A Rough Road Ahead for Honda

Honda (NYSE: HMC  ) has had a rough time of it in recent months, so it's no surprise that earnings were subdued. For the quarter that ended in December, Honda earned just 47.66 billion yen ($624.3 million), a 41% drop from the year-ago period.

For the full year (Honda's fiscal year runs through March 31), the company said it now expects net income of 215 billion yen ($2.8 billion), well below the 250.5 billion yen expected by analysts.

The normally slow-moving stock dropped sharply on the news and was down about 2.5% in New York at midday Monday. And there's worse new: Things may continue to be rough for a while.

Continued costs of last year's floods
The big story isn't last March's earthquake and tsunami in Japan -- Honda, like most manufacturers, has largely recovered from that disaster -- it's the flooding in Thailand that made world headlines last fall. While rivals Toyota (NYSE: TM  ) and Ford (NYSE: F  ) suffered incremental production losses as flooding hindered key suppliers and transportation, Honda suffered a huge loss. In fact, one of Honda's factories was completely underwater for several weeks, and thousands of just-built vehicles were turned into scrap.

That factory could cost as much as 50 billion yen ($650 million) to repair. Honda officials have said that the damage was so extensive that they will essentially be building a new factory from scratch. Though some of that cost will be covered by Honda's insurers, that's a big expense, in part because Honda's doing it in a hurry, hoping to have the factory back up and running by the end of March. Honda now estimates that the Thai floods will cost it a total of 110 billion yen ($1.44 billion) through the current fiscal year, a substantial bite out of earnings.

Part of that cost is in lost sales. Honda has posted year-over-year sales declines in the U.S. for months now, and is expected to post another one in January. Even when production is restored, that loss of market share may be difficult to recover. Hyundai (OTC: HYMTF) and General Motors (NYSE: GM  ) have both made gains with strong new products while Honda has struggled. It may take time and require the introduction of cutting-edge products before Honda is able to retake lost ground.

But that's not the only problem putting pressure on Honda's earnings.

The problem beyond Honda's control
The yen has been rising against major currencies like the dollar and the euro for several years now. Because Honda books its profits in yen, that rise has eroded its profits in critical overseas markets like the U.S. and Western Europe.

A Toyota official said last year that the yen's appreciation had cost his company an average of about $4,000 in profits for every vehicle sold. That's a staggering sum and the yen has continued to appreciate since. Toyota's in a more difficult position when it comes to the dollar, as it imports about a third of the cars it sells here versus the roughly 10% brought in by Honda.

But Honda has still seen a significant impact and the yen's recent rise against the euro has added to the pressure. Honda is now saying that the yen's appreciation will cost it about 57 billion yen ($747 million) for the full fiscal year. Efforts by Japan's central bank to drive the yen down a bit haven't been effective.

No quick fix in sight
While restoring production will help, the yen represents a greater challenge, one that's likely to drag for the foreseeable future. As I've said in the past, what Honda needs most is a product overhaul that will allow it to match the great products introduced by competitors Ford and Hyundai head on.

Honda executives have been saying the right things on that front recently, but a real product revamp will take at least a couple of years to bear fruit. Shareholders probably shouldn't expect much from the stock until those products start to see the light of day.

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