Biker Lifestyle Magazine

Harley-Davidson: The Pain Continues

Summary

In July, we got cautious and said to avoid the name on the uncertainty in this space.

Sales are falling in every region except Asia-Pacific.

Revenue and EPS declines have justified multiple contraction.

Margins remain under pressure but could improve if the company’s plan for accelerated growth works.

Very shareholder-friendly.

Prepared by Stephanie, Junior Analyst at BAD BEAT Investing

We have been once again asked about our opinion on Harley-Davidson, Inc. (HOG), and as such we decided to have another look with an open mind. The name fell to $30 a share following our July call to avoid the name on the uncertainty. That said, HOG began a rally in the fall that was capped by a somewhat positive earnings report, in which shares rallied to $40. Since then we have remained mildly bearish, and shares are down about 15%. Shares have continued to slowly move sideways to down.

The bottom line is that less people are riding these days, and tariffs that remain have caused pain. Sales pressure remains a weakness and a primary reason we have been moderately bearish. Even with buybacks and a good dividend, we just do not want to park our money here, as we have watched earnings per share decline. In this column, we take another look at sales trends, where we see positives, and offer our thoughts on what to do at $34 a share going forward.

Revenue declines continue

As we mentioned in the opening, revenues have faced pressure. Unfortunately, these sales pressures continue. The last few Q4 sales results show this pretty clearly overall:

This is simply a poor trend. You see, as seasoned traders and experienced investors, we will tell you that it is still key to realize management forecasted declines. So, we were also expecting a sales decline, and we are not surprised by the result. But we will tell you, declining sales can be tolerated if the company is more profitable. However, that is also weak. While we will discuss earnings power in a moment, the declining sales are tough to invest in. It seems that the sales pressure continues quarter after quarter and continues the weakness that began way back in 2016. Overall sales dropped another 8.5% year over year, from $955 million to $874 million. This was actually way below our expectations for $900-920 million. Total revenues were $1.07 billion down from $1.15 billion. And our projections were conservative relative to consensus, the latter which was missed by $54 million.

Discussing sales

Obviously, Harley sells motorcycles, but it also makes money from associated parts, as well as accessories. It does some work in financial services. Motorcycle sales are a key driver of course. Trends in the U.S. have been weak for years despite the economy being so strong for so long. That is a major problem. Harley is working hard to bring youth into riding. The main question you need to ask is “what could happen in a recession”? This question is a chief concern all investors should have because sales have struggled in economic good times. Ouch. As we suspected, volumes were down again. We saw another 1.4% decline in motorcycle sales volume. This led to a 9.7% hit in revenues from motorcycle sales. We will point out, however, that these volumes were a touch better than we expected (a decline of 2% or more was our expectation), so that was a piece of good news.

So, with volumes down, the company can make it back by upping its pricing. The pricing power certainly helped offset declines, but the bottom line is that far less units were hitting the roads, continuing a long run lower. Revenue from motorcycles fell to $666 million compared to revenue of $738 million last year. This is down 15% in just two years. Of course, actual shipments were also down. The company shipped 40,454 motorcycles to dealers and distributors worldwide during the quarter, compared to shipments of 43,489 last year and over 45,000 motorcycles in Q4 2017.

Ouch. This is a painful trend. There was a total 6.4% decline in shipments this year in 2019. With all the declines, we still have prevalent concerns over retailers’ ability to sell these delivered bikes to consumers. This is serious cause for investor concern. The pain was also felt more in the U.S. and EMEA, with sales down 3.1% and 2.3%, respectively. The bottom line here is that the company must find a way to improve sales. Some of this was offset by international growth. Asia-Pacific saw a huge boost of 6.2%. A nice takeaway was strength internationally, overall, as total international sales of motorcycles were up 0.5% in the quarter. However, in 2019 overall sales fell everywhere, except for Asia-Pacific.

There are other sources of revenues. Sales of parts and accessories came in at $129 million during the quarter, down from $142 million. With lower retail sales of motorcycles, this trend makes sense. General merchandise also fell 2.2% to $57 million, from $58 million. Finally, we will add that financial services were up 4.2%, with revenues of $198 million, which is better than expected considering the sharp decline in motorcycle sales. These results overall combined for sales that were far less than expected. Now, we turn to earnings.

Expenses still weigh

Harley has been in the middle of a manufacturing optimization initiative to help control expenses and improve margins going forward. However, coupled with lower shipments, both gross margins and operating margins took a hit. This is also a major problem. Gross margin was pressured down to 25.2%, down from 27.6% last year. Coupled with restructuring costs, operating margin was -5.3%. There is just not much to love. There, and it all led to net income of $13.5 million or $0.20 per share. This was up from $0.17 a year ago, a slight positive. However, the annual numbers are alarming. Annual EPS contracted to $3.36 from $3.78 a year ago. This earnings reduction, while anticipated, still is painful to see on paper, and comes despite big share repurchases.

Those holding are being paid

Harley-Davidson has been boosted by share repurchases helping boost shareholder value. The company bought back $287 million worth of stock this year, and it retired 8.2 million shares. We expect continued share repurchases and future authorizations. Right now, there are 8.2 million shares available to be repurchased under the current authorization. Finally, the company is paying $0.375 quarterly, which is a 4.4% yield on today’s share price. That is attractive for income purposes, as investors are paid to wait. Still, things need to improve.

Looking ahead

Looking to the next decade, we have to face facts. Loyal, repeat, long-time customers cannot keep the company going. Harley-Davidson has had to be innovative to attract new riders. It is doing this by expanding globally and diversifying into electric motorcycles. The company is also working diligently to market its brand to millennial consumers. We think this progress will be key to whether the stock moves one way or the other. Right now, we see it stuck in the high $30s at best without confirmation of changing trends/improvements.

In 2020, motorcycles segment revenue is expected to be $4.53 to $4.66 billion. In the first quarter, the company expects Motorcycles segment revenue of approximately $1.09 to $1.17 billion. Motorcycles segment operating margin as a percent of revenue should be 7-8%. Longer term, the “More Roads to Harley-Davidson” is the company’s accelerated plan for growth that aims to deliver sustainable growth and build committed riders from 2018 through 2022. The company is focusing investment and building new capabilities to build new committed customers. This includes new products, broader access, stronger dealers and amplifying the brand as catalysts to ignite and sustain momentum and deliver growth. It remains to be seen on the volume front however.

Our take

We see value here and a nice dividend, but not enough to justify committing new capital. We need a confirmed trend reversal, or even a bending of the curve, to get some bullish momentum. We would avoid the name right now.

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