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...
At least, that seems to be the view at investment bank Nomura, which announced yesterday that it is upgrading shares of Honda to buy and assigning a target price of 3,850 yen (up from 3,400 yen previously). That works out to a target price of $34.77 on Honda stock, which currently sells for $27.67 -- a profit of more than 25%.
But is Nomura right about that? Let's find out.
The big theme
Why does Nomura like Honda so much? Well, there's the obvious answer: Both the banker and the car manufacturer are based on Tokyo, Japan, after all. But more than that, close familiarity with Honda may give Nomura special insight into goings-on at Japan's No. 3 automaker, where Nomura sees a "flexible management approach" as likely to yield big benefits for Honda shareholders over the next few years.
Take the threat from Tesla, for example. I previously wrote about Tesla's growing dominance in such key new car technologies as autonomous driving and electric car batteries, and this fact hasn't gone unnoticed at Honda. To help meet this threat, Honda made the unusual move last year of investing $750 million in General Motors' autonomous-driving Cruise subsidiary -- and promising to invest a further $2 billion over the next 12 years as the two companies work together to develop self-driving technologies to counter Tesla's dominance.
Teaming up with an archrival may not have been listed on the first page of Honda's playbook for winning the electric car war, but the company didn't hesitate to flip to it when the situation demanded it.
Belt-tightening around the globe
Similarly, Honda has taken aggressive steps to rein in costs and head off emerging risks by closing factories in countries such as the U.K. (where exports are threatened by Brexit) and Turkey (where the economy is going sour) -- and even in Japan itself.
Honda plans to close "plants in the UK (production capacity of 150,000 vehicles) and Turkey (50,000 vehicles) in 2021," explains Nomura in a note covered by StreetInsider.com (subscription required), "in addition to the previous decision to close the Sayama plant in Japan (250,000 vehicles, plant to close at end-22/3), which it announced in October 2017."
As a result of these closures, Nomura predicts that Honda will lower its fixed costs and vehicle production costs, savings that could grow operating profits for the company by as much as 60 billion yen annually "from 22/3 onwards."
What that means to investors
These savings could be very important to Honda investors, inasmuch as they may well reverse the story of Honda's being a stock in decline. According to data from S&P Global Market Intelligence, over the next five years the company's profits are expected to suffer an average decline of nearly 9% per year.
But here's the thing: This decline, while likely to happen now that the automotive cycle has peaked, is calculated based on the $5.34-per-share profit that Honda earned in 2018, and influenced greatly by the expected drop in profit to $3.74 per share this year. After 2019, however, most analysts expect the company's profits to resume growing -- to $3.87 per share in 2020, for example, $4.14 per share in 2021 -- all the way to $4.34 per share by 2023, which is as far out as S&P's analyst estimates go.
Granted, even these growth projections only amount to about 4% annual earnings growth for the company. But if Nomura is right about the cost savings Honda will reap from plant closures, well, 60 billion yen is about $542 million at current exchange rates, or roughly 8% of the profits Honda earned over the past year. Spread across the next four years, that's another couple of percentage points' worth of earnings growth for the automaker -- potentially, at least -- which could raise the company's growth rate as high as 6%.
With Honda shares currently costing only about 7.3 times earnings today, and paying a very respectable 3.7% dividend yield, I think even 6% earnings growth could be strong enough to make Honda Motor stock what Nomura says it is: a buy.