By all accounts, Harley-Davidson (HOG) reported one of its best financial performances in quite some time on Tuesday morning, and in response shares rose more than 8% in heavy trading. Although sales slid by more than 19% from a year ago, they still came in slightly ahead of expectations at $1.04B. The company reported net income of $33.3 million or 14 cents in the quarter, but excluding one-time charges the results were considerably better. Harley earned about 29 cents per share ex-items, which was about 32% better than consensus analysts’ estimates. Perhaps most important was the fact that Harley Davidson Financial Services returned to profitability quicker than most had anticipated. HDFS reportedly made about $26.7 million in operating profit during the quarter accounting for roughly 11 cents per share, certainly not a small haul for the unit responsible for large losses in the previous three quarters.
The performance of the financial services division clearly outpaced expectations of just narrowing losses. The company added an impressive $1.9 billion in finance receivables, and delinquency rates improved as well. Improving credit trends are a welcome sign to HOG investors, but we also see some considerable reason for concern, primarily in their core business of selling motorcycles. Net shipments fell 28% from a year ago to less than 54k, but the firm did reiterate its forecast for full year shipments of 201k to 212k. We believe that forecast (for declines of between 5% and 10%) implies a rebound in sales activity through the rest of the year. While that is certainly a possibility, we are concerned that the American consumer is still reluctant to commit to this size of discretionary purchase on a wide scale.
The lack of domestic demand has forced Harley-Davidson to think outside the box or borders to be more accurate. Domestic HOG dealerships shrunk in number by 6 in the last quarter, but they also opened 5 new dealerships in India. Further growth into Central and South America is expected in the next few months. Indeed, international sales (-2.8%) have been more steady than domestic sales (-24.3%), and it is clear that Harley has turned its attention abroad for more promising avenues for growth. At this point, the company claims just over a third of total sales from outside the US, but has aspirations to grow that to 40% by 2014. We think that benchmark will be achieved relatively easily with the current course of action, but protecting the company’s bread-and-butter of US sales seems to us a bigger challenge. An aging rider base and competition from lighter bikes have taken a major toll already, and Harley faces serious challenges into the future.
As you can see from our ratings history chart, we downgraded Harley-Davidson to Overvalued as of this week’s report. So, based on our methodology, HOG investors should be looking for an exit and today’s nice pop may provide the right opportunity. The stock has more than doubled in the last twelve months and quadrupled since bottoming in March of 2009. Since that time, the company has rebounded thanks to heavy cost cutting, restructuring/streamlining operations, and better performance from HDFS. However, we believe the stock price has outrun the fundamentals and there is not a lot of support for the stock at these levels. For instance, HOG has historically traded for a price-to-cash earnings multiple between 11.1x and 23.7x, but at current levels it is near the high end of the historical range. We see a similar overvaluation when looking at historically normal levels of price-to-sales.
While Harley is showing much needed signs of strengthening, particularly as it relates to HDFS, we think that the valuation has become too rich. Perhaps the market is assuming US sales will quickly return as the domestic economy steadily improves, but that is an assumption we are not willing to concede. We do think that international markets present great opportunities for HD, but they also come with unique challenges as well. We believe Harley management is doing a decent job of operating in a difficult environment, but according to our methodology it’s just premature for this price level.