Harley-Davidson: Looking for a Good Short? Shed Some Fat

Includes: HOG, SPY
by: David White

The market is overbought in the near term. The Fed is on the verge of removing massive amounts of liquidity ($1T). Some Fed governors are even talking about wanting to remove the assurance that Fed Funds rates will be held low for an extended period of time. A massive health care bill is on the verge of being approved. This will in all likelihood mean further expenses on health care; it at least symbolizes further entitlements. After the recent Greece fiasco, entitlements are anathema to the markets. They are Greece’s biggest problem. The market could turn down on this news, especially if the health care bill is approved.

If it does, you probably want to have a few stocks to short.

One stock that looks promising is Harley-Davidson (NYSE:HOG). It has had a big run up lately as the market has moved upward. Yet it looks to have put in a double top (yet to really be confirmed). It has a high beta of 2.3. If the market moves down, it should move down faster. It has a -26.47% revenue loss last quarter. It has a debt/capital ratio of 72.78%. It does not earn enough from current operations to cover its debt obligations.

However, it currently has enough liquid assets to do so. The average analyst 1 yr. target price is $26.80. The current price is $26.85. The average analysts’ rating is 2.4. Even if you thought it would perform as the analysts estimate, it could still easily go down in a market downturn.

Arguing against the analysts' current projections is the fact that analysts have cut estimates for FY2010 by $.33 to a currently still positive $.95. This would give it an approximate 28.3 FY2010 PE. That’s too high for a company that may have trouble getting enough financing to continue next year.

Additionally, HOG has missed EPS estimated by an average of 72.5% for the last 3 quarters. Even the analysts are predicting that its revenues will shrink further in 2010. That prediction is -5% to -10%. The actual figures may turn out to be far worse. The Price/Book is 2.98 -- hardly great. The Price to Cash Flow is 19.864 -- not great either.

Further the first quarter has not started out well for HOG. According to a Baird report,

Harley-Davidson dealers in the United States are on pace to sell 28,000 to 30,000 motorcycles for the first three quarters of 2010, based on trends for January and February, which is in line with Baird’s estimate of 29,000. However, the estimated figure is down 30 percent from the first quarter of 2009. Dealers are comfortable with current inventory levels, but are selling more bikes below manufacturer’s suggested retail price.

In other words, HOG has been performing badly for most of Q1. I would expect bad news when it reports.

BMO Capital Markets

found a correlation between Harley’s stock price and measures like the unemployment rate, interest rates, gross domestic product and consumer sentiment scores. It found that the Case-Shiller index of house prices did more than any of these to explain the stock’s movements.

We are about to enter the heart of the real estate selling season. The Fed is ending MBS buying March 31, 2010. The Federal government is ending its home buying tax credit before long. RealtyTrac says there will be about 3M-3.5M foreclosures this year. The Homes Sales figures have been dropping so far this year. Most think home prices will drop again this year. It is harder to qualify for mortgages now. Unemployment is still high. Homes will be a hard sell.

If HOG stock price correlates well with home prices, I would expect it to go down again this year. Money and credit worries should keep a lot of people out of the showrooms of this “recreational vehicle product”. It simply is not a necessity in a still tough economy.

There may be some risk to the high side, especially if the markets continue to go up from here. The Senate has approved an approximately $140B stimulus bill, which is awaiting House approval. It has approved a $15B to $18B jobs bill. It has at least one more stimulus bill in the works. All of this extra free money could buoy the markets.

Still the nearly $1T health car bill would trump all of these. The market seems to go down each time some politician even talks about it. Consider all of these things before making a decision. A chart of HOG is below.

The HOG 6 month chart:

Over the last week or two the HOG chart has developed a weak double top formation. This has yet to be confirmed, but it is a positive indication that good down side action may be in the offing soon. Plus the currently overbought state of the market should work in favor of a short position in the near term. I have drawn some support points in with yellowish green lines. They are at approximately $21, $22, and $24. These are all potential exit points. This is not to say that HOG stock will not go down further. In fact it is still very much in danger of a bankruptcy next year or the year after.

However, I am suggesting a shorter term trade. I am thinking the market is not about to crash near term. Therefore I am suggesting reasonable near term targets. Which you select will depend on your risk tolerance and the overall market performance as it develops. I have also included two resistance points that you could use as exit points to the high side, if the stock and/or the overall market goes up near term. These points are at approximately $27.60 and $28.70. You may wish to set a still narrower high end exit if you wish to ensure only a very small loss. The problem with that is that you can get stopped out by noise.

Warning: The most recent SPY chart formation is an almost perfect cup. If the SPY retreats in such a way as to appear likely to form a "cup with a handle" formation, you probably want to exit once the higher side of the handle starts to develop.

Advice: If you own HOG stock, this could be a good time to take profits (at least partial profits). It seems likely, especially given the analysts average 1 year target price of $26.80, that you will have a chance to buy it more cheaply at a later date.

Good luck trading.

Disclosure: I have a small short position on HOG