Harley-Davidson Is A Buy
Summary
- The shares of Harley-Davidson trade at a ludicrously low multiple both relative to both the company's own history and to the market.
- In my view, investors do best when they buy quality when it's on sale, and Harley-Davidson is quality on sale.
- In my view, investors would be wise to collect the well covered dividend while they wait for price and value to inevitably meet.
Shares of Harley-Davidson Inc. (NYSE:HOG) are down about 22% over the past year. That, and the fact that riding season is fast approaching (should be here in Toronto by about mid August) put the company on my radar. While I admit that I have a very strong pro-Triumph bias when it comes to actually riding bikes, the shares of Harley-Davidson are good value at these levels for a host of reasons.
I’ll go through my reasoning below by focusing in on the financial history here, by attempting to model future price based on the dividend history, and by looking at the stock itself. Things have obviously slowed for this iconic brand, but the shares trade as though the business has absolutely fallen off a cliff. I think investors can take advantage of the market’s current myopia.
Financial History
A quick review of the financial history suggests that Harley-Davidson has had a bumpy ride over the past few years. Forgive the pun. Last time, I promise. Anyway, since 2013, earnings per share have declined at a CAGR of about 1.1%, in spite of an aggressive share buyback program. At the same time, though, free cash flow per share (a more relevant measure than EPS in my view) is up at a CAGR of about 6% since 2013. As most of us know, earnings may be affected by non-cash charges, like the $53.1 million write-down of deferred tax assets in the final quarter of 2017.
Turning very briefly to a discussion of future obligations, the company has grown long-term debt at a CAGR of about 6% over the past five years, which is obviously not sustainable. What I find problematic about the debt level is the fact that most of it (83%) is due before 2021, which presents some refinancing risk to the company. That said, the weighted average cost of debt is coming down.
For example, I really like the fact that the 6.8% notes issued way back in 2008 are coming due in May of this year and will be replaced with much cheaper debt. Also, I’m not as concerned about the debt as I otherwise might be because the weighted interest expense is quite low (~1.5%). All in, I think the level of debt is something to keep an eye on but not something to worry about too much at this point.
Management has proven themselves to be very shareholder-friendly, as evidenced by their share buyback and dividend programs. Since 2013, management has returned just over $4.6 billion to shareholders (~$3.4 billion has been returned in the form of stock buybacks, the balance have come from dividends).
This activity has resulted in dividends per share growth at a CAGR of about 11.7%, and the number of shares outstanding declining at a CAGR of about 5.4%. This is an enormous rate of growth in my view, especially for a company that has had challenges raising the bottom line. In my view, a friendly management is a necessary precondition to investing, and Harley-Davidson obviously checks that box in my view.
Source: Company filings, 10-K, 10-Q
Modeling The Future Price Based On Dividends
While the financial past can give us some sense of what may happen, investors are understandably more concerned about the future than the past. It’s with that in mind that I need to spend some time forecasting future price here. Whenever I try to forecast, I employ a methodology developed by fellow contributor John Dicecco. Dicecco employs a ceteris paribus assumption and derives likely future share price by “moving” only one variable, usually the dividend. So, if we hold yield constant, and grow the dividend at a reasonable rate, we can make a reasonable assumption about what future price will be.
As I pointed out earlier, dividends per share have grown at a CAGR of about 11.7%. It may be unrealistic to assume that this level of dividend per share growth will continue, so I’m going to drop my growth assumption somewhat to 8% over the next four years. I consider this to be sufficiently conservative given the high free cash flow in evidence and the fact that the payout ratio is of 48% is relatively modest.
When I model a dividend per share growth rate at a CAGR of 8%, I estimate a CAGR return for the stock of about 9% from now to 2021. I consider this to be a very reasonable return for this stock.
Source: Author forecast
The Stock
Obviously, investing is about more than finding rapidly growing cash flows and paying almost any price for them. In my view, more than half the battle involves buying the stock at a reasonable price. The stock is supposedly a proxy for the cash flows the business generates over time, but often it acts according to rules all its own and disconnects from the economics of the firm. We are in the position to take advantage of that disconnect when the shares trade at a sufficiently cheap price relative to the underlying business.
For my part, I use a number of methods to judge the cheapness (or not) of a stock, and I write about two of them on this forum. The first of these involves working out what the market’s long-term assumptions are about a given business, and the second involves comparing the company’s share price to free cash per share.
The way I work out the market’s long-term assumptions about growth is to employ the methodology described by Professor Stephen Penman in his excellent book “Accounting for Value.” Penman basically takes a typical financial formula, and isolates the “g” variable in order to work out what the market assumes for a perpetual growth rate for the business. At the moment, Harley-Davidson shares are priced as though the company will grow at a perpetual rate of 1.8%.
In my view, this is historical and overly pessimistic, given the company’s excellent history of long-term growth. Although net income growth has obviously slowed over the past few years, over the long term, they are up quite strongly. For instance, since the financial crisis, EPS are up at a CAGR of about 19%, and over the past 18 years, they’re up at a CAGR of about 5.6%. Will the company enjoy this sort of growth in the future? It’s very challenging to offer very specific growth forecasts, but the market’s assumption about 1.8% long-term growth seems to me wildly pessimistic.
The other thing I look at when reviewing the relative expensiveness of a company is to compare the price to free cash flow per share. At the moment, the shares are trading at a relative and an objective discount relative to the overall market and the company’s own history. In particular, the shares are trading at about half the premium now than they did in 2013. Like the market’s assumptions about growth, this screams ludicrously pessimistic in my view.
Source: Gurufocus
Conclusion
In my view, over the long term, investors do well when they buy the shares of a growth company at an inexpensive price. They do very well when they buy at a time when the market itself is very pessimistic about the company’s future prospects. In my view, the market is marking down these shares too much, and investors would be wise to buy now. The choice is made even simpler when they have the prospect of clipping a well-covered 3.5% dividend yield while they wait for price and value to inevitably meet.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in HOG over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (7)
I wouldn't call myself "Pro-Trump" at all, actually. I think the idea of steel and aluminium tariffs are idiotic.
My view (hope?!) is that this is short term noise.