Harley Davidson: Wait 'Til Next Year

We would expect Harley Davidson (HOG) shares to trade sideways over the next six to nine months, as investors re-assess the long-term growth potential of Harley Davidson. After reaching highs in November 2006, the shares are down significantly to the current $47-level. In turn, the valuation is very compelling at 12x forward EPS (forward EPS are estimated to be around $3.90) and a discount to the S&P 500 and other strong branded companies, especially considering the company’s dominant brand and market share, dividend, strong balance sheet with no operating debt, and ongoing share repurchases. (Historically, HOG has traded between 13x and 21x forward EPS and a premium to the S&P. Moreover, many of the most valuable global brands generally trade at 19x forward EPS).

On the surface, it would seem that you should buy on valuation alone. However, valuation can be unreliable if trust in earnings is waning (i.e., if earnings expectations continue to decline, the multiple will rise and HOG won’t look as cheap). Nevertheless, we believe the current valuation discount is warranted, as HOG’s earnings growth rate has decelerated from 20% in the early 2000’s to negative territory in 2007 and a projected 4 to 7% in 2008. Management recently cut production and earnings guidance significantly due to weak sell through domestically and despite double-digit international growth. The cut back in production should benefit the Harley brand longer-term, since HOG could have tried to boost retail sales through aggressive financing promotions like the auto companies have done (i.e., ridiculous rebates, 0% interest, etc.).

With no other near-term catalyst to drive the shares higher (barring a huge special dividend or share repurchase), domestic consumer spending concerns, especially on big ticket items like motorcycles, are likely to offset strong international growth and keep a lid on HOG’s performance over the next 12 months. Over the long-term, analysts are also worried about a secular shift in demand, since the number of males age 40 – 50 is expected to decline through 2017 and the median age of a Harley buyer is 47. In conclusion, we would expect HOG shares to trade within a tight band over the next 12 months, as investors re-evaluate the long-term prospects. We would revisit the story next summer.

Disclosure: none