Harley-Davidson: Recession-Friendly Domestic Investment 25 comments
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As the world’s biggest economy's growth slows, the global economy is also trending down. Inflation is peaking high in the fastest growing nations, such as India and China. Commodity prices are sky-high, denting consumer spending. The yield curve is pretty much flat in most of the global economies. US dollar depreciation against the Euro and other global currencies is slowing exports in Europe and China.
This year, investors may not get the above average returns from international markets as they have in the past few years. With the economy expected to grow at zero to negative growth this year in the US, it is prudent to preserve the capital invested and take advantage while the market is about to rebound. The disparity of investment returns from international markets to the US is converging. That brought my attention back to solid companies in the domestic US market.
A known devil is better than unknown angel: rather than searching for gems in nebulous international markets, it is wise to look for value stocks in the domestic market to preserve the capital from down sliding. Harley Davidson (HOG) is one of these great companies with sound fundamentals and decent upside potential once the dark clouds of recession pass.
From the lakes of Minnesota to the plains of Texas, Harley Davidson is a proud American icon carrying an immense brand image. Harley Owners Group has more than a million members all over the world. The average Harley buyer is well educated and has a median income of $84,000, which is twice the median household income. Though the slowing economy impacts every part of society, the impact of financial troubles are less prone to higher income households.
Eighty percent of Harley's revenue comes from core bike sales and 20 percent of its revenue from parts and merchandise. International sales represent 27% of revenue and have a commanding 50% of US market share, while its nearest competitors, Honda and Suzuki, hold 14 and 13 percent of the market share respectively. Harley Davidson also represents 40 percent of the Canadian motorcycle market and 11 percent in the European Union. So far, the year of over year sales keep growing even in the recession periods, with an exception in 1995 and probably flat sales in 2008.
On average, over the four past four years, Harley Davidson maintained 34 percent return on equity and 26 percent return on capital. Its current ratio is at 1.8 and networking capital is 1.5 times the long term debt, so it is safe to assume that downside risk is limited.
click to enlarge images
Is HOG Recession Proof?
I dare not to predict that. When I glanced through the cash flow (net income added to depreciation) and year over year change compared with year over year GDP data, cash flow was always trending up with the exception of last year. It will probably trend downwards next year, too. However, absolute cash flow has been positive every year.
The current PE for Harley Davidson is 10.5, an historically low ratio, and with 3 times the book value it has tremendous upside potential when the economy start turning back. Harley Davidson has been consistently raising its dividend since it started in 1993. It is an equity that looks compelling to hold in the forthcoming uncertain economy.
Disclosure: I hold Harley Davidson in my personal portfolio and am still accumulating.
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This article has 25 comments:
americans should stick to what they're good at, and as of right now, that does not include building internal combustion transport devices.
I suspect this stock will tank down to the mid 20's by end of year.
And Hog will be doing everything they can just to survive
Hogs.
Your research sounds good on the surface. Of COURSE Harley-Davidson wants you to believe its patrons are educated and wealthy!
Hogwash.
Harley's customers are hiding while their trailers are being auctioned off to the highest bidders. And guess what else is being auctioned off?
That's right. Hogs. At fire sale prices. And THAT smells like a glut to me.
Yeah, HOG may be a little under-valued. But don't expect to see returns like the stock produced in the last fifteen years...at least not anytime soon.
Paco Ahlgren
disciplinenovel.com
Sure, the brand is iconic (while overexposed) and the stock much cheaper than it was, but that does not make the stock a buy.
(Note how their inventory number seems to get bigger each year.)
I increased my short position a little today. I am surprised it has hung around at this level given that the media is starting to catch onto this story.
2007 238.5 (in 1000s, total shares outstanding)
2006 265
2005 281
2004 297
2003 304
2004 305
Even if they spend only 600 - 800 mio this year on their buyback, this will still amount to some 15 - 20 mio shares [at an average price of USD 40], which will bring the float down to 223.5 - 218.5.
HOG should be able to earn not less than 750 mio, which would amount to USD 3.36 - 3.43 EPS - as a worst case scenario!
We have a market cap of 9000 mio at yesterday's close of 37.68.
Should the stock dip below 30, the market cap would be less than 7200 mio with a float of 238.5 and less than 6600 mio with average float of 220 mio.
The dividend yield would be more than 4% (and even higher in case HOG increases the dividend).
That sounds very cheap to me!
*
In case HOG only earned USD 600 mio, which would have to be considered 'catastrophic' (!), it still would trade only at a PER of 11, if the stock droped somewhat below 30 (average float 220 mio, EPS 2.73).
2007 1520 mio
2006 1170
2005 995
2004 917
2003 809
In 2008, I think we can safely assume international revenues of above 1750 mio. And due to the weak dollar one could even be very optimistic and flirt with a number closer to 1825. In case HOG's domestic revenues tank, the effect is well absorbed by international sales growth.
Domestic revenues have been:
2007 4206 mio
2006 4630
2005 4347
2004 4097
2003 3814
So even in case domestic revenues drop down to below 4000 mio this year, which would have to be considered as very bad, we still would end up with total revenues of more than 5700, which is no less than last year!
In three days from below 35 to above 42 [up 20%] and in 5 days from below 34.5 to above 41.5 [again up 20%].
Let's say you get the choice: either short or long at 37.5. What would you choose? Support 35 - 34 and resistance 40 - 41. We are excactly in the middle of the range.
In order to break the stock down to 30 you need people who are willing to sell below the support level of 35 - 34. And they would have to think that the stock goes much lower than that in order to want to be a seller.
Now, it could be that the stock tanks to 35 - 34 after earnings, but the stock will only fall further IF there are additional aggressive sellers coming in at these levels,
which I think is unlikely!
I think it is much more likely that this will be a trap for short sellers; but, of course, this is only my market opinion!
It is not necessarily wrong to short here, but the surprise attack tends to be on the buy side in this range bound market!
The short sellers go for the breakdown of the financial system, which is kind of a bold bet!
It usually does not pay to be overly pessimistic!
But I think your international sales projection is very optimistic. I would not be surprised if there is not some moderate channel-stuffing going on with the 2007 number. The other annual increases were much smaller, ranging from about 100-175.
I will not dispute that international sales could be the way this company continues to grow. It is not in domestic sales, IMO.
There is support at 34-35, but where is the upside? A company that has suffered shrinking revenues for however many Q's does not deserve a PE over 10.
*
I agree, the upside is not there (yet). There is currently no growth, but HOG pays a descend dividend and there is a buyback program. That's all for the time being. One can look at it as a typical 'value play', but of course not everybody agrees and how could it be otherwise? We wouldn't have a market!
It usually works this way in my experience: value buyers tend to come in too early, but they can wait!!! Combine this with a lot of short sellers who run the risk to have to cover under unfavorable conditions once the company fundamentals recover;
the only way a short seller can make a decent buck here is when we have a catastrophic brakedown of the fundamentals, making some long term holders capitulate. I cannot see this happening!
Are there people who short at 37.5 to buy it back at 35?! I don't know, but whoever sells at 35 must look at least for 30 in order to have a risk-return of 1:1, if we cap the upside at 40 for the medium term. That's meager, isn't it?! In case these sellers come in and short 35 and it goes back to 40 and some positive news hit the ticker, we are at 45. This is 30% heat on a short position! A little euphoria can get the stock up to 50, and even if it does not stay there and comes back down, you would have to finance through an open loss of more than 40%. In order to make some 40% from a base of 35 would necessitate the stock to go down to 21. That's extremely unlikely.
I have to admit I don't understand the rationale of short sellers right now.
Some observers see a possibility of sales hitting a wall, or at least dropping dramatically, changing the fundamentals of the company. Its key demographic has more important things to spend its money on.
I have observed on another thread that Harley management has not been a good steward of the brand. This reminds me of a few days ago when a neighbor showed me his new dog leash. The neighbor is not a motorcyclist or Harley fan, but the leash had a small Harley insignia on it.
I asked, why did you buy a Harley leash? He said, "Don't ask. It was all they had."
This is what brands look like before they go down. I don't mean out of business, but into a down cycle. Harley's brand has been overexposed. Anyone -- not just riders -- could buy into the Harley mystique on the cheap. Just buy some Harley gear.
Along with the drop in the economy, I think Harley has to contend with an overexposed brand.
you are certainly right about what looks like an overexposed brand, but a couple of points:
(1) International sales holds up (very) well (+17%). [I see great upside internationally in the long term; the weak dollar certainly helps!]
(2) Cost reduction will help earnings to bounce back to 3.24 - 3.46 next year - given no further erosion of market conditions.
(3) HOG sales decline is more resilient than the overall market sales decline. [This clearly shows that HOG *is* a brand and less overexposed than the overall market!]
*
“[F]rom my vantage point it is unclear when the US economy will recover.” [CEO Ziemer]
From an investor-speculator point of view, HOG is a macro bet on the recovery of the economy. In an ok - good environment (probably in 3 years) HOG should be able to generate earnings of at least USD 4. Or in other words: even if HOG repurchases only 10 - 12 mio shares a year, this would translate into a float of "only" 200 - 210 mio shares or 800 - 840 mio in profits, which is well below of previous peak earnings of above 1040 mio in 2006].
The next bull / hype-cycle in the stock market can get the stock to trade up to a PER of 15, which translates into a price target of 60. Measured against the current potential tripple low of 35, this would be a profit of 70%, or on an annualized base some 20% (which is great!!!)
As I ruminated in my previous postings, I do not see any immediate reason why investors should want to sell their shares down to 30. Only NEW short sellers would do so, and they don't because they are afraid of selling to strong long term buyers at deflated prices. A short squeeze could get the stock quickly from 30 to 45, which translates into open losses of 50% for the shorties, which they obviously would want to avoid!
It is simply a question of risk-return considerations which holds the stock price stable!
*
I would not make too much out of this, because it is pretty much true for any luxury brand nowadays! You can buy into the mystique of Gucci, Prada, Louis-Vouitton at Ebay with an opening bid of USD 1. You can buy an umbrella with a Jaguar logo or a key ring with a Bentley logo, or a paperweight with a Ferrari logo etc.
Buying cheaply into the mystique of what is otherwise a dream too expensive to become real is simply the signs of the time; this is a form of marketing pseudo-social status to mass consumers!!!
On Apr 18 03:28 AM Mallarde wrote:
> The stock is holding up nicely. Not sure if this is wishful thinking
> or not as the dust settles.
>
> I have observed on another thread that Harley management has not
> been a good steward of the brand. This reminds me of a few days ago
> when a neighbor showed me his new dog leash. The neighbor is not
> a motorcyclist or Harley fan, but the leash had a small Harley insignia
> on it.
>
> I asked, why did you buy a Harley leash? He said, "Don't ask. It
> was all they had."
>
> This is what brands look like before they go down. I don't mean out
> of business, but into a down cycle. Harley's brand has been overexposed.
> Anyone -- not just riders -- could buy into the Harley mystique on
> the cheap. Just buy some Harley gear.
>
> Along with the drop in the economy, I think Harley has to contend
> with an overexposed brand.