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Why You Can’t Ignore HOG After This Gap-Down |
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Bad news is out at Harley-Davidson (HOG), and shares are down 9.2% to a 15-month low as I write this. The motorcycle maker cut guidance and said it would be reducing unit shipments in the near future after soft sales over the summer. Is Harley-Davidson really worth 9% less today compared to yesterday because next year’s earnings are being placed at 9% less than estimates? Given the strong brand behind the company, I would say that should certainly not be the case. As part of its 2007 Global Brands study, BusinessWeek ranked the Harley-Davidson brand name as the 45th most valuable in the world, being worth $7.7 billion. Combining that with the net tangible assets the company is holding of $2.6 billion gives you a value of $10.3 billion; HOG’s current market cap is just a 24% premium to that figure. With Harley’s average annual free cash flow over the last three years clocking in close to $700 million, the company is exceptionally profitable too. Why is the market knocking a good company like Harley down? I suspect this is a case of a company providing too much information on a bad day. The jobs report coming in very weak would likely have led to HOG getting hit to some degree, but now that Harley has put their problems in the context of a poor economy and lack of consumer strength, they’ve added that stigmatism to the stock. As Jim Cramer said just before his famous rate-cut rant, executives need to adopt the Henry Ford model: “Never explain, never complain.” If Jim Ziemer (Harley’s CEO) simply came out and said something along the lines of “we’re seeing some slowness in sales, but we’re doing fine and will continue to do so” how severely would the reaction have been? I’d guess something less than what we’ve seen, but lets play the hand we’re dealt. This set-up with HOG looks like a gift. Not a perfect gift, mind you, but a very compelling opportunity to establish and excellent long-term long position. If you look at the ten-year numbers for Harley, you can easily see how phenomenally successful the company has been during that period. The average ROE for that period was 27.9% and improving; over the last five years the average ROE is 30.7%. Gross and operating margins have held steady or increased year-over-year without fail, and although that trend seems likely to end this year, investors are still looking at a company with exceptional pricing power and a track record of making solid marginal improvements that increase profitability. Harley has weathered economic weakness before (between 2000 and 2004, EPS shot up from $1.13 to $3.00) and I imagine this time will be no different. Harley has a great lineup, and sources have told me a huge order backlog exists for top-end Harley models. I think long-term investors will be rewarded if they take advantage of this opportunity to scoop up a great and profitable brand when others are being short-sighted and fearful. For the valuation, I’ll approach it using the philosophy of buying the business for current net worth plus the sum of discounted future cash flows. Current analyst estimates call for growth over the next five years to run around 11.5%, although I’m anticipating those are going to be slashed in a wave of downgrades. Conservatively cutting that number by about half to 6%, discounting those estimates at 9%, applying a slightly-below-average 15x exit multiple to those cash flow estimates, and adding in the net tangible assets gives a per-share value for HOG of $54.60, or approximately 11.3% above the current trading price. I believe that valuation, however, overlooks the enormous value in the intangible asset that is the Harley brand name. So, a simple solution: for each $1 billion you think the Harley name is worth, add $3.88 to the share price. Using the $7.7 billion figure given by BusinessWeek adds another $29.90 per share in value for a total price near $84.50 - that represents a 72% premium to current trading prices. You can slice the valuation however you’d like, the inevitable conclusion seems to be that HOG is cheap right now. A chance to buy a company as profitable as Harley at such a cheap valuation doesn’t come around often, and perhaps I’ve understated this, but you also might be getting a piece of the brand with the most fanatically loyal customers ever in the bargain. Look at the BusinessWeek list and ask yourself what other brand there has customers tattooing the name onto their skin. Macaholics don’t even do that. You think someone with a Harley tattoo on their bicep is going to be seen riding a Suzuki? I don’t think so either. HOG under $50 is your buy. |