- Harley-Davidson increasingly looks like it was a “pandemic winner”
- Earnings across the business look set for a decline
- At 9x earnings, HOG seems cheap—but likely remains overpriced
- The core motorcycle business;
- Financing through Harley-Davidson Financial Services;
- Apparel;
- The Livewire electric motorcycle division
Harley-Davidson (NYSE:HOG) derives value from four revenue streams:
Breaking down Harley-Davidson in that simple manner highlights the intriguing case for shorting HOG stock. Every aspect of the business seems under potential pressure.
Big-ticket vehicle sales of all kinds appear set for a decline, a core reason why recreational vehicle stocks, for instance, are trading at 6-8x forward earnings.
Harley-Davidson’s financing profits are already declining and are at further risk amid an increase in both interest rates and credit losses. Apparel manufacturers of all stripes are struggling after sales were pulled forward by the novel coronavirus pandemic.
Meanwhile, Livewire is going public via a merger with special purpose acquisition company AEA-Bridges Impact (NYSE:IMPX). The general track record of so-called de-SPAC mergers and the specific valuation assigned to Livewire in that tie-up both suggest potential downside. That apart, the idea that Livewire much expands the total addressable market for motorcycles—required for a benefit to Harley as a whole—seems questionable.
To some extent, the market is pricing in these pressures. HOG trades at about 9x this year’s consensus earnings per share estimate. But that’s still a premium to most companies facing similar challenges. With the stock at a clear technical top, it seems likely HOG has a downside ahead.
The Case For Harley-Davidson Stock
There are things to like about the Harley-Davidson business as presently constituted. The H-D brand unquestionably is iconic worldwide. In its core categories, notably so-called “cruisers,” the company has a dominant market share.
Last February, Harley announced its “Hardwire” five-year plan, following the “Rewire” strategy that allowed the company to navigate 2020. The company expects cost-cutting and a focus on fewer, more popular models to boost profit margins. In the motorcycle segment (which includes apparel and parts and accessories revenue), Harley forecasts operating margins of 15% in 2025, up from just 8.5% in 2018.
Meanwhile, Livewire is affecting the company’s still-cheap multiple to earnings. The company projects an operating loss of $111 million this year (see p. 147-148), a $0.57 hit to Harley’s consolidated after-tax earnings per share. Despite being unprofitable, the business has real value: the SPAC merger currently values Livewire at roughly $1.6 billion. Harley will own 74% of the post-merger company.
When considering the value of the Livewire stake (almost $9 per HOG share), then, the legacy motorcycle and financing businesses are trading for less than 7x earnings.
The Problems With HOG
But there’s a chance for a sharp, significant reversal in profitability going forward, thanks to the post-pandemic return to normalcy and changing macroeconomic conditions.
The motorcycle business was in trouble before the pandemic. Harley-Davidson has long been a brand popular with the “baby boom” generation — but those riders are aging out. (The youngest baby boomer is now 56.)
The business got a reprieve after the pandemic. Notably, pricing strengthened, providing a boost to long-compressing profit margins. Harley this year also decided to take more profit from its dealers.
In a more normal environment, pricing returns to its past trend. The boost from dealer profit can’t recur — and may have to reverse.
Indeed, in an inflationary environment, margins may even return to below pre-pandemic levels. Harley’s costs are going up—but a strong U.S. dollar threatens its competitiveness. Thanks to a sharply weaker yen, Japanese rivals will be able to compete aggressively on price, as they have in the past.
The financing business is at risk as well. Harley already expects profits to decline 20-25% this year. But even with that fall, those profits remain well above the historical average. Here, too, if and when the economy turns south, Harley will likely see another leg down.
Livewire may not be the asset the SPAC merger suggests. IMPX stock fell 5% in early trading Tuesday after the redemption deadline (before which shareholders can redeem the stock for $10 in cash) passed.
SPAC mergers have performed abysmally over the past 12 months, and there’s little evidence at the moment to suggest that Livewire will be different. Even if Livewire grows, at least some of its sales will come from Harley’s legacy ICE (internal combustion engine) business.
To top it off, the technical picture looks worrisome, with a low-volume rally clearly running into strong resistance around $42:
So, yes, the stock looks cheap. But that alone is not enough. HOG looks like it has further downside ahead.
Disclosure: As of this writing, Vince Martin has no positions in any securities mentioned. He may initiate a short position in HOG this week.
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Read the full article at Overlooked Alpha.