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Published: July 20, 2010
There’s an old adage in Detroit. You make
money selling cars, but you also make money helping consumers
finance those purchases. And there’s never been a better time to
be a lender. Big firms can borrow money at super-low interest
rates, but consumers still need to pay 6%, 7% or even 8% to
finance their purchases. The profit spreads have rarely been so
juicy.
That’s all you need to know about this morning’s quarterly
results from Harley-Davidson (NYSE: HOG). Profits are up
sharply, thanks to a big boost in financial services revenue,
pushing shares up more than +10% in Tuesday trading.
From Red to Black
Of course, to make money when lending, you hope that your
customers will repay their loans. A year ago, Harley-Davidson
had to set aside reserves to account for many delinquent
customers. That led to a $90 million quarterly loss for its
financing arm in the second quarter of 2009. But with a more
stable economy, that unit has swung from red to black, posting a
$61 million gross profit this time around. That $151 million
swing accounts for all of Harley’s eye-poppingly strong
quarterly performance.
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Need to Move the Metal
But investors are looking past some more sobering news.
Consumers are buying fewer new motorcycles these days.
International sales at dealerships for Harley were flat in the
second quarter, as a weak European economy offset the positive
impact of a push into emerging markets. That global expansion is
nearly complete, which may make further emerging market gains
harder to come by. Sales at dealerships in North America fell
-8% from a year ago. And management expects total sales to stay
in a funk for the remainder of the year.
So in the absence of organic growth, the company has been paring
expenses. Management has already shed nearly $150 million from
annual
overhead, and is seeking further gains from its workforce in
terms of flexibility (which basically means that unionized
employees will agree to a reduction in hours if sales are weak).
So you can look at this two ways. On the one hand, motorcycle
sales may not return to their previous highs any time soon.
Harley’s sales peaked in 2005 through 2008 at around $6 billion
per annum, leading many to conclude that those glory days were
tied up in a broader spending bubble that also impacted home
sales and other high-ticket items. These days, annual sales are
stuck close to the $4 billion mark, and some think they may stay
there for awhile. If so, cost cuts can only support a stock for
so long, as investors look out a year or two to flattening
profit growth.
But perhaps sales will rebound as the global economy picks up,
in which case those cost cuts could turn this into a powerful
profit growth story. Sales forecasts appear reasonable. Analysts
think sales will remain under $4.5 billion in 2011. That’s
roughly 25% below the boom years. If the company can move up
above $5 billion in sales by 2012,
earnings per share (EPS) could approach $3. (Per-share
profits peaked at $3.93 in 2006).
Action to Take --> From 1996
to 2007, Harley-Davidson traded for about 25 times next year’s
earnings. But sales and profits are on a lower growth path these
days, and a high-teens multiple is likely more justifiable. That
multiple is at a premium to the broader market, which is
justified in light of the company’s very strong brand name
recognition. If shares trade up to 18 times projected 2011
profits, then they’d rise to $36, or more than 30% above current
levels. Consider this: If
EPS can approach $2.50 in 2012 (a reasonably conservative
assumption), then shares would be worth $45, more than +80%
above current levels. Even with today’s sharp gain, the reward
looks better than the risk for Harley-Davidson.
-- David Sterman
Staff Writer
StreetAuthority |
