Harley Davidson: A Great Company That's Slightly Off Course

Another update of a past post. In early February I wrote about shares of Harley Davidson (HOG).

Please read the initial post as this one will reference it and it will make a whole lot more sense if you do. In that post, I advised NOT buying shares at their then $70 a share levels, but waiting until shares dropped to $60 (they sit at $61 currently). There were a couple of factors I alluded to that I thought would drive the price down, but would not have any long term negative effect on the company. Let's update those and see where we are at now.

The Strike

In February:

For the first time in history, Harley has a strike at its production facility in York, PA. This plant makes Harley's most profitable bikes. Now even though Harley says there should be no long term effect, there will be an effect now and this year (the longer the strike, the larger the effect).

The strike turned out to me a non-event. It 's duration was about three weeks and workers and management played nice in the end. It caused a drop in Q1 earnings and shipments, but even that was less that expected.

Credit

In February:

Harley has been selling more and more self financed motorcycles recently through Harley Davidson Finance (this is no different that any other retailer offering you "a credit card" at the checkout). The number of bikes sold this way has gone from 21% to about 48% in the past six years. There is concern that more of these loans may be of questionable credit. This could cause losses or decreased earnings at this division, which would negatively effect earnings as a whole.

It would appear that credit tightening in all markets is affecting Harley. Not significantly enough to cause real serious concern, but enough to cause people to dial back their expectations for next year. A recent survey of dealerships showed significant pricing below Harley suggested prices on bikes. This is being done to clear dealer floor before new models come out. Now, if these bikes cannot be moved, then orders to Harley will drop and earnings are going to be negatively affected.

Consumer credit is the main issue with Harley now. Since "easy money" is not so "easy" anymore, there is a certain segment of potential Harley buyers out there who will not be able to get financing to either buy their first bike or, more significantly upgrade to a bigger, more expensive one.

What To Do?

Recently, share jumped as rumors swirled that Honda Motors (HMC) would make a bid for Harley. Days later Honda denied the rumor. This illustrates the effect of rumors and how people react to them before they really think about them. I am going to say that shareholders, management and those who work at Harley would rather lay their private parts a hot tailpipe than see their company sold to the Japanese. This is not to say they have anything against the Japanese, but Harley is America through and through and nothing will ever change that. The executive that blessed the transition of Harley from US to foreign ownership would probably spend the remainder of their life "looking over their shoulder," and would have Sammy "The Bull" Gravano saying, "thank God I am not that guy." Let's just put this one to bed.

Now, does that mean Harley will not be bought out? No, it just means it will not be Honda. It's valuation is becoming compelling, and once this current credit squeeze shakes itself out, shares resume their perpetual upward climb. It would make sense for one of the US auto makers such as Ford Motor (F) or General Motors (GM) to try to pick it up - at least then they would have a profitable division - but admittedly, the chance of that happening is very slim, if not non-existent.

Buy now? I am going to say no . . . I think the current credit situation will last a while and next year's earning will be negatively affected. If you are a value investor looking to buy shares, this is good news as the share price will fall more from here. Harley has yet to reduce earnings estimates and when they do (and they will), share get hit, hard.

From their current $61 level, I would wait for another 10% fall the $54 to $55 and then jump in. Again, this assume no dramatic news event, just the event we anticipate here.

Harley is a great company that is in the midst of a stumble, not a fall, and that may give we value folks a golden opportunity to pick up cheap shares.

HOG 1-yr chart:

Comments

[Richie]

My perspective: Weak managment of an over-priced company whose principal product is inferior to that of the competition.

[dectra]

Let me get this straight: According to Ravernon, the "weak management" of Harley-Davidson is responsible for fiscal 2007 estimates of EPS growth of 4% - 6% compared to 2006 based on moderate revenue growth, lower operating margin, and the benefits of our strong free cash flow.

For 2008 and 2009, the Harley expects solid revenue growth, operating margin improvement and the strong free cash flow to drive EPS growth to 11% - 17%. According some estimates, analysts on average are expecting the Company to report EPS of $4.11 for fiscal 2007, $4.63 in fiscal 2008 and EPS of $5.20 in fiscal 2009. The Company expects to ship between 94,000 and 97,000 Harley-Davidson motorcycles in the second quarter of 2007.

As for being an 'inferior' product, the Harley of today is not the Harley of the past as far as breakdowns are concerned. They are just as solid as the Jap bikes yet without the cheap imitation styling. Even after surviving the AMF years, it still managed to regain and rebuild its status as an American Icon. It couldn't become so if it was in fact, an inferior product.

[Privateer]

My guess is that Richie rides a ricer.....