KEY RATING DRIVERS
Strong Business Profile: Honda's ratings reflect its leading market shares in key markets, including Japan, the US, and Asia; its strong product line-up; competitiveness in hybrid vehicles; and a diversified business portfolio, which includes the world's largest motorcycle business by unit sales.
Operating Performance to Improve: Fitch expects Honda's EBIT margins on industrial operations (automobile, motorcycle and power products) to be around 3%-3.5% in the financial year ending 31 March 2017 (FY17) and improve to around 4% in FY18. Profitability will be supported by continued cost reduction, reduced selling, general and administrative (SG&A) expenses, a solid pipeline of new and refreshed models, and a steady contribution from the motorcycles business.
This follows a weaker operating performance in FY16. EBIT margin fell to 2.4% from 4.0% in FY15 due to recall-related costs sharply increasing selling, general and administrative (SG&A) expenses, negative currency effects, and higher R&D costs, which were only partly offset by positive contributions from volume and mix, and cost efficiencies.
In 1QFY17, Honda posted a material improvement in operating profit with EBIT margin increasing to 7.2% (1QFY16: 5.8%) because of the positive effects of cost efficiencies, a more favourable volume mix and reduced SG&A costs, which more than offset negative currency effects and higher R&D costs.
Modest Sales Volume Growth: We expect Honda to achieve auto sales volume growth in the low single-digits in FY17. Moderate-to-robust sales volume growth in Europe and Asia, and modest growth in the slowing US market should offset declines in Japan and in emerging markets. However, a sharper-than-expected slowdown in the US market - which is a key profit driver for Japanese automakers - and in Asia, as well as fiercer-than-expected competition in these markets could shrink margins further. Japanese automakers are less reliant on China than some of their global competitors, but south-east Asia is an important market, and the demand outlook there is sluggish.
Negative Currency Effects; Reduced Exposure: Honda's expansion of overseas production capacity over the past few years has reduced its overall currency exposure - notably to swings in the yen/dollar rate - as it has lowered the proportion of its production in Japan for export. While this proportion has increased since last year as Honda has sought to improve production utilisation in Japan, it still remains lower than those of its key competitors. Nevertheless, weakness in emerging-market currencies against the US dollar is likely to compound negative effects of a stronger yen to US dollar in FY17 as purchasing costs are typically denominated in US dollars in emerging markets.
Moderate-to-High Capex: We expect capex/revenue of around 5% over FY17-FY18 (FY16: 5%), with investments focused on new technologies, including connected car, electric vehicles and autonomous driving, and on technologies to meet increasingly stringent emissions targets.
Strong Financial Profile: We expect Honda's financial profile to remain strong, supported by continued positive free cash flow. We expect FFO-adjusted gross leverage of below 1.0x (FY16: 0.5x) and CFO/adjusted debt comfortably above 100% (FY16: 221%) in FY17-FY18.
Ample Liquidity: Honda continues to maintain a healthy net cash position, backed by ample liquidity. Honda's industrial business had net cash of JPY1,172bn at FYE16 (FYE15: JPY786bn). Over 60% of FY16 total debt was short-term and consisted primarily of domestic Japanese bank loans, but it was more than covered by cash and cash equivalents of JPY1,667bn (FY15: JPY1,379bn).
Fitch's key assumptions within our rating case for the issuer include:
- Low single-digit sales volume growth in FY17
- EBIT margin (industrial operations) of 3%-3.5% in FY17 and around 4% in FY18
- Capex/revenue averaging around 5% in FY17-FY18 (FY16: 5%)
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Market share erosion in key markets
- Substantial deterioration in global auto demand leading to significant decline in operating profit
- Sustained negative FCF
- Industrial FFO- adjusted gross leverage above 1.0x on a sustained basis
Positive: A near term upgrade of Honda's ratings is unlikely. Typically, the inherent cyclicality and potential financial pressures of the auto manufacturing industry result in a soft cap on IDRs at the 'A' level, although in rare cases a manufacturer with very strong business profile and unusually strong credit protection metrics could be considered for the 'A+' category.
FULL LIST OF RATING ACTIONS
- Honda Motor Co., Ltd
- Long-Term Foreign-Currency IDR affirmed at 'A'; Outlook Stable
- Long-Term Local-Currency IDR affirmed at 'A'; Outlook Stable
- Senior unsecured rating affirmed at 'A'
- Short-Term Foreign-Currency IDR affirmed at 'F1'
- Short-Term Local-Currency IDR affirmed at 'F1'