Honda Hits the Gas on Capacity

By expanding production in North America, the carmaker is insulating itself against currency fluctuations and an anti-import backlash

Few car company bosses can afford to be more relaxed about high oil prices than Honda (HMC) chief Takeo Fukui. After all, the Japanese automaker's hard-earned reputation for fuel efficiency means that whenever there's a spike in prices at the gas pump, more auto buyers will think about buying one of its cars.

Toss in the benefits of a well-honed "green" image at a time when global warming is a hot topic, and an enviable record for quality—Honda is the leading mass-market automaker in J.D. Power's study of initial quality—and it's no surprise that Japan's No. 2 automaker is scrambling to raise production capacity around the world. (Like BusinessWeek, J.D. Power is part of The McGraw-Hill Companies (MHP).)

Speaking at a wide-ranging press conference in Tokyo on July 18, Fukui outlined Honda's plans to increase global production, consolidating the company's position as the world's ninth-largest automaker. "To support booming sales, production facilities are being expanded," Fukui told reporters.

Insurance Against a Backlash

Not surprisingly, North America, which accounts for about 70% of Honda's earnings, is central to its expansion plans. Production in North America will increase from 1.4 million units to 1.62 million by fall next year. That, noted Fukui, will help keep Honda's ratio of locally produced cars in the North American region at around 80%. That helps insulate Honda against currency fluctuations and makes the company less vulnerable to an anti-import backlash at a time when Detroit's Big Three are struggling. By comparison, Toyota (TM), in the year through March, built 53.7% of the vehicles it sold in the region locally.

Much of that growth will come from a new auto plant in Indiana, Honda's seventh in North America. The new plant is set to begin production in the fall of 2008 and will increase production of the new, fully remodeled Accord, which will be introduced later this year. Also in fall 2008, a new engine factory will open in Canada. And in Mexico, Honda will begin manufacturing its CR-V crossover sport-utility vehicle, helping to increase production from 30,000 to 50,000 units.

The investment is needed. By 2009, Macquarie Securities projects Honda's North American unit sales will reach 1.92 million, compared with 1.79 million this year.

Emerging Expansion

Fukui also reiterated that a weak yen won't deter U.S. investment. The Japanese currency, currently at around 122 yen to the dollar, is at a 22-year trade-weighted low when adjusted for inflation, prompting some analysts to suggest carmakers delay U.S. investments because it's more profitable to simply export from Japan. Fukui disagrees. "We don't want to export from Japan. We know what happened to us when the yen was at 80 to the dollar," he says, referring to the weak margins Honda posted when the yen soared against the dollar in the 1990s.

Outside of North America, Honda is aiming to raise production by 50,000 units in Europe, to 300,000 by next year, boosting output at British and Turkish plants amid growing demand for Civic sedans and CR-Vs.

Expansion in emerging markets, though, is arguably more spectacular. Honda on July 18 announced two new plants. In Argentina, Honda will spend $100 million on a new compact-car plant. The facility will be located in Buenos Aires and initially have a capacity of around 30,000 units. In Thailand, Honda will add a second plant that, from the second half of 2008, will double production to 240,000 units.

Japan: Technological Test Bed

Meanwhile, in India, Honda will triple auto production, to 150,000 units, by 2009. And in China, where Honda will produce 530,000 cars this year, the company announced it and partner Guangzhou Auto have established a new research and development venture to launch a new vehicle in 2010.

Even in Japan, where the auto market is shrinking, Honda has new production facilities in the pipeline. Among them, a new auto plant in Yorii, outside Tokyo, will be Honda's most advanced plant anywhere when it opens in 2010. Honda says the plant will be used as a testing ground for new technologies that will eventually filter through to overseas plants.

Fukui also confirmed reports that Honda will launch a new hybrid car in 2009 and that "clean" diesels, slated for a U.S. launch in 2009, will also be sold in Japan. That's part of a move by Honda to tweak its hybrid strategy. It now plans to focus on hybrids for smaller models, and diesels for larger models, including the next-gen Accord, CR-V, and Odyssey minivan, where the cost benefit is most marked (see, 6/8/07, "The Trouble with Hybrids").

Delay for Accord Launch?

Still, for all Honda's spending, analysts say the capacity increases may not come quickly enough. In a July 11 report, broker NikkoCitigroup projected Honda's quarterly operating profits for the three months that ended June 30 will fall 4.2%, to $1.6 billion, due to "sluggish sales growth caused by production capacity shortages and increases in the up-front investment burden."

While the projected operating margin of 6.7% remains highly respectable—only Toyota is higher among Japanese carmakers—the broker warns that capacity shortages could hinder the launch of the new Accord, Honda's best-seller in the U.S. "We expect the lack of supply to be cured by the start-up of the Indiana plant, slated for autumn 2008, but think that sluggish sales growth will continue for a while," note NikkoCitigroup analysts Noriyuki Matsushima and Andrew Phillips.

The weak market in Japan is also a headache (see, 7/23/07, "Here, Kid, Take the Wheel"). This year, Honda's sales at home fell 8.5% during the first six months of the year, to 321,696. Honda hopes that the launch of a new, fully remodeled Fit subcompact in the fall will help turn around its fortunes at home.

It should definitely help. The current Fit, known as the Jazz in Europe, was Japan's best-selling car in 2001 and has sold 2 million units around the world. Nevertheless, in a sign of just how tough it is to eke out sales in Japan, Fukui added that the domestic launch of the Acura luxury brand, which had been slated for 2008, will now be delayed by two years. "The market environment isn't going to improve. We don't need to rush," says Fukui.

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