Honda's Home-Field Disadvantage

Sputtering sales in Japan are hurting the carmaker's profits

When Honda Motor Co. (HMC ) heard that dealers in Japan had inflated sales figures for new cars--and angered some customers by overcharging them in a related tax scam--the company brushed off the problems as isolated incidents. On one level, Honda was right: Only a handful of dealers were involved, and the carmaker isn't accused of any wrongdoing.

Yet the scandal is a sign of how brutal the once-booming Japanese car market has become. Even Honda is feeling the pressure. The company's volume has fallen for the past two quarters year-on-year, and it expects domestic revenues for the year ending in March to slip 3.7%, to $15 billion--about 22% of its global sales. And although some two -thirds of Honda's earnings come from the U.S., analysts say the drop at home is starting to hit profits. Operating margins slid to 8.4% in the half-year ending in September, from 9.0% a year earlier, and are now lower than rivals Toyota Motor Corp. (TM ) and Nissan Motor Corp. (NSANY ) "The downturn in Japan is severe," says Satoshi Aoki, Honda senior managing director and finance chief.

Honda is in no danger of driving off a cliff. On Jan. 31, the auto maker said it expects record earnings this fiscal year, with net profit up 18.6%, to $3.6 billion, on sales of $66.7 billion. The great driver of those sales is the U.S., where buyers can't seem to get enough Accord sedans, Odyssey minivans, and Pilot sport-utility vehicles. Even in Japan, things aren't desperate: Honda's market share climbed last year to 15.6%, from 14.6%. But if U.S. economic woes cut demand this year, falling sales at home could hurt that much more. Weaker performance in Japan "increases Honda's dependence on the U.S.," says Lehman Brothers Inc. analyst Clive Wiggins.

Honda isn't backing off in Japan. CEO Hiroyuki Yoshino pushed Honda sales staff to sell more Fits in 2002 than Toyota sold Corollas. They did, by 24,000 cars--the first time in three decades the Toyota subcompact wasn't Japan's best-seller. Still, Honda says it does not urge dealers to inflate sales and notes that dealers for other makes also fudge their numbers. "We don't deny that it sometimes takes place, but it's not a practice that we condone," says a Honda spokesman.

Even as Fit sales set records, Honda's other cars in Japan face a rougher road. Rivals are targeting Honda's strongest models--its subcompacts and minivans. Nissan's popular March subcompact is chasing the same buyer as the Fit. Toyota is blitzing the market with minivans such as the seven-seat Alphard and the new Wish, which are aimed squarely at Honda's Step WGN, Stream, and Odyssey minivans. "Toyota's coming after us in all the sweet spots," says one senior Honda exec.

The change marks an end to an era when Honda ran circles around Toyota and Nissan, which were slow to react to the fading popularity of sedans and to the quirky preferences of younger, recession-weary car buyers. Now, as rivals step up the pressure, sales of the three Honda minivans declined by 7% in the second half of 2002 compared with a year earlier. The Civic saw its sales fall by 40% over the same period.

Worse, Honda has few fresh offerings in store this year for Japan. It plans to launch a new version of its Legend luxury sedan, introduce a pair of SUVs imported from the U.S., and will likely update the Odyssey. But sport-utes are a hard sell in Japan, where the streets are narrow and gas prices high. And the Odyssey, which has never been as popular at home as in the U.S., may not be able to help Honda recover. That's a problem, because minivans have been a key profit-generator.

With Japan's car market in a two-year funk due to the weak economy, some analysts question whether Honda can turn around any time soon. Honda insists it's profitable in Japan, although the company declines to provide exact figures. Still, investors are worried. Honda's stock price has fallen to $34.33, 30% off its 12-month high, compared with declines of 24% for Toyota and 8% for Nissan from their 12-month-peaks.

Honda must walk a fine line in Japan. Although the carmaker depends on the U.S. for the bulk of its sales, Japan remains the world's No.2 car market and a crucial testing ground. Honda needs to strengthen its domestic lineup with more innovative models like the Fit. If it does that, dealers will be too busy selling cars to worry about fudging numbers.

By Chester Dawson in Tokyo

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