HOG Is About to Catch Swine Flu

Harley Davidson (HOG) was upgraded to Hold yesterday by Citi based on better than expected motorcycle sales in August. Apparently the Citi analyst thought this was the start of an up trend in motorcycles sales. While no one can be absolutely sure, this seems unlikely. August auto sales were much better (yet still disappointed) due to the Cash for Clunkers program. More than likely some of the enthusiasm for buying cars during that period spilled over into the motorcycle arena. The big surge in auto buying is not expected to continue without Cash for Clunkers. Just the opposite is true. Future sales may have been robbed so people could buy at a discount during Cash for Clunkers.

A much larger proportion of the buyers are now experiencing “buyer’s remorse”. They probably could not afford the new cars they bought – even at a discounted price. They probably had good reason to be worried. The national rate of auto loans that were 60 days past due was up 7.35 percent for the Quarter ended in June.

HDFS (HOG’s finance arm) is HOG’s biggest problem. Do you think HDFS might be experiencing the same problems as the auto industry? It seems likely they are experiencing even worse problems. Many HOGs are recreational equipment for their riders. In other words, many HOG owners don’t absolutely have to make the payments (as they do for cars) because they can do without them.

In stark contrast to the Citi analyst’s view, I think that HOG will catch Swine Flu this fall and winter. Health officials are now estimating that as much as 50% of the US population will be infected with Swine Flu this fall and winter. 2000+ students at Washington State University already caught Swine Flu this term, and the term just started. Tuesday, many public school students went back to school for their first day. It seems likely they will quickly spread Swine Flu throughout the US. It is already prevalent. We could have as much as 10% to 20% of the US population sick with Swine Flu within one month.

Do you think any of these sick people will really want to ride a motorcycle in increasingly colder and wetter conditions? Will they have the balance and the coordination? If they’re healthy, will they want to use a motorcycle to transport a sick family member or friend to the doctor or hospital? Wouldn’t they be afraid of getting Swine Flu from their sick passenger? Wouldn’t they worry that their passenger might fall off or cause the bike to unbalance? With many of their friends sick, with the country in a recession, would they be thinking about taking a recreational trip (or ride) on their HOG? Would they rather be thinking of saving money? Would they rather be thinking of buying a safe car to transport people with? I certainly don’t see a near term up trend. I don’t know how the Citi analyst did.

More likely than HOG starting an up trend is HOG getting Swine Flu. We are pretty sure that’s coming. Most analysts have failed to consider it in their Q3 and Q4 estimates. However, evidence is mounting that it will be a big factor. In the UK, hard hit early by the Swine Flu, 72% of businesses reported absenteeism due to Swine Flu. 38% of employers anticipated sales would be hit (Reuters). The US is not far behind. Estimates for Q3, Q4, and Q1 2010 will likely fall. Some will fall demonstrably. HOG seems more likely than most to catch a strong case of the Swine Flu. Somehow that sounds appropriate.

Far from HOG pushing upward as the economy recovers, it will be struggling even harder to remain afloat. The economy will be having a harder than expected time. Dr. Roubini is likely correct in his U-shaped recession recovery prediction. HOG is trading at approximately 41 times 2009 estimated earnings. Those earnings estimates are likely to go down. HDFS is likely to have ever more severe problems in the next year. The past due rate on auto loans is up. Unemployment is now 9.7%, and it appears to be going up still further. Moody’s is predicting the peak for credit card defaults will be in mid 2010. It is likely the HDFS loan default rate will peak around then also. It is unclear HDFS will even have the money to operate next year. After a crippling, Swine Flu ridden, fall and winter, it may not.

Swine Flu may be the final straw for HOG. It is quite possible HOG may fail. HOG is a sell for Swine Flu season. After that you have to re-evaluate it. The 1 year average analyst price target is $18.62. The current price is $24.76. This is a more than 300% increase from the March low of $7.99. HOG is over due for a retracement. With the nice pop in stock price due to the Citi upgrade yesterday, today is a good day to short HOG. It has likely benefitted from a short squeeze. That squeeze should not last long. The fundamentals are unchanged. If the markets retrace (as I expect) soon, HOG should outperform to the downside based simply on its beta of 2.3. I have included some basic financial information about HOG below:

• Current Price = $24.76
• 1 yr. target price = $18.62
• Short interest = 18.37% of float
• Beta = 2.3
• PE based on 2009 earnings estimates = 41
• Price/Book = 2.43 (likely to worsen soon)
• Price/Cash Flow = 6.74
• EPS Growth (MRQ) = -91%
• Rev. Growth (MRQ) = -24%

The daily HOG chart indicates a break above the resistance level of $23.78. Normally one might think that this would mean further upward movement. However, the overall markets are poised to move downward. Plus there are many fundamental reasons that HOG is simply over priced currently. HOG is also above its upper Bollinger Band on the daily chart. It seems most likely this will be a failed breakout. The nearest good support levels below $23.78 are at $22.73 and $21.12. It seems highly likely HOG will reach $21.12 in the short term. There is further support in the $18, $17, $16, and $15 ranges. With a 1 year target price of $18.62, none of these support prices is out of consideration.

Disclosure: The author went short on HOG yesterday (9/8/2009). He hopes the Fed doesn’t throw a monkey wrench in his trade today.

Comments

[mallarde:]

Must admit that this never occurred to me as a HOG short position holder. It sounds very plausible although like something that might appear in "Freakonomics" -- a strange cause-and-effect relationship.

Sep 09 08:43 PM

[MickOlas:]

HOG may be a great short but shorting it based on your belief that there will be a swine flu epidemic is just silly. There are many other sectors (think cruise ships, shopping malls, movie theaters) that will suffer much more due to a swine flu outbreak.

Winter tends to be a seasonally weak period for motorcycle purchases anyway. If you have insight on HOG's finance arm and the trends in delinquencies, that would be a much better short thesis than the swine flu.

Sep 10 12:24 PM

[Rider:]

Harley has fixed it's overproduction issues..great company- great history- amazing customer loyalty. But no I wouldn't take my sick grandma to the hospital on the back of my bike. What a dumb thing to consider on a stock price/value. Still a great American success story- those people are in this for the long haul...

Sep 10 03:01 PM

[FUJIMO:]

mallarde:

Citigroup and other institutions of similar stature baffle me with their knowledge of the recreational industry.

Some dealers are taking on additional inventory for the upcoming months in anticipation of plant shuttering, relocation of production, layoffs, etc. in the fourth qtr.

Units with actual titles?

Channeling of inventory ?

Sep 10 03:33 PM

[David White:]

Rider: Actually HOG almost went bankrupt in the 1980's. The only thing that saved the company was a huge tariff put on imported (especially Japanese) motorcycles. With all of the free trade rhetoric these days, that won't happen this time. Selling in India is not going to fix the problem. India imposes a 105% tariff on all foreign imported motorcycles. The cheapest HOG they will sell in India will have a price tag of $14,000 (only about $7,000 in the US). The average motorcycle sold in India costs $1277. Plus they will probably have a few HOG discouraging laws as China does. For instance, in many of China's big cities it is illegal to ride a high powered motorcycle (1000cc or greater) within a certain distance of the city. I am guessing this has to do with pollution, but there could be law enforcement reasons. Regardless, this kind of law discourages HOG buyers. India will probably never be a great sales area for HOG.

As for the Swine Flu, part of my reasoning was that Swine Flu would have negative economic effects. HOG's are considered recreational vehicles. In hard times, when money is short and everyone is sick, you are likely not going to spend your money on a recreational vehicle. Plus there will likely be more defaults on HOG's on a percentage basis because it is a recreational vehicle (not strictly necessary for most people). HDFS used to sell a lot of the loans they made. However, the market for them is so bad now that they cannot get anywhere close to face value. HDFS is now keeping a lot of these loans on the books as "kept for investment". If a lot of them default, HDFS will be left holding the bag. The market for used HOGs has also gone down considerably, so a lot of these loans are substantially under water.

In other words, yes there are substantial financial reasons for shorting HOG. It is trading at 42 times 2009 estimated earnings. It could fail to get the funds for HDFS to operate next year. It had trouble getting them this year. It would make many fewer sales without HDFS. Plus HDFS could incur huge losses. I believe it is now holding about $5B to $6B in debt instruments. It is entirely plausible that HOG could lose a significant percentage of this money.

Sep 10 11:02 PM

[Snitzer:]

Harley riders are a lot like Mac fan-boys, they form a hard core band that will always ride the brand. The question is will the dedicated enthusiasts be enough to hold HOG's head up until sufficient prosperity returns to entice the fence sitters to go HOG-wild?

Sep 10 11:49 PM

[mallarde:]

I do not think that HOG's brand is close to collapse. I also think that the US gov. could go to bat for HOG even while it gives the auto industry a difficult time. The reason is that I think there is a unique sentimentality towards HOG that outstrips even GM and Ford.

Still, unlike Snitzer I do not think that things will return to "normal" ever again. And when I say "normal" I mean the climate that HOG operated in the last 10 or 15 years. I do not think that HOG's core fan base will be able to pay over $20K for a recreational vehicle used only on the weekends. I do not think that anyone will want to finance such purchases by HOG's core fan base -- including HOG.

Also, I think that HOG's margins were unsustainable. The motorcycles became garish fashion accessories for those that are not wealthy and were stretching to make the purchase. Like a Hollywood actor in his final throes, HOGs motorcycles have become a caricatures of themselves.

I do not think that the government will allow this icon to fail. Or some private equity fund will swoop in and buy a stake before it fails completely.

But I do not think that things will ever return to the so-called "normal" of the late-90s through 2007 for this company.

Sep 11 02:01 PM

[BigOlDave:]

Here's Value Line's take in this week's edition:

"We are purchasing shares of Harley-
Davidson for Portfolio III this week.
With annual revenues of about $4.5 billion,
Harley is one of the world’s most
recognizable manufacturers and marketers
of heavyweight motorcycles.
The leisure-related stock, though well
off its 52-week low of $8, has taken a
big hit over the past year. Motorcycle
demand has dried up in the face of
weak economic fundamentals, and investors
have grown increasingly concerned
that the aging of the huge Baby
Boomer generation would permanently
damage the company’s domestic
business. (Baby Boomers have long
had a love affair with high-end Harley-
Davidson bikes.) But we believe that
the company’s best days are yet to
come, and that results will recover
quickly once the global economy
warms up.

The company, now headed by CEO
Keith Wandell (he took the helm in
May), has been managing its business
fairly well during the recession. Indeed,
Harley has slashed headcount,
boosted manufacturing efficiencies,
and significantly reduced its inventory
position, factors that should support
good earnings growth once the demand
demand picture stabilizes. Meanwhile,
over the next 3 to 5 years, results are
poised to benefit from share advances,
efforts to attract younger consumers in
the U.S., and a foray into the large market
in India."

I'm not convinced.
Dave

Sep 11 04:50 PM

[joe_no_say:]

Swine flu? It went through our office, and the longest anyone was out was 2 days. It's killing what, the weakest 1 in 3000?

Sep 12 04:21 AM

[Iconoclast421:]

HOG's price is all about beta and has nothing to do with fundamentals. As far as technicals go, I've seen a lot worse looking charts somehow keep going up.

btw how is that TBT trade going?

Sep 16 03:47 PM

[mallarde:]

OK, now HOG is going to catch swine flu. Time to give back some of the frothy gain based on the notion of Indians saving HOG by buying ridiculous cruiser bikes. Are they going to start snapping up our retro muscle cars also? Dodge Charger? Corvettes?

Sep 18 05:26 AM

[mallarde:]

Anyone who ripped on David want to reevaluate? Anyone else hear of many people getting sick? I have a feeling that getting the flu does discourage such purchases as an overweight, overpriced weekend chrome carnival toy.

Sep 24 08:03 PM

[Buckoux:]

" The motorcycles became garish fashion accessories for those that are not wealthy and were stretching to make the purchase. Like a Hollywood actor in his final throes, HOGs motorcycles have become a caricatures of themselves."

I agree. Harley Davidson's, prior to AMF's acquisition in the 1970's, was technology of farm tractor origin (John Deer's, "Johnny-Popper", tractor motor can be heard in every HD's sound at idle). A replacement headlight could be purchased at a John Deer tractor dealer parts counter ( true, I actually did) and a taillight lens at a Chevy dealer.The engineering and the engineers were off the farms of H-D's origins in Milwaukee and the tractor manufacturers of the mid-west. But pollution politics has forced H-D to seek refuge in electronic technology thereby usurping the "tractor" simplicity of former motorcycles, increasing the purchase price and the cost of maintenance ( an oil/filter change is over $100 at a dealer, I've always done my own). They are, however, still the best motorcycle money can buy because they're still quality and their resell value is high. Furthermore, would you tattoo the word or emblem of, "Yamaha" or "Kawasaki" on your arm? H-D is not transportation, as the articles author implies, but a cult. Can one afford the "tithes" necessary to belong is the question.

Unemployment of 9%+ is a flat tire on H-D sales and credit.

disclosure: one share, H-D, framed.

Oct 05 11:39 AM