Harley-Davidson's Financing Division Needs A Tune-Up

| About: Harley-Davidson, Inc. (HOG)

Harley-Davidson, Inc.'s (NYSE:HOG) stock price is expected to become more volatile and slide downward due to new scrutiny of its cash flow, intercompany borrowing and retail lending practices. The stock price could drop precipitously with intermittent small rebounds, so a successful investment strategy could include short sales, puts and/or an alternating series of short-term puts and calls.

Until very recently, the main uncertainty about Harley-Davidson has been whether the company will continue to be relevant as its customers change and age. The typical Harley-Davidson customer is an older white male in the US; and it remains to be seen whether new customers will be attracted to the brand fast enough to keep the company afloat.

But the concern about Harley-Davidson's aging customers is already reflected in the stock price. The current and continuing stock price volatility stems from new and more significant uncertainty about the health of Harley-Davidson's financial segment ("HDFS"). Here are five things to look for in the upcoming third quarter 10-Q to assess the status of HDFS:

1. In Q3, did the motorcycle segment make a loan to HDFS? In the last few years, the motorcycle segment has been making short-term loans to HDFS that straddle the end of the quarter. (See the 'Intercompany Borrowing' disclosures in Harley-Davidson's most recent 10-Qs and 10-Ks).

2. Did the company fail to file an 8-K when it issued debt in Q3? The company did not file an 8-K when HDFS issued $600 million of medium-term notes in September 2012, so the 10-Q might again include the first disclosure about a Q3 debt issuance.

3. Does the cash held by HDFS seem reasonable given the amount of debt HDFS incurred in Q3? Lately, HDFS's cash on hand at the end of the quarter seems low given the amount of cash raised during the quarter (e.g. by issuing notes or taking out a loan), so the numbers should be checked for disappearing cash.

4. What percentage of the retail sales are financed through Harley-Davidson? In recent years, about 50% (or less) of Harley-Davidson's motorcycle retail sales in the US have been financed through Harley-Davidson's subsidiary bank (Eaglemark Bank). On the Q3 earnings call, the company said that this percentage could increase to 60%. This could indicate that Harley-Davidson is making riskier loans.

5. Is there new disclosure about the repo process or increasing defaults? On the earnings call, the company indicated that the resale value has dropped for repossessed motorcycles. Furthermore, management indicated that default rates are expected to increase. This raises the question of whether the company is now losing money on defaulting loans and repossessions, and how fast these losses could worsen.

The company is expected to file its third quarter 10-Q in early November, so the stock price could stutter downward until then. When the 10-Q is filed, there could be a significant move in the stock price, based on whether the 10-Q relieves or worsens worries about HDFS.

Disclosure: I am short HOG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.