Harley Davidson: Plan for More Downside

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ANALYST CALL

While the Harley Davidson (HOG) brand is a very iconic one, with a loyal core of followers, to the extent that the company’s products can be placed in the category of non-essential luxury, as the economy continues to deteriorate, it will have a drastic negative impact on the company’s bottom line.

It does not help that in an environment where consumers are increasingly worried about job security and keeping up with the mortgage, the average price of a Harley Davidson motorcycle is $13,379. On that basis, we feel the shares, which have already fallen 71.5% since September 30, 2008 have some more downside.

LOGIC

Current economic conditions are already having an impact on Harley Davidson’s sales. On March 5, the company reported that dealer sales for the first two months of this year fell 13% on a global basis. Unless one firmly believes that the economy has reached bottom and we are now on the cusp of an upswing, then even worse days are ahead for Harley Davidson.

The sales news from the company underscores the fact that the economic malaise and its effects seem to be progressing at a pace that the company hasn’t yet come to terms with. Back on January 23rd, Harley Davidson provided lowered guidance in which it said it plans to ship between 74,000 and 78,000 new motorcycles in Q1 2009. Those numbers represent a 3-8.5% increase over 2008 first quarter shipments.

Less than two months later, the company announced the 13% decline in dealer sales quarter to date. With just two weeks left in the quarter, the actual revenue numbers for the period should not be much worse but concerns have now been raised for the rest of the year and there should be a question mark next to the company’s guidance of shipments of 264,000 and 273,000 new Harley Davidson motorcycles in the current year, which is just a 10-13% decline from the year ago period.

In the fourth quarter, the company saw revenue declines of 8.5% to $1.02 billion from motorcycle sales, unit shipments of 76,581, which was a 5.7% decline from the same period a year ago, revenue declines of 7.9% to $152.1 million in Parts and Accessories, while revenues from General Merchandise, which includes apparel and collectibles, fell to $69 million, a 6% decline. On a positive note, actual retail sales of Harley Davidson motorcycles in the U.S, fell just 19%, while motorcycle sales overall were down 25.5%.

However, even though the company is performing better than the industry as a whole, we will continue to see sales decline and the rate of decline should actually start to accelerate. We are already seeing margin erosion as the company has announced that for fiscal year 2009 it expects gross margins to come in between 30.5 % and 31.5%, compared to the 34.5% gross margins in fiscal 2008.

SUMMATION

Using traditional valuation metrics, Harley Davidson shares are cheap, but we are of the opinion that unfortunately, they will get much cheaper. The stock hit a 52 week low of $7.99 on March 5 and we are looking for the stock to test that again. From current levels, a move down to $8 would represent a 25% gain. We recommend shorting here and to start covering once the stock is trading below $9.

TRADING RISK ANALYSIS

While a strong case can be made for shorting the stock on near to intermediate term fundamentals, the stock will probably participate in any broad-based bear market rally. Thus, with the current trading environment, this is a concern. However, with the S&P 500 having gained 11.13% in just four days in the past trading week ending 03/13/09, we should see the market take a breather - that is in the absence of good news.

Disclosure: We do not have any position in Harley Davidson.

Comments

[ChipSeal:]

Last week we actually saw a pig fly!

Mar 16 09:22 AM

[gac1innj@ao...:]

I would say that the author of this article probably does not own a Harley. If he did, he would not be so quick to call for more hard times. As the saying goes, "If I have to explain, you probably wouldn't understand."

I just bought a new 2009 H-D Crossbones two weeks ago, which is my second Harley. I have a 2007 Road King as well. That is in the face of 15 people in my company that do my same job being laid off two weeks earlier.

I am bullish on Harley-Davidson and I own plenty of shares and I am still buying.

Mar 16 09:52 AM

[User 121516:]

The days of the chromed Lawn mower are numbered.
The peeps who owned these dinosaurs are nearly too old to hold them up, thus the 3 wheel trike makes entry into the HD line up. When this generation passes so does the air cooled motor and the era of the little pirate do-rag syndrome.

Mar 16 10:53 AM

[harleydlr:]

You might not want to bet on what you have just said. I am a dealer and represent many dealers on the National Advisory Council. As of last week there was a substantial surge in business that was not expected,but very welcomed. Floor traffic is up substantially and so are sales. This is just the tip of the season and already things are getting hot. The American public is tired of all this(mostly) dramatized bad news and they are beginning to spend. That will in itself turn this economy around. Just watch. At current inventory levels many dealers will be short supply by May or June and margins will be positively affected.


On Mar 16 10:53 AM User 121516 wrote:

>
> The days of the chromed Lawn mower are numbered.
> The peeps who owned these dinosaurs are nearly too old to hold them
> up, thus the 3 wheel trike makes entry into the HD line up. When
> this generation passes so does the air cooled motor and the era of
> the little pirate do-rag syndrome.

Mar 16 11:11 AM

[Car Guy:]

The average selling price that the author cites is actually the average WHOLESALE selling price to the dealers. The average retail price is in excess of $20,000, which only adds to the argument for the discretionary nature of these products.

In response to gac1innj: You, as well as most other HD owners are quick to point out the strength of the Harley brand, and the appeal of the Harley "lifestyle". While I agree to a certain extent, I believe there are several issues facing the company which will overwhelm these positives:

1) In an environment where auto sales are down 35% and the scrappage rate for cars exceed the purchase rate, you have to ask yourself whether the company's projections for just a 10-13% decline is realistic. A motorcycle is far more discretionary in nature than a car, and I believe that the US consumer is entering a new era of austerity where frivolous purchases such as that of a Harley will be down dramatically. For starters, the company recently acknowledged that International sales were down 21% in the first 2 months.

2) HDFS, the company's captive finance company, played it very loose during the credit bubble -- 25% of their portfolio is subprime and obviously big concerns about the potential default rate and residual risk. The fact that the President of HDFS recently quit (not to mention the retirement of Harley's CEO) only adds to the concern.

3) The company recently issued bonds to Buffet and their biggest shareholder yielding 15%. No company with decent prospects has to pay 15% to borrow money. And the proceeds are to be used by HDFS for funding purposes which will no doubt be losing out on the negative interest rate arbitrage.

Best case, I see the company earning maybe $1.45 in 2009. With so many issues confronting the company, its difficult to ascribe anything higher than a 6x multiple to it, which suggests a price of $9, best case. After this bear market rally runs its course, I believe HOG shares will resume their trend downward.

Mar 16 11:35 AM

[jefe:]

Our open house was this weekend and we are on track for breaking records this year, i think people look at it this way, better to invest in something that has value rather than the tax man or the stock market take it from you. People need to stop listening to the bad preachers on TV and go out and have some fun.

Mar 16 11:48 AM

[User 121516:]

Can't argue the numbers..
*I was in the HD shop this saturday and it was E M P T Y

Mar 16 12:44 PM

[Nathaniel C:]

Harley Davidson has been able to play the wall street game for a long time. They use accrual accounting which allows for them to stuff their inventory channels to boost short term eps. Under accural based accounting, Harley can book revenue just by shipping their bikes to dealers regardless of how many bikes are actually sold by the dealers. They can only keep up this trick for so long. At a certain point the dealers cannot sell the bikes even with large discounts. At this point Harley will have to dramatically scale back the planned bumber of bike shipments to dealers.

Mar 16 01:19 PM

[jackooo:]

I would expect the bikes to sell better than cars so to compare them is not valid. How does 55 mpg on the Harley compare to 30 on the car.
In Ca. a bike like a HD holds it's value more than a car and the taxes and registration and insurance is lower.

Mar 16 01:41 PM

[Car Guy:]

jackoo: The only reason a comparison is not valid is that a car can take you to work everyday, a bike cannot. In most regions of the US, the riding season is, by definition, seasonal and the company's sales reflect that seasonality.

I agree that historically, HD's have held their value well. However, I believe that with the decline in sales and increased discounting (e.g. the Ride for Free campaign) those days are over and that HDFS will suffer for it. There are already reports of widespread weakness in residual values (and plenty of used bike offerings on ebay support that).

I also think your comment on gas mileage is irrelevant. I doubt people are dropping 20k on a new bike primarily for fuel economy - the payback would be awfully long. In addition, with the decline in gas prices, fuel economy is no longer at the top of consumer mindset as can be evidenced by the recent fall off in sales of fuel efficient cars.

Mar 16 01:59 PM

[Marcap:]

I really do not think that H-D is going anywhere anytime soon. It has a been down a few rough roads before, and has roared back with flying colors. I am confident it will do it again, because now it has a solid balance sheet, plenty of cash, reasonable debt, and a world of supporters.

Trading at just over their book value of $9.09 at $11.16, with a P/E ratio of only 4.00, and a dividend to boot at 3.7%, H-D shares are indeed a bargain, and one that we can count on. In fact, in my opinion there are only 3 sets of wings that we can all truly count on: The American Eagle's, Harley Davidson's, and of course our own Guardian Angel's.

Mar 17 02:29 AM

[pirateshipinc:]

I agree that Harley is over priced, we bought one 3 years ago for 18k. We bought used because the new price was way over inflated. We have made every effort to maintain ownership during this downturn. And it looks as if we are going to keep it. I look at it this way....

If I would have bought stocks equaling 18k on Dec 8, 2006 I would have paid 71.00. That would have got me around, 230 shares (with fees and cost subtracted). Today if I turned my stock in, it would be worth $2000 minus fees and so on.

I feel that my wife and I made a good choice because a Harley will eventually retain its value. Especially since we purchased a discontinued classic model (not one of those idiot choppers). I know that some will argue with me about the decision, but keep in mind, nobody is really safe in investment no matter what you choose. But I will say this.

My investment is well worth the risk, I enjoy my risk everyday rain,snow,sleet or shine. And hopefully my grandchildren will enjoy the risk, and story that goes with it for generations to come.

All need to get over the money materialistic nature and start to enjoy what they have.

Mar 17 03:03 AM

[aarc:]

The author is talking about a short term trade for HOG. He is sweetening the deal with some fundamental analysis.

This is typical of short-term technical trend traders. When the arrow is down, short the darn thing.

However, a medicum of Elliott Wave analysis and some familiarity with fibonacci retracement levels implications and understanding of common chart patterns as related to momentum indicators will immediately say "danger ahead" for short sellers. This is not a high probability short sale trade. IF HOG goes above $12.16, probability goes high it can reach $20.01 with $23.55 the next high probability entry price for shorting the stock using a common expanding flat pattern the current price structure is very capable of supporting.

Fundamentals works its way in glacial manner. Fundamental analysis clouds a short-term technical trade and is therefore too fraught with peril. Stick with technical analysis if you want to scalp trade HOG. Scalping HOG at current price levels is good only for day-traders with high levels of technical analysis experience who can get in and out of a trade within a trading day or a few days at best.

Long-term investors need not worry with this article.

Mar 17 04:17 AM

[aarc:]

And don't use that stupid chart above the author is illustrating for visual aid for technical analysis or whatever type of analysis he is trying to convey. Use a professional chart such as TradeStation or eSignal.

Mar 17 04:22 AM

[mkreisel:]

Harley may have a loyal following, but the company itself behaved like a subprime lender over the past several years.

Unless they can collect their financial receivables, they will be in deep trouble. (Check HOG's cash flow statement, not pretty)

Mar 17 04:33 AM

[prudentinve...:]

I agree with the author in the short-term. My guess is that sales and earnings will languish for some time, with the bottom not yet in sight, and likely worse than current management expectations.

However, I have been a fairly successful value investor, and I like to buy good companies when they are cheap. HOG is a great brand, but I am glad I closed out my earlier positions some time ago. Recently I bought a few shares @$12, a bit more @$10 and a lot more @$8. I would greatly appreciate it if some readers of this article follow the author's advice and short the stock and drive it down, as I would like to pick some more below $8 before I sit back and wait it out.

I realise that (a) if the recession becomes a depression the company may ultimately fail; and (b) even without depression, I may have to wait some years before the stock recovers the 30's; but all in all these are risks that I find acceptable for the potential reward of 300%-500% appreciation over a period of, say, 4-7 years.

Mar 17 08:12 AM

[Chris B:]

HOG may have an enthusiastic customer base, but it's the financials that matter. Default rates on its subprime bike loans are about to go through the roof. If you think housing subprime loans are a problem, imagine the difficulty of repossessing a motorcycle and reselling it. Also, if you think people will decide to lose their homes or cars before giving up what is basically a recreational vehicle, I'd like to hear the rationale. Sounds like a bad debt write-off to me.

Wait until you see how well their pension fund has held up in this environment! HOG is no better an investment than Ford or GM - those earnings in the PE ratio could swing negative in the next quarter depending on how upfront they are in recognizing bad debt and replacing pension fund losses.

The motorcycle industry's history is littered with decades-old, widely loved icons that eventually went bankrupt - Triumph, Indian, Norton, BSA, Jawa, Hondaka, etc. The wildly cyclical and highly discretionary nature of the product means that when companies become too dependent on debt, they will be unable to survive the next economic downturn. Harley's 15% junk bonds might bring back unpleasant memories for older investors who held common stock in the iconic companies listed above in decades past.

I'm not a Harley hater. In fact, I think a stockpile of spare parts could appreciate at double-digit rates per year post-bankruptcy.

Mar 17 11:09 AM

[Biker Boy:]

Harley is fine as a long term investment if it is throwing off sufficient cash in its dividend. The large motorcycle market in the developed world has been roughly flat years. That means Harley is not going to grow. It could be a cash cow, but that's about it. If you are interested in Harley you need to be getting a good enough dividend to make up for the lack of future growth.

Harley has a higher risk as a brand because it's customers are on average in their 40's and the company is highly finance dependent for sales. As these customers continue to age they are going to have to put money otherwise spent on motorcycles towards retirement. Unless HD manages to attract a younger set its going to be tough to maintain sales.

Used Harleys are all over the place on craigslist, at least where I live. How many of those are financed? How many people are going to have to hand them back to the bank or HDFC?

Motorcycle lovers all believe their bike is worth $20k because thats what they paid for it. Would you buy a used bike for that much? Every motorcycle depreciates to roughly $1000 after several years, just like cars. These are disposable consumer products, not family heirlooms.

Mar 17 01:28 PM

[Alex Salkever:]

Maybe they can start making primo electric bikes of mopeds -- though it'd be hard to call them hogs, no?

Mar 17 02:39 PM

[NickMpls:]

I think the thing people are missing is how closely this will mirror the housing crisis, not only are the bikes expensive relative to their utility, the huge glut of used bikes coming on the market. I know that there are doctors and lawyers, that ride harleys, but there is a disproportionate number of people who are affected the most in this economy, tradesmen and blue collar workers, not only will they not be buying a new harley anytime soon, they may be forced to sell theirs. As far as selling new bikes, its a tough sell when you can get last year's model for 40 percent off of the sticker with only a few miles on it. I dont see any huge turn around for harley any time soon.

Mar 17 07:42 PM

[ideal ride:]

My Harley is my retirement program. At 45mpg and insurance with a maGor company @ $74 a year I save plenty to BUY more HOG at current prices.
I save even more money/time cruising effortlessly through LA traffic, even factoring in an occasional day or two in the hospital.

Mar 18 02:01 PM

[Irockuroll:]

As long as it's not snowing- I'm riding. I'm not afraid of a little water, and neither are many riders. I see more and more 20 -30 yr/old people riding Hog's every year. It's the sizzle, not the steak.
I've bought a new bike every year for the past 5 years and this year is no different.
The author is trying to generate a emotional response- sorry bud- go pick on GM. H-D has nothing in comparison to the big three. H-D was just listed yesterday as the #3 brand recognition IN THE WORLD behind Coca-Cola and Johnson and Johnson. I challange anyone to travel to a major city in the world, and not find an H-D trademark somewhere. I saw one in Northern Africa, just last year.

Mar 19 01:35 PM

[User 379577:]

I understand the author says that selling short might be a good near-term strategy, but I agree with most of the riders here that long-term, HOG is a good bet.
The company has plenty of good product and legions of loyal fans, many of whom are raisiing their children on the value of the brand.
As for being seasonal, in most of the country, the season easily runs six months. Once gas prices climb (again) this summer, my 53 MPG will again save me money - I saved over $600 last summer.
Granted, that won't pay for the bike, but I use mine for commuting, not pleasure riding.
Buy HOG, and for Pete's sake, buy a Harley. Ride American iron - it's good for you AND for the country.

Mar 19 08:58 PM

[User 357469:]

To Irockuroll and User 379577. I agree with you both on Harleys. Its brokers+analysts like Daniel Shepard who have their own motives for pushing stocks lower which have only helped to reduce America so much economically. Well they may think they are soooooo smart but in my humble opinion such people are doing far worse economic damage to America than any terrorist ever did. Isn't it about time we just turned OFF those like Daniel Shepard and his firm Navivest with their selfserving opinions? And just in case some have not yet noticed disagreement with an article results in more thumbs down than usual. No wonder so many brokers+analysts don't comment aftrer they post an article. Well here's a thumbs-UP for both of you Irockuroll and User 379577. Enjoy your Harleys!!!!!!!!!!! Happy and safe riding!!!!!!!!!!!

Mar 20 01:40 PM

[staples - w...:]

I am not a huge follower of Hog, but outside of the economic BS, we are all going through, I am lost on a little FYI HD info.

for the record, I am the in the age bracket mentioned above for Harley riders. do I ride, NO. If I did, it would be a Harley.

The same goes for the mystiques that my generation has on HD's and bikers in general. Bad 60's and 7-'s movies made people think bikers=bad. They are some of the coolest guys I ever hung out with. Partying with, another story, but they will always stop to help someone out it seems. OK, a huge stereotype, but i am from the 70's and still don't wanna make no enemies. Think of the movie 'Mask' and how cool riders are.

MY stock question comes from the strike that went on a little while ago at HD. Did they ever fully recover from that only to be drawn down again in this credit crap crunch?

I would find it an interesting how all the HD riders reacted in the post strike time, if there was one before the Suzuki Hit The Fan, ya folla

Thanks guys and I have my bandannas and don't even ride...so there! I'm with the orange one...walking

Billy Staples

Mar 23 12:00 AM

[User 379577:]

Billy - stop dreaming, start riding. I bought my Sporty because I can't afford the Softtail yet - that's my next one.
And yes, bikers of all stripes are the coolest people around. I hung around a group of riders in my teens and twenties, and even though I never had a bike, they would give you the shirt off their back, their last dollar or their last cigarette. Salt of the earth.

Mar 24 08:42 PM

[NYCDart25:]

Great, harley is a great brand, we all know that....but do you choose your bike or your house? Any the big buyers (i.e. middle and upper middle class are the ones bearing the bulk of the financial problems...and spare me all your stories of the wealthy Dr. or Lawyer you know who is a biker...because there sure are not enough of those people to buy 250K bikes EVERY year


On Mar 16 09:52 AM [e-mail] wrote:

> I would say that the author of this article probably does not own
> a Harley. If he did, he would not be so quick to call for more hard
> times. As the saying goes, "If I have to explain, you probably wouldn't
> understand."
>
> I just bought a new 2009 H-D Crossbones two weeks ago, which is my
> second Harley. I have a 2007 Road King as well. That is in the face
> of 15 people in my company that do my same job being laid off two
> weeks earlier.
>
> I am bullish on Harley-Davidson and I own plenty of shares and I
> am still buying.

Mar 28 10:12 PM