The revised outlook on the ratings on Honda and related entities reflects Standard & Poor’s view that Honda’s operating performance has bottomed out in fiscal 2011 and is returning to a steady growth path driven by a rapid recovery in production and sales of automobiles. While the strong yen against other major currencies is likely to continue to pressure Honda’s profitability, we believe the automaker should continue recovering its profitability (excluding financial services operations) over the next two years to around 7%-8% in operating and 10%-11% in EBITDA margins, which should be largely comparable to the levels the company had maintained before the financial crisis in 2008.
In 2011, Honda suffered from significant productions cuts resulting from supply chain disruptions after the Great East Japan Earthquake in March and the Thai floods in October. In particular, a shortage of microchip controllers after the earthquake had materially constrained the company’s recovery in sales after the financial crisis in 2008 and, again, supply disruptions related to the Thai floods hit just as Honda was returning to full production in the wake of the March 11, 2011, quake. As a result, Honda projects that its consolidated sales and net profit for the fiscal year ending March 31, 2012, will be weak at JPY7,850 billion and JPY215 billion, respectively, down 12% and 60% from the previous fiscal year.
However, we view Honda is already returning to a steady growth path, which the company had to give up temporarily in fiscal 2011 due to natural disasters. Honda’s global unit sales of automobiles has shown a steady recovery in recent quarters: 547,000 units in April 2011-June 2011, followed by 772,000 in July 2011-September 2011 and 830,000 in October 2011-December 2011, and Honda plans to increase the figure for the January 2012 to March 2012 quarter to around 1 million units. We view this as a clear sign of Honda’s full recovery and expect Honda’s annual unit sales of automobiles in the fiscal year ending March 2013 to reach 4 million globally. We believe Honda’s competitive position remains solid in major global auto markets and expect the company to regain some of its lost market share in the U.S., which is the largest market for Honda, in 2012 and thereafter.
We view continuous pressure on profitability from the strong yen and intensifying global competition as the major threats to Japanese automakers. Still, we believe Honda’s good product competitiveness and strong engineering expertise support its strong market positions in both automobiles and motorcycles. We also believe Honda has amongst the strongest flexibility and resilience against negative impacts from currency fluctuations among major Japanese automakers, based on its long history of manufacturing and procurement overseas.
Honda maintained its modest financial risk profile throughout 2011, when the company faced challenges caused by earthquake and floods, and we expect Honda’s strong capital structure, liquidity and a conservative financial policy should continue to support the company’s financial strengths. Honda has virtually no debt at its nonfinancial services operations and has substantial cash at hand. Honda’s credit metrics are likely to remain very strong over the next two years, with the ratio of funds from operations (FFO) to debt significantly above 100% and the ratio of debt to EBITDA of far below 1.0x, on a fully adjusted basis.
We also view Honda’s liquidity as strong. Honda maintains ample liquidity to weather the increasingly challenging business environment, including sizeable cash holdings and the ability to tap various funding sources. In addition, Standard & Poor’s believes Honda’s historically strong relationships with major Japanese banks preserves its access to additional sources of liquidity, even during times of stress in capital markets. As of Dec. 31, 2011, the company’s industrial operations had JPY1.12 trillion in cash and cash equivalents, compared with total industrial debt of JPY406.7 billion.
The stable outlook reflects our expectation of Honda’s strong recovery prospects in sales and profits over the next two years from the weak performance in the fiscal year ending March 2012. In addition, we expect Honda to solidly maintain its modest financial risk profile even in the increasingly challenging operating environment for global automakers.
We may consider an upgrade if we are convinced that Honda is highly likely to fully restore and even exceed its historical profitability that the company had demonstrated before the financial crisis in 2008 and further strengthen its business risk profile by, for instance, diversifying geographically across major global auto markets, while further improving the level and stability of its cash flow. Still, we consider that the chance of an upgrade is remote at least in the next two years, given the continuous pressure from the strong yen and increasingly fierce global competition.
On the other hand, we may lower the ratings if Honda fails to stay on a steady growth path due to, for instance, a resurgence of the yen against other major currencies and increased competition. In particular, if the recovery prospects in profit to around 7%-8% in operating and 10%-11% in EBITDA margins over the next two years materially weaken, we are likely to view it as a major obstacle, which may prompt us to lower the ratings on Honda.