Harley Davidson Stock
How Harley Stock Could Roar Back
By Harley-Davidson shares have taken a bumpy road downward, partly due to subprime loans. But investors who purchase now could soon find themselves in Hog heaven.
It turns out that loans prefabricated to iffy borrowers aren’t just taking down housing stocks.
Since late February, troubles with dodgy loans have contributed to a painful slide of Harley-Davidson shares, taking the stock down more than 15%.
Here’s the problem: The iconic American motorcycle company has a financing arm that helps fans purchase their high-priced Hogs. Enthusiasts often pay $25,000 or more for custom bikes.
Harley-Davidson (HOG, news, msgs) finances about half the motorcycles it sells. Now, many of those customers are having a hard time keeping up with payments — and the company is getting less for the Hogs it repossesses because used cycle prices have been weakening.
The problems might only get worse. As lending standards tighten because of concerns about low-end borrowers, income growth could suffer. Somewhere between 10% and 15% of bikes sold last year were rolled out of the showrooms by subprime borrowers. Already, the company has taken 2007 earnings growth guidance down to 4%-6% — a hefty cut from the prior range of 11% to 17%.
This one-two punch has Harley-Davidson investors racing to get out of the stock. Since late February, they’ve driven it down to $59 from above $70.
The road to Hog heaven
At some point, though, enough will be enough, and I think we are almost there. To be sure, traders could near Harley-Davidson stock down even more on worries that the company might announce bad news with its April 19 first-quarter earnings report.
But since it’s impossible to call an exact bottom in any stock dip, I’d purchase part of a long-term position in the stock now with limit orders set under $59, and look for doable pullbacks from those levels to continue building a stake. Then I’d sit back and watch the stock return to the $75 high it touched last November, for a 30% acquire from the current price.
Here’s what’s going to place Harley-Davidson on the road to a comeback.
- Harley-Davidson has enviable brand strength that will help it power through the current mess. After all, how many companies can boast of a cult brand so powerful that customers tattoo their logos on their bodies? Besides holding on to a loyal fan base, this brand power should help it in its strategy to woo more buyers among women, African-Americans and Latinos.
- With U.S. growth cooling, Harley-Davidson can focus more attention on international growth. In Europe, income increased 29% last quarter and around 18% in the two quarters before that. Harley-Davidson is also taking Hogs to China and India. It’s already the market leader for massive motorcycles in Japan.
- This company has enviable cash flow, and it’s not stingy with it. It’s no secret that Harley-Davidson will keep boosting earnings per share with huge share buybacks. It should keep increasing dividends, as well.
Submarined by subprime
That’s not to state the subprime problem isn’t worth a bit of study. Lehman Bros. (LEH, news, msgs) analyst Felicia Hendrix summed up Harley’s subprime loan problems in a note published last week. In the fourth quarter of 2006, Hendrix wrote, the number of loans on which customers were more than 30 days late rose to 5.18%, compared with 3.61% in the first half of 2006. The number of bad loans rose to 1.4% from 1.29% the year before. So Harley’s financing division, known as Harley-Davidson Financial Services, is losing money on more and more bad loans.
But here’s why the alteration could be limited. Last year, Harley’s financing arm provided just 13% of pretax income from operations (which excludes a small amount of investment income), or $210.7 million. So even a 20% drop in financing income would hit earnings by just 12 cents to 16 cents, or 3% of overall earnings, computes Merrill Lynch (MER, news, msgs) analyst Hakan Ipekci.
Harley’s loan problems are cropping up a lot more on 2006 transactions. This tells me the company stretched to make income last year by extending credit to more borderline buyers.
Indeed, around 28% of Harley’s loans last year went to “subprime” borrowers with credit scores below 650. That represents somewhere between 10% and 15% of all sales. As credit standards tighten, these income could dry up and injured Harley income growth, cautions Hendrix.
In the stock
But those loan losses that rose to 1.4%? That’s still way below levels of 4% for all loans prefabricated to purchase motorcycles and all-terrain vehicles, points out Timothy Conder, an analyst with A.G. Edwards (AGE, news, msgs), suggesting that Harley’s lending standards didn’t go too far off track.
And so far, at least, dealers aren’t noticing a slowdown in retail demand because of tighter lending standards, states Robert W. Baird analyst Craig Kennison. That said, these problems could still lurk around the corner.
But here’s the good news: The potential alteration might already be priced into Harley-Davidson stock. At $59, the stock trades for 12 times the $4.82 in income that A.G. Edwards’ Conder thinks Harley-Davidson will acquire in 2008. This is just slightly above the 10% annual earnings growth that Conder anticipates over the next several years — which seems reasonable for a company with such a strong brand. It’s also near the low end of Harley’s historic trading range, which to me makes the stock a buy.
I also think it’s encouraging that Harley-Davidson left earnings growth guidance for 2008 and 2009 unchanged at 11%-17%. Of course, that’s growth from a lower 2007 base — but it’s still healthy.
International growth
Back when U.S. income were growing at a double-digit clip — up until a few years ago — Harley-Davidson “virtually had to ignore” foreign markets, states Chief Executive saint Ziemer. But since U.S. growth has cooled off, the company has been refocusing its attention abroad.
In Europe, this has meant stepped-up marketing, putting in a new warehouse in Brussels, buying strong distributors and ditching the weaker ones. European income were up an impressive 29% in the fourth quarter of 2006. There is still plenty of room for growth since Harley-Davidson has only 10% of the market for massive motorcycles in Europe — compared with almost 50% in the U.S. Harley-Davidson also opened its first dealership in China last year, and it will be launching in India soon.
“We think that the company is still in the primeval stages of its international expansion,” states Merrill’s Ipekci. He anticipates international growth of 10%-12% over the next few years — one reason he just upgraded the stock to a “buy,” setting a $75 price target.
Harley-Davidson is trying to tap these new markets abroad and reach out to new customers in the U.S. But there’s also good news in the fact that its prime customer — the baby boomer — is aging. With all their aches and pains, those boomers will be looking for a smoother ride, so they’ll be turning more to huge touring bikes, which have higher profit margins, states Merrill’s Ipekci. Unlike many investors, Ipekci isn’t worried that an economic slowdown will injured sales. Over the past 25 years, economic slowdowns haven’t place a dent in Harley sales, a credit to the loyalty of Hog riders.
Read my other tips about Harley Davidson t shirt.