It has been a rough 2018 for Harley Davidson (NYSE:HOG). Not only has the motorcycle giant been a financial victim of tariffs (margins are getting whacked), but the company has also drawn the ire of U.S. President Donald Trump after management decided to shift production overseas (to offset the negative margin impact from tariffs).
Meanwhile, the company is still battling demand headwinds in the U.S. market, which have been persistent and relentless for several quarters.
All together, HOG stock has dropped more than 15% in 2018.
But, that same HOG stock that is down big year-to-date and has been plagued with numerous operational headwinds, is now popping on encouraging second-quarter numbers. U.S. retail sales are still dropping, but the declines are moderating. Meanwhile, in every other geography, last year’s big declines have turned into either smaller declines or even gains (Europe and Latin America sales were up in the quarter).
On the margin side of things, HOG’s overseas production shift is offsetting tariff headwinds. Operating margins are still expected to be about 9.5% this year, which isn’t that bad for a company with big tariff exposure.
Overall, the narrative at HOG isn’t good. But, it is certainly getting better. And, at current prices, an improved narrative could lead to healthy gains for HOG stock.
Here’s a deeper look.
Harley Davidson Reported Much Improved Q2 Numbers
Upon first glance, Harley Davidson’s second-quarter numbers weren’t that good.
U.S. retail sales dropped 6.4%, marking the sixth straight quarter of declines in the U.S. business. Canada retail sales were also down year-over-year. Same with Asia Pacific sales. Overall, total motorcycle retail sales dropped nearly 4% in the quarter, while operating margins compressed in a big way from 20% to 16%.
But, if you put those numbers in context with prior quarters, then a silver lining appears.
U.S. retail were down 6.4%. That isn’t good. But it is a whole lot better than last quarter’s 12% decline, and last year’s 8.5% decline. In other words, the U.S. sales trajectory remains negative, but is gradually improving.
Also, every geography reported negative retail sales growth last year. This year, each one of those geographies is either declining by less or actually growing. That led to international retail sales growth of 0.7% in Q2, versus a near 4% decline last year. Thus, just like the U.S. sales trajectory, the international sales trajectory is gradually improving.
Also, operating margins fell 410 basis points in Q2. Not good. But, they were down 510 basis points in Q1. Again, this is sequential improvement.
Overall, then, we see that the Harley Davidson growth narrative may have finally bottomed. U.S. sales growth is improving. International sales growth is improving. And margin erosion is moderating.
Harley Davidson Stock Could Rebound In A Big Way
These moderate improvements in the Harley Davidson growth narrative could translate into big gains for HOG stock.
In simple terms, HOG stock has been killed over the past several quarters thanks to a confluence of headwinds. The valuation on HOG stock now reflects exceptionally low growth expectations (11X forward earnings versus the five-year average 13.5 forward multiple), while forward earnings estimates are very low.
Slight improvements in the narrative will bring up forward estimates and spark healthy multiple expansion. Thus, HOG stock could get a double tailwind from improved results and improved investor sentiment.
Overall, I see HOG stock heading toward $50 by the end of the year.
Here’s the math. Motorcycle sales have been dropping by roughly 0.1%-per-year over the past five years. But, these declines are moderating, and management plans to launch a fleet of new products to reinvigorate growth. Thus, over the next five years, I reasonably think Harley Davidson can grow sales by roughly 0.5%-per-year.
That would put motorcycle sales at just over $5 billion in five years. The last time motorcycle sales were over $5 billion, operating margins were near 15%. I don’t think Harley Davidson gets back to that level in five years. But, I do think 13% operating margins are achievable on a $5 billion-plus motorcycle sales base.
Assuming financial services operating income stabilizes around $280 million and that the company continues to buyback shares in bulk, I think that Harley Davidson can do about $4.90 in earnings-per-share in five years. A historically average 13.5X forward multiple on that implies a four-year forward price target of just over $66. Discounted back by 10%-per-year, that equates to a year-end price target of right around $50.
Bottom Line on HOG Stock
Things aren’t great at Harley Davidson. But, second-quarter numbers affirm that things are improving.
HOG stock isn’t appropriately priced for even marginal improvements in the growth narrative. As such, I think this rebound in HOG stock has legs to $50 in 2018.
As of this writing, Luke Lango was long HOG.
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