Now Honda Is Feeling the Pain, Too

Honda (HMC) had been tipped to weather the storm engulfing the auto sector better than most other carmakers. Analysts cited its penchant for fuel-efficient small cars and the absence of unpopular large models in its lineup. And while Honda trimmed earnings forecasts at its half-year earnings announcement on Oct. 28, it was by less than rivals, and the company still planned on making $5.5 billion this year.

All that changed Dec. 17. Speaking at a hastily arranged press conference in Tokyo, Honda Chief Executive Officer Takeo Fukui, flanked by solemn-looking fellow executives, announced a huge downward revision in the company's earnings. Honda now says it will earn $2.1 billion this fiscal year, 62% less than it said just six weeks ago. Sales are now expected to plunge $4.5 billion, to $131 billion, 10.3% worse than previously expected. That means Honda expects to lose more than $2.1 billion in the six months through March 2009 after making $4.2 billion during the first half. "The situation is worsening every day in all regions," Fukui told a packed press conference at the company's Tokyo headquarters.

In an earlier announcement, Nissan (NSANY) said it would cut production in Japan by a further 78,000 from January, which means it has now announced cuts of 238,000 vehicles in Japan. Nissan, which started the fiscal year in April with 2,000 temporary employees, also said it will employ none by March 2009. Toyota (TM) is delaying the opening of a new Prius plant in Mississippi.

Yen Troubles

While slumping auto sales and a surging yen remain the causes of Japanese automakers' problems, their combined impact has grown rapidly in recent weeks. The yen is now below 89 to the dollar, a 13-year high, after the U.S. Federal Reserve cut its target interest rate to a range from zero to 0.25%. The strong yen reduces the profitability on cars exported from Japan and reduces the value of earnings made overseas when converted back into the Japanese currency.

Sales, meanwhile, are falling in the U.S., Europe, and Japan and slowing in emerging markets. In the U.S., where Honda traditionally makes most of its profits, its pace of sales has fallen at a remarkable rate in the past few weeks. Honda's sales year-to-date are down only 5.4%. That's not good, but it's much better than the declines at Nissan, Toyota, and the Detroit Three. However, as the financial crisis has worsened, Honda's sales have fallen into line. In November, sales plunged 32%. "The impact of November says everything," Honda Senior Managing Director Koichi Kondo said at the press conference when asked why Honda had slashed its projections so soon after the last revision.

To avert more red ink, Honda is undertaking a series of measures, most aimed at cutting costs. Among them, a new flagship plant in Yorii, outside Tokyo, and a minicar plant in western Japan will be delayed by at least one year, while planned capacity increases in India and Turkey have been postponed. Honda has dropped a plan to release the Acura luxury marque in Japan in 2010 and has axed the development of the successor to the NSX sports car, scheduled to have been equipped with a new V10 engine. And the company's plans to use diesel engines in larger models are now on hold. All new projects will be "reassessed from scratch," Fukui added. Earlier in December, Honda had already pulled out of Formula One in order to save the company about $500 million a year.

"Dramatic Action"

Management will take its share of the pain. In January all Honda directors will take a 10% pay cut and Fukui expects executive bonuses to be "cut dramatically." So far, Honda has avoided laying off full-time workers in Japan, but 760 temporary employees have been told that their current contracts won't be renewed beyond December. Next year, a further 460 will be released after their contracts expire. "We need to take dramatic action to avoid losses at any cost," Kondo added.

Still, amid the rapid-fire restructuring, Honda isn't skimping on small-car or hybrid plans, which it insists are the key to its long-term health. Within three years, Honda plans to introduce a new entry-level small car that will be smaller than its Fit subcompact. While diesels for bigger cars are on hold, Honda is now developing new diesels for smaller cars.

And more greener, gas-sipping models are in the pipeline. Fukui confirmed the new Insight model will go on sale in spring 2009 as planned and that it will be priced below 2 million yen in Japan, or $22,000 at the current exchange rate. The U.S. price is expected to be below $20,000. The CR-Z sports hybrid will follow by the end of 2010, and, breaking away from the plan to use diesels for larger models, Honda now says it is considering applying hybrids to larger models. In a second press conference, Honda revealed that it will team up with battery company GS Yuasa to form a new company that will develop and manufacture lithium ion batteries for future hybrids.

Mutual Funds: Know Where the Risks Lie

As the alleged Ponzi scheme run by money manager Bernard Madoff has made clear in recent days, people put their money into "black box" investment strategies at tremendous risk. The scandal underscores the need for investors to have access to more information about how their returns are generated.

Performance measurement and attribution systems, as the most sophisticated of these tools are called, account for a growing niche within the business technology sector. Thomson Reuters (TRI), StatPro (SOG.L), and SS&C Technologies are the top three providers of installed standalone software systems used by pension fund sponsors, endowments, and other institutional investors, and a growing number of smaller boutique firms now offer similar tools, according to a September 2008 report by the Aite Group, an independent research firm in Boston. Retail investors have little need for the specialized information these software platforms provide, but some of the data could help them decide which mutual funds to invest in.

Some market professionals believe the bear market has increased investors' desire to identify where a fund's returns come from now that gains are harder to come by. David Spaulding, president of the Spaulding Group, a money-management consulting firm in Somerset, N.J., and a leading provider of training in performance measurement, says these tools have become more important over the past decade as part of the natural desire for as much information as possible. And while the concept of attribution—which distinguishes returns due to asset allocation from returns due to stock selection, currency effects, and other factors—goes back nearly 40 years, the technology that supports it has been available for only 10 to 15 years, he says.

Predicting Returns

Spaulding says attribution becomes more important when managers try to explain losses to their clients. "We know of cases where managers will sit down with clients and say, 'We had a bad year, but I know why it happened, and this is what we're doing to correct that,'" he says. "That ability clearly has value. It gives the client some confidence in the manager that he has his finger on the pulse [of the market] and is taking corrective action."

Philip Silitschanu, senior analyst at the Aite Group, notes a trend over the past two to three years to use newer performance measurement and attribution systems not just as a reporting tool but also as a way to predict future returns. Martin Gruber, a pioneer of mutual fund research and a finance professor at New York University's Stern School of Business, believes investors can study how certain fund styles have performed over time. But he believes that it's easier to predict a fund's negative returns than positive returns based on past performance. "Bad managers tend to stay bad managers," he says. "Good managers tend to a lesser extent to stay good managers."

One of the most basic things an investor needs to understand when it comes to investing in mutual funds is a 30% positive return in any year may not actually be the investor's return, because it depends on when he put money into the fund. The timing of investors' contributions and redemptions affects their returns. For example, if a fund's net asset value goes from $10 to $20 per share, and at that point money pours in from new investors, and the NAV then settles back to $13, those people who invested money when the NAV was $20 may have lost some money. But the portfolio manager will still report a 30% return because the fund's value rose from $10 to $13, says Spaulding.

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Marcial: Why the Pros Pick PepsiCo

In these times of economic distress, investors are constantly seeking safety in companies whose earnings are predictable and whose stock prices are relatively stable. That's too high a bar for most companies to clear these days, but one of the few that meets the challenge is PepsiCo (PEP).

The Pepsi name is widely recognized worldwide as a leader in beverages and snack foods. The company's stable of market-leading products has helped bolster earnings despite the global recession. In fact, PepsiCo's business outside the U.S. is fueling much of its earnings growth these days.

"Any company that can grow earnings, even a little in this very weak economic environment, should be prized," says Edwin Walczak, chief investment officer at Vontobel Asset Management, which owns shares. PepsiCo, he adds, can be regarded as a defensive stock in this tough environment.

Relatively Cheap Stock

PepsiCo's stock hasn't been immune to the market meltdown, in spite of how well its earnings are holding up—and rising. Walczak figures the company will earn $3.66 a share for 2008 and $3.76 in 2009, which are below consensus analysts' estimates. The company earned $3.34 in 2007.

With the shares now trading at 52 each (down from their 52-week high of 79 on Jan. 10), PepsiCo is selling at a price-earnings ratio that's lower than its "normal" annual average p-e of 20-21. Based on Walczak's 2009 profit estimate, the stock is selling at a p-e of just 14. For a company that has a "great franchise worldwide, that is a bargain," he says.

PepsiCo should be regarded by investors as a "food [snacks] company with a beverage component rather than the other way around, as most investors do," says Eric Schoenstein, a principal at Jensen Investment Management, which owns shares. He notes that its food operations, such as Frito-Lay and Quaker, accounted for 36% of operating profits and 29% of total sales, while the beverage components, including Pepsi, Mountain Dew, and Tropicana, generated 28% of operating profits and 26% of sales. PepsiCo International, which includes both snacks and beverages, accounted for 29% of total profits and 40% of sales. In the third quarter, the international unit continued to perform well, and the outlook ahead remains robust, says Schoenstein.

Workforce Cutback

The company's snacks and cereals spell the difference between PepsiCo and Coca-Cola Co. (KO), which doesn't have a large food component, says Schoenstein. And the company intends to expand the foods unit through acquisitions. PepsiCo has done a good job expanding product lines in sodas, and thus can focus acquisitions on stronger growth areas such as foods, he says. Meanwhile, the foods operations are growing at a faster pace than the beverage business, and should continue to do so in the years ahead, according to Schoenstein.

Although there are pockets of slowing growth in the company's international markets, "the business is holding up well," says analyst William Pecoriello of Morgan Stanley (MS), who rates PepsiCo overweight with a price target of 74. The brokerage firm's internal analysis shows there is little correlation between a country's gross domestic product growth and growth rates of salty snacks, Pecoriello says. Frito Lay, for example, remains "rock solid" in foreign markets as well as in the U.S. (Morgan Stanley has done investment banking for PepsiCo).

With the economic slowdown, the company has announced a cost-cutting plan that includes a reduction of 3,300 workers, or nearly 2% of its total workforce, and the shutdown of six plants in order to save $1.2 billion over the next three years. The rise in commodity prices cut into the company's top and bottom line results, prompting PepsiCo to lower its earnings forecasts. That, in turn, spurred analysts to trim their sales and earnings estimates.

Nonetheless, for long-term investors the stock is appealing, says analyst Tom Nikic of investment research firm Value Line (VALU), in part because of PepsiCo's earnings predictability and financial strength and its dividend yield of 3%. "With all things considered, we see a good risk-reward scenario" in the stock, says Nikic. He gives PepsiCo the highest rating on Value Line's safety scale.

Also bullish is analyst Esther Kwon of Standard & Poor's, who rates the stock a buy based on the company's "domestic and international growth opportunities, pricing power, and healthy cash-flow growth." In addition, she says, PepsiCo's leading positions in its markets and its emphasis on health and wellness through its products "should continue to drive the top line." (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP.)

Slowing economies worldwide present difficulties for companies of all stripes. The Pepsi challenge, of course, is to continue to add fizz to its bottom line amid the downturn.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

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Algeria's Carbon-Capture Experiment

About 700 miles south of Algiers, the capital of Algeria, a monumental assemblage of pipes and cylinders rises from the bleak Sahara Desert. Not far away is a small airstrip and helicopter pad. And in a compound down the road, surrounded by a thick stand of trees to break the whistling winds, there are dormitories, tennis courts, even a mess hall, where a crew of chefs whips up hearty meals including lobster pie and potato tarts for several hundred people.

In a way, this oil industry camp represents an effort to turn the desert—or at least the natural gas Algeria exports to Europe—green. The plant, which is situated on a tiny oasis known as Krechba, is designed to strip out and cleanly dispose of the carbon dioxide contained in the gas produced by a vast network of seven distinct fields below the desert floor.

The gas in this part of gas-rich Algeria contains about 7% CO2, on average. That contaminant level must be reduced to about 0.3% before it is exported to Italy and other European countries. In the past, energy companies vented such unwanted CO2 into the atmosphere, adding to the greenhouse gas problem. But in this case, the partners, Sonatrach, the national oil and gas company, BP (BP), and, Norway's Statoil (STO) decided in the late 1990s to store the carbon dioxide underground.

Executives at the site say that the In Salah Gas Project, named for an oasis about 100 miles to the south, is the largest so-called carbon, capture and storage venture in existence. Accounting for about 12% of Algeria's gas output, it is an experiment—but a very large-scale and profitable one. Including military units intended to deter attacks by Islamic militants, who are still a serious threat in Algeria, there are some 2,000 people working on the vast undertaking.

Oil Industry Visitors

The companies say their project, which will produce gas for roughly 25 years, is preventing about 800,000 tons of CO2 from going into the atmosphere annually. That's comparable to taking 200,000 cars off the road, they say. While there are difficulties and questions, it looks like a promising step in the effort to reduce CO2 emissions from one large source: the oil and gas industry. Although not highly publicized, In Salah attracts visitors from within the industry who want to see if there are any lessons they can learn for their own oil and gas fields. Recent guests included a group from Abu Dhabi National Oil.

The added cost of disposing of the CO2 isn't huge. Mohamed Keddam, a Sonatrach executive who serves as vice-president of In Salah Gas, put the price tag at $100 million out of an overall $4 billion investment, or about 2.5%. That doesn't include daily operating costs. When the partners decided to move ahead with In Salah in the late 1990s, they were attracted by the opportunity to experiment with a new, possibly environmentally friendly technology. "We didn't feel it was right to vent the CO2 if we could do something else with it," says Michael Mossman, a BP executive who is also president of In Salah Gas.

Once the methane is purified at the Krechba plant to export-quality grade, it heads north in a buried export pipeline to join the Algerian gas network. The captured CO2 is pressurized by two giant compressors supplied by Mitsubishi Heavy Industries.

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Rethinking Computers in the Classroom

Three fourth-graders sit around a computer in one corner of a classroom at Harvey Milk Civil Rights Academy, a school of 220 students in San Francisco. One 9-year-old boy dons headphones to take his turn with the machine, reading passages from a virtual storybook as an animated panda cavorts on the screen. When he stumbles over words, voice-recognition software from IBM cues him to give it another try. After all the kids finish, the computer gives teachers a report on the students' progress, down to the letter combinations that throw them most often.

This may be a scene from the future of U.S. education. But Harvey Milk is no cutting-edge institution. The school is trying to reintroduce computers into its classrooms after a failed experiment with PCs a decade ago. The school once had plenty of computers and a dedicated technology lab, but a shortage of funds and lack of trained computing staff put an end to the effort. Today, the lab room is used for storage, piled high with boxes. "We've lost money over the years," says Sande Leigh, the school's principal.

Leigh is now trying to scare up funds to finance another effort to integrate computers into classrooms. The school bought PCs, literally at a fire sale, and plans to outfit its 11 classrooms with them early next year. She hopes to install IBM's (IBM) Reading Companion on enough systems to accommodate 44 kids at a time, though she's counting on a grant from IBM to cover the $10,000 cost of the software.

Short of Funds and Faculty

Leigh's experience is an example of what educators say is ailing computer programs in U.S. classrooms. Schools are enthusiastic about the technology's promise, but short of the money and trained faculty to extract many of its benefits. The debate over the efficacy of PCs in schools is gaining new charge as President-elect Barack Obama proposes new federal spending to outfit classrooms with computers and wire schools for Internet access as part of his economic stimulus plan.

In many schools, PCs have failed to aid students' learning or improve test scores, or equip them with the analysis and communications skills that today's workplace demands, according to studies. The problems include a reliance on paper lesson plans that don't factor in technology, and inadequate teacher training and technical support. Also at fault, say educators, is American classrooms' occupation with teaching kids strategies for raising standardized test scores to meet provisions of the No Child Left Behind Act.

That often leaves little room for creative extras. Other times, school boards buy computers to prove their technical savvy to politicians and parents, without thinking through how kids will actually use the machines. "Any school that focuses on putting more computers in the classroom as their core goal will undermine the transformation that technology can provide," says Anthony Salcito, Microsoft's general manager for U.S. education.

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Now, bolstered by the prospect of new spending on school technology programs, educators are exploring new ways to weave the computer skills seen as essential to this century's workforce into children's daily lessons. "What's exciting about the Obama plan is not just the money," says Elliot Soloway, a computer science professor at the University of Michigan who studies the effect of technology in education. "He's going to help schools rethink what the kids do on a day-in, day-out basis." Giving more kids Internet access could compel teachers to switch from asking students to Google for answers to questions, to assigning more involved research projects, Soloway says.

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Indian Voters' Top Worry? The Economy

After a set of surprise victories in state and local elections last week, India's Congress Party, which governs the country in a coalition, now enters a period of intense campaigning for the national elections scheduled for April 2009. And although its spirits were buoyed by several unexpected victories on Dec. 8, Prime Minister Manmohan Singh's government may find there is not much it can do before Indians go to the polls to improve what voters regularly indicate they care about most—the economy and local development.

Indian business is struggling. Industrial production fell for the first time in 15 years, according to data released on Dec. 12, underscoring how deeply the country's economy has been hit by the global slowdown and paucity of credit for business. The textile industry, the country's largest employer, may have laid off as many as 700,000 workers in the past months, according to some estimates, and even a nearly $8 billion stimulus package released in early December was not enough to pick the once bullish Bombay Stock Exchange off its multiyear lows. "The first priority for the government now is to figure out some way to boost domestic demand," says Mahesh Rangarajan, a professor at Delhi University. "There's no way you are going to see any market-friendly reforms."

Indian law imposes a code of conduct that restricts governments from making major policy changes within about a month of declared elections, reducing Singh's timetable for action. Already the stimulus package, which included $4 billion in new spending, stretches India's fiscal deficit to nearly 10% of its gross domestic product, according to Aninda Mitra, a Singapore-based analyst at Moody's (MCO). That limits how much more money Singh can throw at the problem. With elections looming, Congress may make a few more adjustments to interest rates and perhaps add a few more spending projects, says Rangarajan. "Frankly, I don't think that the government is looking at the fiscal deficit as a primary concern," he says.

Terrorism—An Urban Issue

In New Delhi, for instance, where a popular Congress leader, Sheila Dixit, was returned to power for a record third time, the party campaigned on a platform of development and growth. The capital boasts of the highest per capita expenditure on infrastructure in the country, with new roads, a new metro railway line, brand new government-run buses, and a nearly $11 billion budget for the 2010 Commonwealth Games. The result has been India's highest per capita income and a steady creation of new jobs.

The impact of the Mumbai terror attacks on Indian politics still is unclear. Bharatiya Janata Party (BJP), Congress's biggest opposition, campaigned on an anti-terror campaign (the elections were held on the weekend the Mumbai attacks ended), running front page newspaper advertisements that showed blood running down a wall. But the BJP lost to Congress in three of the five elections. Whether or not that indicates a national trend is unclear, says Biraj Patnaik, a political analyst and expert on malnutrition in India. These elections were decided mostly on local issues, such as the conditions of roads in Delhi and the availability of cheap, subsidized rice in rural Chattisgarh, which is among India's poorest states. "Price rise matters so much more than terrorism," he says, basing his opinion on weeks of travel in the states where the elections were being held. "Terrorism is an urban issue, a middle-class issue."

Without a doubt, India's slew of market-friendly reforms have been effectively stopped since August, when the Congress-led coalition survived a no-confidence vote in Parliament over a nuclear deal that brought India closer to the U.S., but opened its secret nuclear establishments to international scrutiny. Having used up much political capital to survive the no-confidence motion, the coalition hasn't had a lot to spend since. For instance, the government had indicated it might allow foreign companies to hold as much as a 49% equity stake in companies providing military supplies, prompting BAE Systems to seek permission for a 49%-51% partnership with Mumbai-based industrial group Mahindra & Mahindra to make armored and anti-land mine vehicles. The government's Foreign Investment Promotion Board rejected the original application, so BAE came back Dec. 11 with a scaled-down proposal giving it a 26% stake instead, and Mahindra a 74% share, according to the application.

Congress's unexpected victories don't necessarily provide a road map for how India's 695 million voters will move in the April elections. But with 70-year old Congress President Sonia Gandhi's son, Rahul Gandhi, attempting to come into his own as a national politician, this election is also expected to be a referendum on the Gandhi family. For the BJP, which has earned a reputation for strong anti-Muslim views and pro-business policies, the recent results pose a challenge, since it appears that anti-terrorism rhetoric is less convincing to voters than the party had expected.

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Can Airbus Keep Its Edge on Boeing?

It has been a rotten year for Boeing's (BA) commercial jet business. Production glitches and a 58-day machinists' strike this fall have pushed its newest plane, the 787 Dreamliner, a full two years behind schedule. Archrival Airbus (EAD.PA) has pulled ahead in the race for new orders, logging 756 net sales this year, compared with 657 for Boeing. At the same time, Airbus seems finally to have untangled its A380 mega-jet's production mess. And the strengthening of the dollar against the euro has boosted Airbus' bottom line and helped the European planemaker regain some of its competitive edge.

All that, and yet the market for big planes looks worse than it has in years. Total orders this year are likely to be half the level in 2007, and some financially strapped airlines are canceling or delaying earlier orders. "Traffic is collapsing," says Nick Cunningham, a London aerospace analyst with Evolution Securities.

It's a perilous time—but it could be even more dangerous for Airbus than for Boeing. Airbus' A350, its planned competitor to the Dreamliner, looks to be falling behind schedule, too. The company had expected to settle on a detailed design for the A350 by October, but now that timetable has slipped into 2009 as the planemaker negotiates with airlines over specific design features. That makes it almost certain that the A350 won't enter service before 2014, at least 4 years behind the Dreamliner's delayed launch in early 2010.

Permanent Majority?

The danger for Airbus is that further slippage on the A350 will seal Boeing's dominance in the high-volume, richly profitable market for midsize widebody jets. "Boeing may be guaranteed a permanent majority," says Doug McVitie, an analyst with Arran Aerospace in Dinan, France. Already, the Dreamliner has racked up 910 orders, almost twice the 478 logged by the A350.

The strengthening of the dollar, which has risen almost 20% against the euro since the summer, certainly offers short-term relief to Airbus. When the dollar was sinking, the company noted that every 10 rise in the euro would knock more than $1.3 billion off its bottom line, because airplanes are priced in dollars but most of the manufacturing costs are in euros. Airbus has launched a series of cost-saving measures, known as Power 8, aimed at slashing more than $4 billion in operating costs.

But such savings will be much harder to achieve if Airbus has to trim production in a downturn, because fixed costs such as buildings and equipment will account for a higher percentage of total expenses. Airbus already has said it will postpone a planned increase in production rates, and CEO Tom Enders said last month the company could take "further action if the situation deteriorates." Evolution's Cunningham thinks production cuts are inevitable, as he predicts annual aircraft deliveries worldwide will fall as much as 50% from 2009 to 2013. What's more, the dollar is now weakening again.

Danger could also lurk in Airbus' seemingly healthy order backlog. For example, more than half of its A350 sales come from Middle East airlines and leasing companies, leaving it far more exposed than Boeing to a downturn in that region. Although Middle Eastern carriers such as Emirates Airline have expanded rapidly in recent years, many analysts contend the rate of growth was unsustainable even before the global recession hit. A slowdown could threaten orders from carriers such as Qatar Airways and Etihad Airways of Abu Dhabi, each of which has dozens of planes on order from Airbus.

Certainly, Boeing faces risks of its own. For example, it has more planes on order than Airbus does from financially weak airlines in India and China. And Boeing's problems with the Dreamliner have clearly helped Airbus by providing a textbook case of how not to build a new aircraft. Indeed, according to a recently leaked copy of an October 2008 report, "Boeing 787 Lessons Learnt," Airbus has assigned an "engineering intelligence" team to study the Dreamliner's woes in detail.

No doubt its Chicago-based rival is now gearing up for a similar exercise on the A350.

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