Harley-Davidson Shares Are Out of Gas
Wednesday May 29, 7:00 am Eastern Time
Morningstar.com
By Pat Dorsey
me: I posted about the tax rate chanegs over 1.5 years ago besides the decline in luxury recreational vehicle sales. Personally because of 911 people are spending more on home and national recreation than travel so that figure should be considered. Rates going down is of course obvious. The other points kinda make sense. Do I think HDI will go down? I always think it's overvalued but it never really goes down much. I guess compared to all the other investments out there, at least they're profitable and somewhat honest.
On the surface, Harley-Davidson (NYSE: HDI - News) looks like a great investment. The company sailed through last year's recession with aplomb, recently unveiled its first brand-new bike in decades, and regularly thrashes Wall Street's earnings estimates. It's little wonder six of the Wall Street analysts covering the firm rate it a "strong buy" and the other eight party poopers merely give it a "buy" rating.
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In my humble opinion, this optimism seems very misplaced. Rather than being a stalwart "core holding"--as I recently heard Harley described--I think investors buying Harley at $53 a share are looking for trouble.
For one thing, it's tough to justify a price-to-earnings ratio of 31 (based on the generous consensus forecast for 2002) for a company that's sensitive to any whiff of a slowdown in consumer spending. Sure, Harley's been growing at better than 20% over the past few years, but that was during one of the strongest economic booms in quite some time. (For the record, Morningstar estimates Harley's fair value at $43, assuming that sales growth slows down to the mid-teens and margins shrink somewhat.)
One sell-side report I recently read justifies Harley's valuation because its current forward P/E is slightly below its average forward P/E over the past three years. Given that the 1998-2001 period encompassed the latter stages of a bull market that got pretty speculative, I'd question whether a slight discount to that inflated earnings multiple warrants a "buy" recommendation.
Compounding the valuation risks are some financial warning signs. Though none is very worrisome by itself, together they paint a somewhat troubling picture. Consider, for example, that Harley's corporate tax rate has declined by a couple of percentage points over the past couple of years. Nothing wrong with that, except that eventually the tax-rate sponge can be squeezed only so dry, at which point the tax-enhanced bottom-line growth rate suddenly slows. Consider also that interest rates are a lot more likely to go up than down over the next few years, which means that Harley's finance division won't be adding as much to the company's bottom line as it has over the past couple of years. (As rates rise, the spread between the rates Harley can charge its customers and the cost of making those loans will narrow, which will reduce profits from financing.)
Even more troubling is the absurd 10.5% rate of return Harley is projecting for its pension plan assets. Since the plan is currently underfunded--meaning that the assets in the plan aren't enough to cover projected future payments to Harley retirees--Harley may have to take a pretty big charge to bring its pension plan up to snuff. (For an explanation of how optimistic pension return assumptions can lead to trouble in the future, click here.)
Finally--and most problematic to me--Harley has been buying back its stock even though it trades at a premium valuation. It seems that Harley's management doesn't have any profitable ways to internally reinvest the cash. In other words, management thinks the best allocation of shareholders' capital is in Harley stock at almost 40 times trailing earnings--which means that either management has poor investment acumen, or the company's growth opportunities are starting to get tapped out. In either case, shareholders won't come out ahead. The bottom line is that expectations are simply too high for Harley--it's a well-run company with a great brand, but buying the shares where they are now is unlikely to make you much money. |
