Harley-Davidson Inc (NYSE: HOG) shares have been hammered in the past six months, dropping 52.3% to under $20. Harley investors are hoping the stock can get back on track when the company reports first-quarter earnings on April 28, but JPMorgan strategist Shawn Quigg isn’t optimistic.
On Thursday, Quigg said the negative economic impact from COVID-19 will likely slam Harley Davidson Financial Services, which represents 15% of the company’s total revenue and 48% of operating income.
He estimates that about 18% of HDFS receivables are subprime, creating risk for the company’s valuation.
Harley’s Potential Valuation Downside
Harley shares currently trade at roughly 1.56x tangible book value per share, but Quigg said financial institutions often trade at or below book value during periods of perceived credit stress.
“With HDFS such a significant contributor to earnings, it should not be out of the question to consider not if, but when, investors should begin to value HOG on a multiple of its tangible book value per share that is closer to its vehicle-lending peers (e.g., NICK, CACC, CPSS, TCF, OMF, ALLY, COF, SC, F and GM),” he said.
The median price-to-tangible book value of that peer group is only 0.6x, suggesting a share price as low as $6.78 for Harley, the JPMorgan strategist said.
To make matters worse, the timing of Harley adopting current expected credit losses methodology (CECL) for estimating allowances for credit losses could not have been worse, Quigg said.
Under the CECL standard, which Harley adopted Jan. 1, Harley can no longer delay recognition of losses until it is probable they already incurred and must instead recognize full lifetime expected losses “upon initial recognition of the financial instrument,” he said.
A HOG Option Trade
Given the potential for significant valuation contraction following Harley’s earnings report, Quigg recommended investors buy May $17 strike puts ahead of earnings. On Thursday morning, those puts were trading at just 87 cents.
On Wednesday, bullish sentiment among StockTwits messages mentioning Harley Davidson was at 44.5%, up from 26.7% a week ago.
If Harley’s earnings report is as bad as Quigg anticipates, the stock could easily drop well below $17 and put buyers could make a killing. In addition to the company’s potential financial troubles, motorcycle sales will likely take a big hit during the shutdown, as they are generally more of a discretionary purchase than typical automobiles.