Analysis of Honda Motor Company

Report by Valanium Analysts: Yutaka Matsumoto, Yuichi Murakami, Michio Okazaki (ymatsum@mit.edu,
yuichi@mit.edu, mokazaki@mit.edu )

Investment Recommendation: MARKET OUTPERFORM December 3, 2001

NYSE (11/30/00) $ 76 EPS Forecast

52 week range $ 54.59 - $92.35 FYE 12/30 2001A 2002E 2003E 2004E
EPS $3.85 $5.49 $5.88 $6.27
Revenue (2002 Est.) $ 60.08B
Market Capitalization $ 37.02B Ratios Firm Average of Competitors
Share Outstanding 487.2M Forward P/E 12.42 21.47
Forward PEG 1.96 3.95
Dividend Yield 0.55% M/B 1.97 1.73
Avg. Daily Trading Volume 34K
Valuation Predictions
Book Value per Share (9/2001) $38.7 Actual Current Price $ 76
Return on Equity 13.02% P/E Valuation (Ordinary) $ 131.38
Return on Assets 4.75% P/E Valuation (Segment Adjusted) $ 119.46
Est. 5 Years EPS Growth Rate 6.35% PEG Valuation $ 153.5
M/B Valuation $ 66.58
Industry Automobile EBO (Abnormal Earnings) Valuation $ 43.97
DCF Valuation $ 84.71

Performance of HMC

52 week change of HMC 8.1%

Return on S&P 500 -16.8%

Investment Summary
• We assign a rating of market outperform on Honda Motor Company at its current price of $76
and a 12-month target price of $85 (based on DCF valuation).
• Comparative P/E and PEG analysis also show that Honda is undervalued compared with its
competitors such as GM, Ford, Daimler-Chrysler, etc.
• We expect Honda’s market share in the Northern American market, where Honda generate 80-
90% of its operating profit, due to the introduction of Minivan/SUV.
• Favorable change in the product mix would lead to the improved operating profit margin.
• Global consolidation trend by the major competitors may disadvantage Honda’s global strategy.
US recession and volatile currency may hit Honda’s sales.
Rating System:
BUY: A strong purchase recommendation with above average long-term growth potential.
MARKET OUTPERFORM: A purchase recommendation that is expected to marginally outperform the return of the market.
MARKET PERFORMER: A recommendation to maintain current positions with returns to match that of the market.
SELL: A recommendation to sell the security (or short the security) as it is expected to decrease in price in the medium term.
Strategic Analysis
Business Summary
Honda Motor Co., Ltd., established in 1948, is Japan’s #3 automaker after Toyota and Nissan and
the largest manufacturer of motorcycles in the world. It is the world’s largest producer of internal
combustion engines, including its motorcycle and power products businesses. The Company is
recognized internationally for its expertise and leadership in developing and manufacturing a wide
variety of products, ranging from small general-purpose engines to specialty sports cars that
incorporate Honda's highly efficient internal combustion engine technology. It has a global network
that comprises 434 subsidiaries and affiliates, including 118 production facilities in 33 countries.
Approximately 11.5 million Honda engines were sold worldwide during the fiscal year ended
March 31, 2000. The company's car models include the Accord, Legend, and Civic, as well as the
luxury Acura and the Insight -- a gasoline-electric hybrid. Japan and North America each account
for more than 40% of sales.

Overall performance in FY Mar. 2001

During fiscal Mar. 2001, Honda achieved record-high automobile sales in all regions other than
Europe, with unit sales worldwide increasing 4.3% compared with the previous fiscal year, to 2.58
million units. This increase in unit sales helped offset the negative impact of the yen appreciation on
net sales, which amounted to ¥5,231.3 billion ($42,222 million), an increase of 5.4% from the
previous fiscal year. Operating income amounted to ¥320.0 billion ($2,583 million), decreasing
8.1%, while the operating margin was 6.1%.

Production Process Improvement through the New Manufacturing System

In September 2000, Honda introduced its New Manufacturing System, which improves product
quality, reduces tooling costs, increases global production flexibility and increases the speed of new
model launches. The Company has been steadily advancing the new system and began operations
on the first revamped line at the Suzuka Factory in May 2000, to coincide with the introduction of
the new Civic. In adopting the New Manufacturing System, improvements were made to many
aspects of the production process from the perspectives of quality, cost, production flexibility and
environmental compliance.
In Japan, the principal achievements of these improvements included: 1) 50% reduction in specific
investment associated with the introduction of new models. 2) 50% reduction in the initial
investment required for building a new production line. 3) 30% reduction in production time from
the initial process to final vehicle inspection. 4) Increase in the number of models that can be
manufactured on a single line from five to eight. Honda is planning to adopt the new system
overseas in the future.

Honda plans to continue overseas production

Regarding the production of power products in Japan, Honda will continue to shift production
overseas to mitigate currency risks, with plans to reduce annual production output from the current
approximate 2.6 million units to 2.0 million units by fiscal 2004. These moves will include the
transfer of general-purpose engine production from six lines at the Hamamatsu Factory to two new
flexible lines at the Kumamoto Factory.

Competitors
Ford
Ford is world’s #2 maker of cars and trucks, behind General Motors. It makes vehicles under brands
that include Aston Martin, Ford, Jaguar, Lincoln, Mercury, and Volvo. Ford owns a controlling
(33%) stake in Mazda and has purchased BMW's Land Rover SUV operations. Ford's finance
subsidiary, Ford Motor Credit, is the US's #1 auto finance company. Ford also owns Hertz, the #1
car rental firm in the world. J. Nasser, Ford's CEO, resigned in late 2001 and was replaced by
chairman and great-grandson of the company's founder, William Clay Ford Jr. The Ford family
owns about 40% of the company's voting stock.

Toyota
Is Japan’s largest and the world’s 4 th largest car manufacturer? Toyota sells, manufactures and
markets cars, trucks and buses worldwide under the Toyota, Lexus and Daihatsu brands. Toyota
accompanies its automotive business with a large business portfolio in financial services, including
sales finance, vehicle insurance, and credit cards. Other diversified businesses include
telecommunications through a subsidiary, industrial equipment, prefabricated housing, and leisure
boats.

Daimler-Chrysler
Daimler Chrysler AG, manufactures and sells cars and trucks under the names, Mercedes-Benz,
Chrysler, Plymouth, Jeep and Dodge, manufactures commercial vehicles, provides related financial
services and has aerospace operations. The Daimler Chrysler Group is active primarily in Europe
and in the United States, Canada and Mexico. Through its alliance with Mitsubishi Motors
Corporation, the Group expects to increase its presence in the Asian market. Daimler Chrysler AG
was incorporated on May 6, 1998 in the course of the business combination of Daimler-Benz
Aktiengesellschaft and Chrysler Corporation.

GM
GM is the world’s #1 manufacturer of cars and trucks. General Motors Corporation has two
operating segments, Automotive, Communications Services and Other Operations, which consists
of the design, manufacturing, and marketing of cars, trucks, locomotives, and heavy-duty
transmissions and related parts and accessories, as well as the operations of Hughes Electronics
Corporation; and Financing and Insurance Operations, consisting primarily of General Motors
Acceptance Corporation, which provides a broad range of financial services, including consumer
vehicle financing, full-service leasing and fleet leasing, dealer financing, car and truck extended
service contracts, residential and commercial mortgage services, vehicle and homeowners'
insurance, and asset-based lending.

Nissan
Nissan Motor Co., Ltd. was established in 1933 to manufacture and sell small Datsun passenger
cars and auto parts. Nissan Motor Co., Ltd. and Renault announced a plan to accelerate
development of the Renault-Nissan bi-national group. The plan provides for cross-shareholdings,
with Renault raising its equity participation in Nissan from 36.8% up to 44.4%. Additionally,
Nissan would acquire an equity stake of 15% in Renault, through a reserved capital increase.
Renault and Nissan would create Renault-Nissan BV, a joint and equally owned management
company operating under Dutch law, with headquarters in Paris and Tokyo. Renault-Nissan BV will
steer Alliance strategy and supervise common activities on a global level, while respecting the
identity and culture of each company and not interfering in operations.

Risks
Global consolidation trend not seen as major disadvantage for nonparticipating Honda
Honda has remained steadfastly independent while the global auto industry has rapidly consolidated
in the past few years. Only six groups—in order, General Motors, Ford Motor, Daimler Chrysler,
Toyota Motor, Volkswagen and Renault-Nissan Motor—produce more than 4 million vehicles per
year in the world, which accounts for more than 80% of all vehicles produced globally.
However, we consider Honda is unlikely to be substantially disadvantaged by its refusal to join the
consolidation trend for the following reasons. 1) Alliances and mergers often fail to live up to
expectations. Daimler Chrysler is a typical example. 2) Honda has gained large benefits of
economies of scale in internal combustion engines because of its motorcycle and power product
businesses. Combined with the light-vehicle business, these represent more than 10 million units
per year on a consolidated basis, making Honda the largest producer of petrol engines in the world.
Other larger makers that have invested heavily in alliances—particularly with companies in difficult
situations that subsequently require substantial financial and management resources to correct—
may find that they are unable to spare as much relative to their size in forward-looking R&D.

Even for US recession and exchange rate movements Honda expected to sustain earnings growth
Although the cooling of US economy, Honda’s unit sales is not expected to fall significantly. Due
to a superior product line-up, especially in the light-vehicle market, finds relatively more favor with
comparatively recession-proof middle-class consumers, as well as a growing presence in the light-
truck segment.
Concurrently, we anticipate that the company’s second and third most important businesses—cars
in Japan and motorcycles in developing Asia—will grow over this period to further cushion any
downside risk to overall earnings.
In our view, one of the principal risks for Honda is a full recession in the US, in which the light-
vehicle market falls drastically. Even in a hard-landing scenario, we expect exchange rate gains to
deliver growth. However the risk is foreign exchange rate volatility, which has a major impact on
Honda’s share price. Clearly, the correlation between the yen-dollar rate and the share price is
greatest when there are sharp movements, such as in spring 1995 and autumn 1998.

Growth Prospects (Please see Appendix A for numbers.)

In Northern American market before the 1990’s, the automobile sales have been cyclical with
duration of 5-7 years. In the 1990’s the industry continued to grow for a long time and recorded
historical high sales in 1999. However, we assumed the trend would go back to that of “before
90’s” and the unit growth would be basically zero although there would be ups and downs yearly
basis.
In FY Mar. 2001in North America, net sales increased 7.8%, to ¥2,999.4 billion ($24,209 million).
Although U.S. industry demand grew 2.6%, to 17.4 million units during calendar 2000, it is
expected to drop to the 16.0 million to 16.5 million unit level in 2001 amid concerns over a
continuing economic slowdown.
North America accounts for 57.3% of total revenue of Honda. Even amid fears of a slowdown in the
U.S. economy, Honda sold a record-breaking 1,346,000 units in fiscal Mar. 2001. Brisk sales of the
Odyssey and Acura TL, as well as the introduction of the brand-new Acura MDX SUV, helped
improve the Company’s model mix and contributed greatly to these results. The Company expects
its North American sales in fiscal Mar. 2002 to expand to 1.37 million units, an increase of 1.8%.
Anticipating that the light truck market will continue to be a growth area, Honda plans to expand
the production capacity at the second production line of the Alliston plant in Canada from 170,000
to 180,000 units to meet the massive demand for the Odyssey and Acura MDX. Further, production
of the Odyssey will start in the new plant in Alabama in late 2001.
In the next five years, we assume Honda can gain market share in the Northern American market
due to the introduction of new products in Minivan/SUV segment. In addition, due to the favorable
product mix change, the average unit price would rise in the Honda’s Northern American segment.

In the Japanese market, due to the sluggish economic situation, the unit sales basically stayed flat
in the 1990’s although there were ups and downs in yearly basis. In Japan FY Mar.2001, total
industry demand grew 1.6%, to 5.97 million units. Honda’s unit sales in Japan for fiscal 2001
increased 9.9% to 776,000 units, and net sales amounted to ¥1,529.4 billion ($12,344 million), an
increase of 9.8% from the previous fiscal year.
Strong sales of the redesigned Civic, the new Stream minivan, and the Life Dunk minivehicle
contributed to FY Mar. 2001 results. In particular, average monthly sales of the Stream vastly
exceeded the original sales target of 6,000 units, to surpass 10,000 units in sales. For fiscal Mar.
2002, the Company anticipates an increase in unit sales to 830,000 units, based on full-year sales of
the Civic, the introduction of the redesigned Step WGN, a brand-new 1.3-liter small car with the
new i-DSI (Dual & Sequential Ignition) gasoline engine, as well as the all-new CR-V and Integra.
We believe that it is difficult to assume the Japanese market to recover in the foreseeable future, so
we set the market’s unit sales growth as zero in the next five years. However, as in the Northern
American market, we assume Honda can gain market share supported by the popularity of its
Minivan/SUV in the younger generation. The unit price would stay the same because of the
deflationary economic condition of the Japanese economy and the favorable product mix change is
not likely.

In Europe, several factors negatively impacted automobile operations during fiscal Mar. 2001,
including the appreciation of the yen, the weakness of the euro against the sterling pound and
pricing pressure in the United Kingdom. Due to this business environment, Honda’s automobile
unit sales in Europe declined 23.3%, to 191,000 units, and net sales declined 30.8%, to ¥311.2
billion ($2,512 million).
Honda’s market share is likely to stay constant because we believe it is difficult, as it has been, to
establish Honda’s favorable brand image in the European market in the short period of time. Our
assumption of the Honda’s sales in Europe only reflects macroeconomic inflation.

Other market’s growth prospect is, in the long run, better than those of developed countries.
However, the macro economic and political situations are not stable in this market. Therefore, as in
the European market, our assumption of Honda’s sales in other markets only reflects
macroeconomic inflation.

Motorcycle market’s prospect is better in terms of unit sales, compared with that of automobile
markets, because automobile is still expensive in the developing countries’ standard but people in
developing countries afford motorcycle. Therefore, we assume unit growth in this market is 5% for
the next five years. We also assumed Honda’s market share and the unit price stay constant.

We believe that Financial Services grows steadily at 5% in the next 5 years. Honda rapidly
expanded its direct financing lease business in the mid-late 90’s taking advantage of its excess cash
flow it generated in its automobile business. However, we believe that the growth in this business
would get into steady growth stage in the next five years.

Motorcycle market’s prospect is better in terms of unit sales, compared with that of automobile
markets, because automobile is still expensive in the developing countries’ standard but people in
developing countries afford motorcycle. Therefore, we assume unit growth in this market is 5% for
the next five years. We also assumed Honda’s market share and the unit price stay constant.

We believe that Financial Services grows steadily at 5% in the next 5 years. Honda rapidly
expanded its direct financing lease business in the mid-late 90’s taking advantage of its excess cash
flow it generated in its automobile business. However, we believe that the growth in this business
would get into steady growth stage in the next five years.

Assumptions on the components of the net income (Please see Appendix A for details.)

COGS/Sales
We assumed COGS/Sales to decline over the next five years. The reasons are: 1) the increase of
SUV in its product mix would lead to higher average gross profit per unit. 2) Honda does not have
to build new factory, as it did in the early 90’s, in the foreseeable future.
SG&A/Sales, R&D/Sales, Interest/Debt, Dep./PP&E, Tax rate
We assumed these ratios basically stay the same over the next five years.
SG&A/Sales can be assumed to stay constant because Honda is likely to maintain its competitive
advantage for the foreseeable future and does not have to increase its sales incentives and ad.
R&D/Sales should keep its level for the development of fuel-efficient engines, including hybrid and
fuel cell, and intelligent transportation system.
Interest/Debt would rise if the Japanese economy recover or falls into inflationary situation.
However, it is difficult to reflect those kinds of macroeconomic risks in our assumption at this point.
Dep./PP&E would stay constant since Honda is not likely to invest in totally different equipments
from usual ones.
Effective Tax Rate declined in the 90’s due to the tax rate cut of the Japanese government. We
assumed that there would be no tax rate change in the foreseeable future.

Why do we value Honda as if it were a US Company?

We picked up Honda for this report and valued it as if it were a US company. We believe it is
reasonable to do so because: 1) 57% of the Honda’s automobile sales is from North America. 2)
Based on the company disclosure, 68% of Honda’s operating income is from North America. (If we
add the profit from export from Japan to North America, 80-90% of the operating profit is from
North America.)
2001.3 2001.3

W e ight
Weight Operating Income (Geographical Breakdown)
Sales (Geographical Breakdown)
Japan 35.9%
Japan 29.2%
North America 68.0%
North America 57.3% Europe -13.6%
Europe 6.0% O thers 8.8%

Others 7.5% O u tside Japan 0.0%

E liminations 1.0%
Consolidated 100.0%
Consolidated 100.0%

Valuation Analysis
Comparative valuation methods
We applied P/E, PEG, M/B, and Price/Sales ratio, because these methods allow us to valuate
Honda’s stock price from the various perspective.

- P/E valuation

Next year's
expected Forward Adjusted
Company Ticker Current Price($) EPS($) P/E P/E
Honda HMC 76 6.12 12.42 12.42
Toyota TM 51.9 2.61 19.89 19.89
Nissan NSANY 10 1.51 6.62 13.25
Ford F 18.94 0.77 24.60 24.60
Daimler Chrysler DCX 41.99 1.87 22.45 22.45
GM GM 49.7 1.83 27.16 27.16

Since Nissan had a big loss in the previous several years and Carry Net Loss, considering tax
benefit and assuming tax rate is 50%, we adjusted Nissan’s P/E by doubling the initial ratio.
Based on the adjusted P/E, the average P/E of competitors is 21.47.
We get the expected price of $131.38 per share for Honda. In addition to the ordinary P/E analysis,
we took into account the financial services apart from the main businesses. Almost all auto
companies have financial division, including auto leasing service, rental car service, and rental
equipment service. We assumed that this financial service has the different P/E from the
automobile manufacturing service, and calculated each P/E based on the sales data of Toyota and
Ford as follows.

% sales of Automobile % sales of

division and others financial division Forward P/E
Honda 97% 3% 12.42
Toyota 96% 4% 19.89
Ford 83% 17% 24.6

From the above data, we get each P/E ratio for automobile division and financial division, 18.44
and 54.65 respectively. Applying these P/E to Honda’s case, we get the new P/E of 19.52 and
expected price of $119.46. Since Honda has the relatively lower percentage of financial service
than the other competitors and financial service has relatively higher P/E than automobile service,
the new expected price for Honda was lower than the price we calculated first. We believe this
price more reflect the business segment structure.
Although these expected prices are much higher than current price of $76, we did not consider P/E
analysis a good indicator to get our target price for the following reasons.
Ø Although P/E in the automobile industry has been historically less than 10, the forward
P/E is estimated to be around 20. Since the recent US recession hit the Honda’s
competitors such as GM, Ford, and Daimler-Chrysler seriously, P/E ratio for the
Honda’s competitors has risen up extraordinary.

- PEG valuation

Next year's
expected Adjusted Average growth rate
Company Current Price($) EPS($) forward P/E in the next 5years(%) PEG ratio
Honda 76 6.12 12.42 6.35 1.96
Toyota 51.9 2.61 19.89 5.00 3.98
Nissan 10 1.51 13.25 5.00 2.65
Ford 18.94 0.77 24.60 5.50 4.47
Daimler 41.99 1.87 22.45 7.00 3.21
GM 49.7 1.83 27.16 5.00 5.43
The average PEG ratio of competitors is 3.95, and the expected stock price of Honda is $153.5.
We got the average growth rate of Ford, Daimler-Chrysler, and GM from Yahoo finance consensus
estimates and those of Toyota and Nissan from the estimates of Japanese analysts. For the almost
same reason, we did not adopt PEG ratio to get our target price.

- M/B valuation

Company Current Price($) BV per share($) M/B ratio

Honda 76 38.5 1.97
Toyota 51.9 31.02 1.67
Nissan 10 4.81 2.08
Ford 18.94 7 2.71
Daimler Chrysler 41.99 34.07 1.23
GM 49.7 51.99 0.96
The average M/B ratio of competitors is 1.73.
The expected stock price of Honda is $66.58.
Although M/B ratio reflects the current asset value, we did not adopt this analysis to get our target
price for the following reasons.
Ø M/B is based on only historical data and does not reflect the future cash flow.
Ø M/B does not take into account intangible assets.
Ø Since BV of equity is based on the historical value, M/B ratio does not reflect the current
value of companies.

- Price / Sales valuation

Current Sales pre
Company Price($) share($) P/S ratio
Honda 76 114.67 0.66
Toyota 51.9 58.13 0.89
Nissan 10 24.22 0.41
Ford 18.94 88.82 0.21
Daimler Chrysler 41.99 135.01 0.31
GM 49.7 319.66 0.16

The average P/S ratio of competitors is 0.4.

The expected stock price of Honda is $45.53.
Since P/S ratio does not reflect the profit margin, we did not consider this ratio a good indicator to
get our target value. We believe that most of the Honda’s competitors are suffering from the recent
decrease in profit margin.

Assumptions of EBO and DCF Analysis

Cost of Equity and Equity β

Because we tried to value Honda as if Honda were American Company, we measured Honda’s β
against S&P500. The β, 0.6 with a 95% confidence interval of ±0.35, is relatively low compared
with its US competitors. This is partly due to low debt to equity ratio of Honda.

Cost of Debt
Also for cost of debt, we checked Honda’s credit rating and used interest rate assuming that Honda
issued all of its debt in the US market.

Target Capital Structure

The debt to equity ratio of Honda is almost the same as that of Toyota, but much lower than those
of US competitors. This is because US competitors’ financial service segments have a larger weight
in their total business.
We assumed that Honda would expand its direct finance lease business into the future, but not to the
extent that is equivalent to the US competitors.
Therefore, we set the target debt to equity ratio 1, which is slightly higher than the current level.

EBO Valuation
We performed EBO valuation for Honda and the result is shown on the next table. Based on this
analysis Honda’s current stock price is 72.85% above the fair value, which we derived as $43.97.
We assumed the terminal growth rate of the residual income beyond FY2007 is 0%.
We also performed sensitivity analysis by changing its cost of equity within its 95% confidence
interval, and its terminal growth rate of the residual income.
 EBO Valuation of Honda Motor Company

Cost of Equity
9.00% 10.00% 14.30% 15.00% 20.00% 20.28%
Terminal Growth Rate (Mean)
0% (Main) 43.96 43.97 43.97 43.96 43.88 43.87
3% 43.73 43.80 43.91 43.90 43.85 43.85
5% 43.38 43.57 43.84 43.85 43.83 43.83
10% N.M. N.M 43.46 43.51 43.74 43.74

DCF Valuation
We performed DCF valuation for Honda and the result is shown on the next table. Based on this
analysis Honda’s current stock price is 35.91% below the fair value, which we derived as $84.71.
We assumed the terminal growth rate of the free cash flow was 3% (expected inflation rate) beyond
FY2007.
We also performed the sensitivity analysis by changing its WACC within its confidence interval,
and the terminal growth rate.

DCF Valuation of Honda Motor Company

WACC
7.2% 10.0% 11.4% 15.3%
Terminal Growth Rate (Mean)
0% 118.11 75.98 63.00 39.34
3% (Main) 199.79 107.23 84.71 48.92
380.48 148.91 58.39
10% N.M. N.M.

Quality of earnings analysis

- Aggressive sales booking
First of all, we examined the quality of sales to detect if Honda has been taking overaggressive sales
booking. As we can see the below, the growth rate of A/R of Honda was greater than that of total
sales in the last five years. However, during this period, Honda has been expanded its financial
services significantly. Honda’s financial services consist most of auto leasing business, from which
A/R of Honda has significantly increased.

Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Average

Total sales ($million) 42,653 45,418 51,688 57,455 52,170
%Growth in total sales 6.68% 6.48% 13.81% 11.16% -9.20% 5.78%
A/R ($million) 6,211 7,986 8,783 10,572 9,511
% Growth in total AR 3.09% 28.58% 9.98% 20.37% -10.04% 10.40%
Sales in financial 758 1,057 1,344 1,292 1,366
% growth in sales of
financial service N/A 48.48% 16.07% -15.36% 23.46% 18.16%
A/R in financial service N/A 4,787 5,489 6,892 6,153
% growth in A/R of
financial service N/A N/A 14.67% 25.56% -10.72% 9.84%

The above is the change of growth rates for total sales, total A/R, and sales in financial service. As
we mentioned in comparative valuation part, Honda has relatively lower ratio of financial service to
the automobile service than the other competitors and expanded it recently. Consequently, we can
say that Honda has not been taking overaggressive sales booking though the growth rate in A/R was
greater than that in sales in the last five years.

- Smoothing volatility of earnings using accruals

Next, we calculated the ratio of the scaled standard deviation of Operating Income over the past five
years to the scaled standard deviation of CFO over the past 5 years for Honda and the other
competitors to detect if Honda is manipulating the timing of gains and losses for smoothing the
earnings.

Average Operating Standard deviation of Average Standard deviation

Company Income Operating Income CFO of CFO Ratio
Honda 4038.77 1481.64 3409.85 704.36 1.78
Toyota 11454.65 2384.22 10381.60 2926.52 0.74
Nissan 4681.08 397.05 3946.36 971.46 0.34
Ford 31404.40 2821.88 24194.60 4418.53 0.49
Daimler 8978.00 7789.69 10607.20 7649.69 1.20
GM 23365.78 2445.04 19138.90 4508.87 0.44
The average ratio of competitors is 0.64. Since the ratio of Honda is much higher than 1 and the
average number of competitors’ ratio. So, we can conclude that Honda is not smoothing its
earnings by manipulating the timing of gain and loss.

Appendix A: Honda’s Income Statement

Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04
Sales
Automobile 34,078 35,976 41,386 46,736 42,222 48,860 50,301 52,366
Japan 12,705 11,054 11,037 13,127 12,344 14,777 15,220 15,677
North America 15,713 18,422 23,141 26,207 24,209 28,275 29,123 30,579
Europe 3,367 3,916 4,502 4,239 2,513 2,526 2,576 2,628
O thers 2,293 2,585 2,706 3,163 3,157 3,283 3,381 3,482
Motorcycle 5,556 5,807 5,815 6,773 6,500 7,723 8,109 8,514
F inancial Services 758 1,057 1,344 1,292 1,366 1,500 1,575 1,654
O thers 2,263 2,578 3,144 2,655 2,082 2,000 2,000 2,000
Consolidated Sales 33,059 35,533 37,448 44,389 39,984 42,653 45,418 51,688 57,455 52,170 60,083 61,984 64,534
COGS 24,083 25,688 27,343 32,301 29,096 29,800 31,362 35,004 39,622 36,780 41,697 42,831 44,464
G ross Profit 8,976 9,844 10,105 12,088 10,888 12,853 14,056 16,685 17,833 15,390 18,385 19,153 20,070
SG&A 7,822 8,909 9,345 10,880 9,537 9,619 10,556 12,133 13,818 9,255 10,154 10,475 10,906
R&D 3,147 2,848 3,184 3,285 3,420
O perating Income 1,154 935 759 1,208 1,351 3,235 3,500 4,552 4,015 3,288 5,047 5,393 5,744
NOPAT 693 561 456 725 810 1,941 2,100 2,731 2,409 1,973 3,028 3,236 3,446
Interest Expense 321 373 343 385 288 222 209 231 178 173 180 243 260

Non-operating Income/Expense 1,106 724 503 1,412 1,495 923 1,900 2,144 3,237 0 0 0 0
Other Income/Expense 160 215 140 204 151 209 206 115 241 0 0 0 0
Pretax Income 994 777 557 863 1,214 3,138 3,497 4,435 4,078 3,115 4,867 5,150 5,484
Special Items 0 0 0 164 0 84 0 0 0 0 0 0 0
Income Taxes 505 448 327 503 548 1,523 1,524 1,905 1,606 1,440 2,190 2,317 2,468
Net income 488 329 230 689 666 1,782 1,973 2,530 2,472 1,874 2,677 2,832 3,016
Depreciation 1,435.24 1,494 1,389 1,400 1,175 1,139 1,161 1,474 1,622 1,375 1,586 1,636 1,704

Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04

Sales(YoY)
Automobile 5.6% 15.0% 12.9% -9.7% 15.7% 2.9% 4.1%
Japan -13.0% -0.2% 18.9% -6.0% 19.7% 3% 3%
North America 17.2% 25.6% 13.3% -7.6% 16.8% 3% 5%
Europe 16.3% 15.0% -5.8% -40.7% 0.5% 2% 2%
O thers 12.8% 4.7% 16.9% -0.2% 4.0% 3% 3%
Motorcycle 4.5% 0.1% 16.5% -4.0% 18.8% 5% 5%
F inancial Services 39.5% 27.2% -3.9% 5.8% 9.8% 5% 5%
O thers 13.9% 22.0% -15.6% -21.6% -3.9% 0% 0%
Consolidated Sales 6.5% 13.8% 11.2% -9.2% 15.2% 3.2% 4.1%

C O G S /S a l e s 72.8% 72.3% 73.0% 72.8% 72.8% 69.9% 69.1% 67.7% 69.0% 70.5% 69.4% 69.1% 68.9%
G ross Profit/Sales 27.2% 27.7% 27.0% 27.2% 27.2% 30.1% 30.9% 32.3% 31.0% 29.5% 30.6% 30.9% 31.1%
S G & A /S a l e s 23.7% 25.1% 25.0% 24.5% 23.9% 22.6% 23.2% 23.5% 24.0% 17.7% 16.9% 16.9% 16.9%
R & D /S a l e s 5.5% 5.5% 5.3% 5.3% 5.3%
O p e r a t i n g I n c o m e /S a l e s 3.5% 2.6% 2.0% 2.7% 3.4% 7.6% 7.7% 8.8% 7.0% 6.3% 8.4% 8.7% 8.9%
Interest/D e b t 3.7% 3.8% 3.2% 3.2% 2.5% 2.2% 2.0% 1.8% 1.3% 1.4% 1.3% 1.5% 1.4%

Other Income/Expense/Sales 3.3% 2.0% 1.3% 3.2% 3.7% 2.2% 4.2% 4.1% 5.6% 0.0% 0.0% 0.0% 0.0%
Effective Tax Rate 50.9% 57.6% 58.7% 58.2% 45.2% 48.5% 43.6% 42.9% 39.4% 46.2% 45% 45% 45%
D e p /G r o s s P P & E 8.26% 7.53% 6.35% 5.50% 5.12% 5.26% 5.32% 6.15% 5.99% 5.46% 5.50% 5.50% 5.50%