Harley Will Sputter Into 2009

Harley Davidson, Inc. (HOG) has had as tough a year as any stock, down 73% over the last 12 months and reaching its 52-week low this morning. The company reported 4Q EPS of $.34, well below consensus estimates of $.57. For the full year, earnings were down 25.4% to $2.79 per share, missing even the most bearish estimates of $2.97. Harley Davidson Financial Services was a major source of problems as that unit swung to an operating loss of $24.9 million in the fourth quarter, with exposure to securitized loans continuing to be a problem. We detailed Harley’s precarious position in December (Not So High on the HOG), and warned that the $6.3 million in write-downs in the third quarter had the potential to get worse, which seems to have been an understatement. Write-downs in the fourth quarter totaled $63.5 million, with a $35.1 million write-down of existing securitization interests and a $28.4 million write-down to fair value of finance receivables held for sale.

With the financial services unit in deep trouble and its chief having recently been ousted, it is commendable that the company was able to turn a profit. According to the quarterly report, HDFS has $1.5 billion in net cash flow needs and has already begun to take advantage of the Fed’s commercial paper lending facility. Obviously, the results of HDFS severely impacted the company’s overall performance. Not helping matters, motorcycle sales in the U.S. were down by 19.6%. Interestingly, international sales showed a slight up-tick in the quarter. Revenue for the quarter was $1.29 billion, which was a decline of 6.8% but was in-line with guidance. Interestingly, Harley is planning to boost first quarter shipments to between 74,000 - 78,000, an increase of 3%-8%. That short-term optimism is quickly negated by full year 2009 shipping estimates of between 264,000 - 273,000, an overall decrease of 10% to 13% from the slumping sales of 2008. Clearly, Harley Davidson management sees a rough road ahead in 2009.

As a further sign of belt-tightening at Harley, the company is cutting some 1,100 jobs, or 12% of its workforce. In addition, HOG will slow production at its facilities; in some cases consolidating plants and in others farming out work to third parties. Management’s pessimistic view of the year ahead is echoed by Standard & Poor’s, which last week downgraded Harley’s debt to BBB+ from A. A spokesmen for S&P, Andy Lui stated,

“With consumer sentiment getting weaker and the U.S. economy losing more jobs in 2009, we believe that the company’s results in 2009 will be even weaker than in 2008.” And speaking of Harley’s securitized debt and leverage, “With this market remaining somewhat illiquid and becoming a more expensive source of funding than historically, Harley-Davidson may need to supplement securitization financing with more unsecured debt to help customers purchase its motorcycles, leading to an increase in debt leverage.”

Therefore, while we find the valuation of HOG compelling, it appears that management as well as analysts and ratings agencies agree that the struggles within Harley are far from over. We have rated HOG as Greatly Undervalued because based on historically normal valuations the stock is undeniably cheap. However, just because a stock is cheap compared to historical norms does not necessarily mean this is the right time to buy. Harley faces some serious issues in the year ahead.

The only reason to buy HOG right now would be if you believed that both the consumer spending environment will soon improve dramatically and that the credit markets will improve enough to enable the company to trim its exposure to securitized loans. If you believe that these conditions will worsen before all is said and done, then HOG has more downside ahead.

Comments

[Chris B:]

Anyone who thinks $20,000 motorcycle loans will have a lower default rate than subprime mortgages has some explaining to do.

Bikes, boats, and RV's always drop in value during recessions because they are the first things people sell. They're also the first payment people skip. Harley will have a tough time competing with the used market, much less recovering anything from thousands of defaulted loans.

Then just wait until their unionized workforce starts a strike to protest wage/benefits/pension freezes.

"Undeniably cheap"?????

I have some GM shares to sell you. $10 each, which is cheap by "historical norms"! :-)

Jan 23 04:45 PM

[1worldcurrency:]

Not to mention their bikes have a reputation for conspicuous consumption, or style over function.

Jan 23 04:59 PM

[Jake Berzon:]

All very sad, but also very true. It looks like the stock's closing price today assumes that demand for Harleys will erode significantly and/or that interest rates will greatly pick up. It is difficult to tell if either of these is a bad assumption, so I would not bet against the market on this one.

Jan 23 07:38 PM

[User 265729:]

This economy is wild, isn't it? What a difference a few months makes.

In June-August it was almost impossible to take a motorcycle course, motorcycles and scooters were flying out the doors of local shops... Then September came along...

Now you can see HD's and all other motorcycles/scooters almost given away on various sites. I've seen several adds where owners just want them out of their names!

But it's really tough for HD... It may not help them in the end, but the metric bike companies are just divisions of other units that may include autos and heavy industrials.

HD and Indian... Real Americana...

Jan 23 08:35 PM

[Clarke D:]

I'm sure Harley Davidson's sponsorship of mixed martial "arts" will soon turn their fortunes around. Right. If this is the type of sleaze that Harley wants to be associated with, then obviously heads need to start rolling from the management level. I've been a loyal Harley Davidson customer for years, but I'm done with them. I can't support any business that condones the blood and gore that is mixed martial "arts."

Jan 24 05:43 AM

[Robert Sare...:]

I suggest that Harley go back to the protected market it had in the 80s.
That puts a tarrif on import bikes so American products can recapitalize.
It worked once and might work again. Their product is certainly much better
than it was. And their dealers are much better developed than before.
It's better that way then wait for a new owner down the road.

Jan 24 09:14 AM

[Cora1:]

Company is undeniably facing a perfect storm, but stock appears heavily shorted, negative news is out, downward revisions of unrealistically high analyst earnings expectations done by Monday/Tuesday; with company guiding Q1 deliveries up and Q2-Q4 implicitely down some 19% I tend to see more risk being short this stock than long, especially as the upcoming stimulus package may contain some positive news with respect to consumer financing (catalyst for buying/short-covering)... In terms of valuation: the stock is cheap (2009 EPS should come in between USD1 and 1,5 pre-charges. Comparing HOG to GM (1st comment above) is not valid with respect to balance sheet, margins and thus ability to cope with the current challenges.

Disclosure: bought at $10.3 on Friday

Jan 25 07:44 AM

[Johnny Sher...:]

Clarke,

You may do what you wish, but if your stomach is so weak that you can't handle the "blood and gore" inherent in combat sports like MMA and Boxing, I think it is safe to assume you don't represent a significant percentage of HOG's client base.

If watching an athlete bleed from the nose after being punched makes you uncomfortable, you must ride your bike in a suit of armor.


On Jan 24 05:43 AM Clarke D wrote:

> I'm sure Harley Davidson's sponsorship of mixed martial "arts" will
> soon turn their fortunes around. Right. If this is the type of
> sleaze that Harley wants to be associated with, then obviously heads
> need to start rolling from the management level. I've been a loyal
> Harley Davidson customer for years, but I'm done with them. I can't
> support any business that condones the blood and gore that is mixed
> martial "arts."

Jan 25 10:42 AM