The Bull and the Bear Case for HOG

| About: Harley-Davidson, Inc. (HOG)
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An interesting dual of analysts in this Fortune piece over Harley Davidson (NYSE:HOG) . After seeing a raft of "consumer discretionary" companies report quite awful year over year results but "better than expected" (and watching their stocks soar), I did some double takes this week. Here is the tricky thing with ALL these stocks; mutual funds (of the value kind) love to load up on these things ahead of a recovery. Or at least their vision of recovery - this is "the playbook". The same playbook utilized (in retrospect incorrectly) multiple times in 2008.

Will we have a recovery in "6 months"? Well we've been told we would for about this recovery for 5 of the past 0 recoveries since early 2008. I am in the "paper printing recovery" camp as I've been saying for much of the past month; the thought that so much currency will be shoved into the system, that numbers that matter to "experts" such as GDP will be goosed higher.

These same numbers will be used to goose excited stock jockeys to push prices ever higher. This was the same excuse to explain why Q2 2008 (Bush rebate check "recovery") was an excellent quarter and all those talking recession were off their rocker. So by that measure "the recovery" should be on track for latter 2009 as "aggregate" economic data has to go up from where we are now. As always, reality does not matter; perception of reality does. Just like accounting for bank assets no longer matters; just new FASB interpretations of those values are what matter. As long as we all stick our head in the sand together, we all win. As some 15%+ of the country stands in unemployment lines. Not sure where they are supposed to stick their head....

Harley has been one of my "tells" from the beginning of blog life [Sep 7, 2007: More Retail Tells? Harley Davidson and Office Depot] on the health of the consumer. I was not an ... ahem fan [Jan 25, 2008: I Can't Believe this Pig...err HOG was up Today]

Talk about the prototypical company to short in this recessionary environment where the consumer is getting squeezed. I cannot short individual names, but there was a great opportunity to short this at $42 this morning (it's already down to $38). This is like the men's version of Coach (COH) - any spike, it should be shorted. At least for another year. I can't think of another company that better represents the excesses of credit (house ATM, over spending) we've had over the past decade.

Now the irony is the cause of so many of our issues was a debt-laden, house-ATM using consumer - so many stocks were reliant on this American to keep up their ways. Now for a while there it looked like sanity might return. But not to fear - when all else fails, take rates to 0%, flood the system with free money, turn the house ATM back on, and encourage more debt-laden spending. How else will we prosper? My bad. I thought we'd try that whole "saving" thing for at least 6 months... nope, it was too painful. More prime pumping it is.

Looking at the chart only for Harley, this is a winner -vroom vroom (as long as we "believe" there really are no problems until the 200 day moving average up at $24). Strong like ox!

Here are some snippets from last week's earnings report from Harley Davidson (HOG) - and I will concede the stock was dirt cheap under $12. But as with all these stocks running day, after day, after week, after week - the transition from undervalued to fully valued to overvalued is being breached in durations of time 1/10th of how it used to work.

  • Harley-Davidson Inc. said Thursday it expects to cut up to 400 more jobs as it reported its first-quarter profit tumbled 37 percent due to a sluggish motorcycle market. (not good)
  • But the Milwaukee-based company beat Wall Street expectations (aha! better than expected) and stood by its full-year forecast for motorcycle shipments (we'll see), sending shares higher in afternoon trading.
  • Harley, which is in the midst of a restructuring effort announced three months ago, said it planned to cut between 300 and 400 additional factory jobs over the next two years. That brings the total expected cuts, including white-collar reductions, to between 1,400 and 1,500 over that period. (workers are just an unnecessary expense)
  • Harley earned $117.3 million, or 50 cents per share, in the three months ended March 29, down from $187.6 million, or 79 cents per share, a year earlier. Revenue slipped 2 percent to $1.29 billion from $1.31 billion. Wall Street analysts surveyed by Thomson Reuters expected earnings, on average, of 51 cents per share on $1.28 billion in sales.
  • Despite the weaker quarter, Harley said its rate of sales decline has slowed. (the all important second derivative improvement - "the rate of decline has slowed" notwithstanding the pace that cars, motorcycles, refrigerators, homes, et al were declining would have us selling 0 within a year or so)
  • Globally, Harley said its sales fell 12 percent year-over-year, as the economic downturn spread to its overseas markets.
  • Tom Bergmann, Harley's chief financial officer, said during a conference call that he was confident the company's financing arm would be able to meet its funding needs for the year. The company's decision in February to cut its dividend, coupled with a $600 million debt offering and other financing efforts, should cover the division's $1 billion in needed funding.
  • "I expect 2009 to continue to be a tough year, but believe we have a strong team in place," Bergmann said. (although we will be cutting more of them soon - but they're still strong)
  • Like all vehicle financing arms, Harley-Davidson Financial Services has come under serious strain recently. The division has traditionally funded itself by making loans to motorcycle customers, then bundling and selling those loans to investors as securities. But the securitization market has dried up in the economic recession, so the company has had to turn to other sources to pay for its operations.

And that last piece is where I need to make my adjustment - that used to be my top worry with Harley along with many other companies. I still was living in the pre "Federal Reserve will take anything on its balance sheet so the US economy thrives" mode. It is hard for me to mentally move away from that because it is so wrong that the central bank turns into the lender of last resort and effectively the shadow banking system.

I don't want to believe it - but I must. And with the taxpayer effectively on the hook for these loans via TALF and other such measures go forward, well it's just not a key issue like it used to be. Once I completely get over this mental block I can build bullish cases for a host of companies that were not there under the "free market". Still working on it.

Here is the bull vs. bear case via Fortune.

  • Weak consumer spending and frozen credit markets are making a rough ride for Harley-Davidson. While results beat analysts' downbeat expectations and sent shares up by more than 10%, the real story is what's in store for Harley down the road. With aging buyers and diminishing sales, the ride looks like it could get a little rougher.

Bear Case

  • "The stock has had a big run, going from $8 in early March to $19 today. But the important point is the credit markets, because most of these bikes are financed. In the past six weeks, all the data suggest that liquidity is actually contracting for Harley Davidson's financing arm, HDFS - not increasing.
  • "The best example of that is the $600 million raised in February. The company had to pay 15% interest on the loan from Warren Buffet's Berkshire and Davis Selected Advisers. That was raised through Harley Motor Company, but it was clearly for HDFS.
  • "HDFS now has to restrict credit availability to retail customers - the lowest credit quality customers first. And in February 2008, the latest this information was available, 25%-30% of Harley's customers were subprime. (I know somebody's balance sheet we can send these loans to go to magically fix themselves aka the taxpayer will suffer the losses)
  • "The market is trying to tell Harley-Davidson Financial Services that the model that had worked a couple of years ago is no longer does, and something needs to change. (new model = send debt to TALF)
  • "In addition, recent discounts on bikes have a lot of impacts. A couple of years ago, you just didn't discount a Harley. "Today, bikes are selling at a discount to [manufacturer's suggested retail price] and used bikes have rapidly depreciated over the last few years. (but Harley just confirmed shipment volume sending the stock soaring - what's that? ah yes, you can sell anything if you discount it enough)

Bull Case

  • ... in the longer-term, we're expecting something of a recovery in 2011. (in this market, I suppose that means I need to buy in spring 2009 because if I discount two full years, stocks are cheap)
  • "Harley's market shares have been stable for quite a few years and the brand appears to be intact. It's so strong that I don't see any weakening of its bike pricing in the long term.
  • "We think there may be a little bit of pent-up demand, where customers who would maybe have bought a bike by this year or last year but postponed the purchase because of the weak economy. (wow, now that's Kool Aid.... so as unemployment jumps from "government" 8.5% to "government" 10%+ the pent up demand will start? Or will it be the return of the house ATM? Or... hmm, I'm sure it's somewhere. I am wondering if it comes when Ben's printing presses drive gasoline back to over $3/gallon)
  • Still, we predict sales don't rebound until the first half of 2011, with an increase of 5%, before fading to a long-term annual growth rate of less than 3% by 2013. (ok, so investors are paying 13x 2009 forward estimates... for a recovery starting in 2011, for a long term growth rate of 3% - sounds viable to me)
  • "In the short-term, of course, Harley needs some funding to get through this year. But it's hard to imagine that a company with the brand strength of Harley won't get the funding. There may also be government funds available to help out through the Troubled Asset Relief program. (ahhh, yes - the refreshing milk from the government teet - it is surprising we would even need it with the green shoots crowding the ground, but just in case let's make sure the taxpayer covers it)

So there you have it; for technical reasons I wish I was in the bull case a month ago - but to buy this jewel at this valuation for a staggering 3% growth rate... hard to take. But we know valuation means nothing so the 13x forward earnings can very easily get to 20x - why not.... the stock market is just charts and random 3 and 4 letter symbols nowadays. Not about businesses.

[Mar 23, 2009: NYT - Harley Davidson - You're Not Getting Any Younger]

[Jan 9, 2009: Harley Davidson: "Oink"]

[Feb 3, 2009: Buffet Provides Financing to Harley Davidson]

[Feb 12, 2009: Harley Davidson Cuts Dividend to Protect Cash]

Disclosure: No position