Harley-Davidson, Inc. (HOG) has endured some very bitter comments from analysts in the past couple of trading sessions. On Friday it was a downgrade to “Sell” from a Citigroup (NYSE:C) analyst that sent shares tumbling 7% on the day. On Tuesday a research note out of UBS (NYSE:UBS) piled on the bad news, as they revised their earnings estimates downwards because second quarter sales results appear to be worse than anticipated. However, in contrast to the sell-off instigated by the Citi analyst, Tuesday the stock fell close to 10% in the morning and then battled back throughout the day to end nearly even for the trading session. The fact that HOG shares rebounded so strongly could be a signal that the bulls are taking control and the shares will be resilient to further weakness.
It is no surprise that this market environment is a very difficult one for the iconic Harley-Davidson brand. The company’s sales are slumping down 35% from last year in the second quarter, as referenced by the UBS analyst. The obvious problem is that no one needs to buy an expensive motorcycle, and there is no doubt that sales of luxury goods are going to struggle in a recessionary spending environment. Furthermore, the secondary market for Harleys has never been more active as cash strapped Harley owners look to unload their bikes for cash, and even worse for Harley, used bikes that have been repossessed from less than creditworthy borrowers. Which brings us to the anchor that has weighed down Harley more than any other, Harley Davidson Financial Services or HDFS. HDFS was greatly affected by the credit crisis as the secondary market for Harley loans vanished. At the same time, HDFS was making loans to sub-prime borrowers in order to boost slumping sales as we detailed back in December of 2008 in Not So High on the HOG. That was a recipe for disaster as evidenced by the stock's substantial decline.
“Take a look at stories we’re following. UBS is cutting full year earnings forecast for Harley-Davidson telling clients that the reducing of the motorcycle makers profit outlook is now to 96 cents a share down from $1.49 because sales in the U.S. have hit a wall. Harley-Davidson shares tonight down a fraction.” CNBC’s Closing Bell 6/9/2009
When looking at Harley-Davidson from a value perspective a lot of the traditional valuation metrics look promising, including price-to-sales of .73x versus the historical range of 1.95x to 3.21x. Price-to-cash earnings look similarly depressed compared to historical norms for HOG stock. After all, the greatest value investor of this generation, Warren Buffett, is standing behind Harley with a $300 million debt purchase. However, there is more than meets the eye to that deal, Buffett is receiving 15% annual dividend payments which is more than twice the interest rate normally associated with junk bonds.
Value investors must try to pick stocks that are not only beaten down, but also have good prospects for a recovery. That is what separates a value stock from a value trap. In that way HOG can be a polarizing stock, on one side of the argument you have those that believe the Harley-Davidson model is broken and baby boomers will need to put more capital towards rebuilding their retirement than buying an expensive motorcycle. On the other side you have those that believe that the significant strength of the Harley brand will enable it to thrive once again, and this is simply a temporary set back as many other companies are experiencing now. The fact that the market shook off the disparaging comments from UBS regarding Harley’s disappointing sales could mean that the optimistic value investors had the upper hand today but that could change tomorrow.
At Ockham, we value companies from a long term value perspective, which yields an Undervalued rating for Harley-Davidson shares. That does not mean that the worst is over for Harley as 2010 could present new challenges for Harley’s finance division, but an improvement in the economy and the credit markets would help this stock with a beta of 2.15 rebound relatively quickly.