for Honda.

Our assumed cost of equity is 10.5%, including 0.5% country risk premium. This reflects Honda’s sensitivity to the economic cycle, plus relatively low financial leverage, offset by the company's unfavorable operating leverage relative to other automakers', and results in our above-average systematic risk rating. Our pretax cost of debt assumption is 4.7%, taking into account the spread creditors are likely to demand given Honda's credit quality. We assume a long-run effective tax rate at 27% based on Japan's statutory corporate tax rate and Honda's historical results. We estimate total debt/equity for the automotive operations of 9.5%. Consequently, our weighted average after-tax cost of capital used to discount Honda's future cash flows is 8.5%. We value Honda's financial services business at book value.

Most vehicle manufacturers do not have a moat, due in large part to the competitive landscape of the industry as well as its cyclical nature. The cyclicality of the business makes it difficult to maintain any excess returns above the cost of capital over an economic cycle. Generally, we see two moat sources in the auto sector from intangible assets, such as brand equity, best exemplified by Ferrari, and cost advantage. At this stage, we do not yet see either of the moat sources to be retained by Honda in anticipation of intensifying competition within the next 10 years from electric vehicles and the internal combustion engine market, where consumers have low switching costs. While we forecast Honda's returns on invested capital to recover coming out of covid-19 and the chip shortage over the next five years, we have less conviction that the firm can earn excess returns relative to its weighted average cost of capital, and it is not immune to value destruction in a recession.

Honda operates in a capital-intensive industry that suffers from stiff competition. It is very challenging to build a brand image that warrants a moat, and it takes decades of industry awards and technological innovation to gain a maintainable economic advantage over competitors. There are no switching costs for customers who are looking to change vehicles. Even the longest-lasting mass-market brands are rarely able to create significant pricing power compared with peers. Relying on mass-market appeal decreases the value of a company’s intangible assets, which have proven to be an important moat source for select luxury brands like BMW, Porsche, and Ferrari. Moreover, barriers to entry are not as high as in the past. Competitors in emerging economies like China and India pose a real threat to take market share in Europe and the US. In addition, electric vehicle companies like Tesla and BYD are crowding the space in an effort to capture a meaningful share of the electric vehicle market.

We see a high degree of difficulty for a mass-market automobile manufacturer like Honda to have a competitive advantage. Despite annual global light-vehicle production averaging around 4.6 million units in the past 10 years, Honda is unable to garner significant pricing power relative to competitors. The company failed to generate returns on invested capital above its cost of capital in fiscal 2015-26 and has averaged a negative 2.1 percentage points of economic profit since fiscal 2016.

Honda significantly reduced its EV sales volume plan for 2030 and instead focused on hybrid vehicles in view of the EV demand slowdown in the US market. While the long-term vision of achieving carbon neutrality by 2050 remains, Honda's previous targets, such as a 40% global zero-emission vehicle lineup by 2030 and 100% by 2040, are being reassessed. Regarding EV models and production, the development and market launch of specific models such as the Honda 0 Saloon and Acura RSX have been canceled. The overall plan for launching a total of seven EV models under the Honda 0 Series globally and producing more than 2 million units of EVs by 2030 has been affected by the significant reduction in planned EV sales volume. In North America, Honda is laying the groundwork for flexible product offerings while carefully assessing market conditions and demand trends, with a strong emphasis on introducing next-generation hybrid models. The cancellation of development for certain EV models further indicates a reduced immediate focus on all-electric offerings in this period.

The JPY 10 trillion EV spending plan for the 10 years through fiscal 2031, announced in May 2024, has been reassessed. As of May 2025, the investment plan toward 2030 was reduced to 7 trillion yen. Under the strategic reallocation of corporate resources for the three-year period until the fiscal year ending March 31, 2029, Honda will control EV-related investments at approximately JPY 0.8 trillion. During this period, the company plans to invest JPY 4.4 trillion in gasoline and hybrid vehicles and JPY 1.0 trillion in software technologies, totaling JPY 6.2 trillion. This represents a significant shift and reduction from the original plan, with a substantial reallocation of resources from EV to hybrid powertrain development.

Regarding battery cost reduction and the establishment of a vertically integrated EV value chain in North America, Honda has indefinitely suspended the project to build a comprehensive EV value chain in Canada. Instead, Honda will fully utilize the L-H Battery facilities, a joint venture with LG Energy Solution, and implement a battery procurement strategy focused on North American competitiveness. Furthermore, part of the EV battery production lines at L-H Battery Company will be converted to hybrid-battery production.

We believe the capital requirements necessary for the company’s electrification transition are high. Cost-cutting, such as production capacity optimization, is an effective strategy to lessen the financial impact of a poor economic environment, but it is not enough to completely safeguard returns. The ease with which customers can switch to a competitor's product further adds to the company's challenges in carving out an economic moat.

The popularity of Honda's vehicles usually allows it to use fewer incentives than its US counterparts, boosting the firm's profits and improving the resale value of its vehicles.

Honda aims to accelerate its electrification transition and targets to produce more than 2 million units of EVs by 2030, making EVs and FCEVs represent 40% of its global sales.

In 2025, Honda produced nearly all of the vehicles it sold in the US in North America. This means Honda is better positioned than Toyota (70%) to withstand the yen when it is very strong against the dollar.

Honda sold 0.65 million vehicles last year in China, primarily through its joint venture. China is a market with intense competition, and Honda seems to have lost steam with a retail volume decline for four consecutive years.

Environmental laws are becoming stricter, which will make cars more expensive to produce. Honda, for now, is lagging behind other firms in battery-electric vehicle offerings.

Honda participates in a capital-intensive, highly competitive, cyclical industry where swings in volume and volatile input costs can substantially impact profitability.