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Harley-Davidson Finds a New Gear

By Jim Pearce on October 21, 2016

Harley-Davidson announced Tuesday that it will be laying off 5% of its labor force to offset a 4.3% year-over-year decline in revenue. But this sobering bit of news was greeted enthusiastically by investors, resulting in a quick 12% jump in HOG’s share price.

Adjusting labor costs to match revenue is straight out of Business Management 101, but each time a company does it the market reacts as if the company just discovered how to turn straw into gold. However, as my college professor used to remind us, you can’t cost cut your way to sales growth. So let’s enjoy the boost in HOG’s share price with the caveat that the company may have bought itself a little time to improve its bottom line, but it hasn’t turned the corner to more profits just yet.

In any case, Harley-Davidson is exactly where we thought it would be (“Hogging the Road to Profits”) when I added it to the Personal Finance growth portfolio in early June. It’s climbed 20% since then. At that time I wrote: “Overseas, motorcycle use is also rising, especially in countries where car ownership is restricted by government or prohibitively expensive. Fortunately, Harley-Davidson already has an extensive global presence, with more than a third of its sales made overseas. Most of its smaller competitors lack the global distribution networks to generate revenue abroad.”

In its most recent quarterly earnings report, the company confirmed what everyone already suspected; compared to the same quarter last year, sales revenue in the U.S. declined by 7.1% last quarter, but increased overseas in widely diverse markets such as Canada (+4.3%), Europe (+1.9%) and Asia (+1.7%). The contrast becomes even starker when viewed over the first nine months of this year: Sales were down 4.7% in the U.S., but up 6.3% in Canada, 6.6% in Europe and 2.9% in Asia. Only in Latin America are overseas sales lower, but that region represents less than 4% of Harley’s total.

The boost in foreign sales helps, but U.S. sales are still more than twice as much as the rest of the world combined. Hence, the need for layoffs. That’s bad news for the affected workers in Milwaukee (where HOG is headquartered), but good news for the company long term as it methodically expands market share both here and abroad. Of course, this means nothing if sales don’t start heading back up, something industry analysts expect to occur next year provided the global economy does not slip back into recession.

Also, there is the curious matter of an unsubstantiated rumor that surfaced in July that Harley-Davidson would be acquired by KKR & Co., an investment banking firm that specializes in a particularly daring form of financial engineering by identifying undervalued publicly-traded companies and taking them private so they can then be broken up into pieces and sold off for more than what they paid for it. Although KKR denied the rumor, continued strength in HOG’s share price suggests that someone on Wall Street believes it has merit.

My guess is KKR considered acquiring HOG back in January when its share price temporarily dipped beneath $40, but now that it is trading above $55 the economics of that type of financial arbitrage transaction are not nearly as attractive. Nevertheless, the persistence of that rumor has effectively placed a floor of $50 beneath HOG’s stock, providing valuable share price support while management shifts more of its sales focus to its growing overseas markets.

I must admit to having mixed emotions regarding HOG’s recent popularity. While I am thrilled to see a 20% gain in the stock, I don’t understand why its share price would jump so strongly on what strikes me as a decent, but not spectacular, quarterly earnings report. I also doubt that KKR is still keen on buying Harley-Davidson at is current value, if it was ever interested in the first place.

But there is clearly something good going on with the stock, even if the cause is not apparent. The explanation may be as simple as one or more if its many institutional shareholders are adding to their sizable position in HOG, driving up its share price. About 83% of HOG’s outstanding shares are owned by institutions, leaving only 17% actively traded in the market so even a mild increase in demand could have an exaggerated impact on its share price.

Regardless of the reason, we’re hanging on to HOG in Personal Finance to see where this wild ride takes us.

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