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2019-10-11 03:21:26

Written by Robert Kovacs

Introduction

Around 18 months ago, I warned investors to stay away from Harley Davidson (HOG):

I don’t believe the worst is over yet for the company and, as such, believe the stock price will come down more. I would reconsider my position if the stock drops more - to around $35.

Source: Open Domain

This year, the stock price has dropped below $35. In fact, HOG is currently trading at $34.11 and yields 4.40%. My M.A.D Assessment gives HOG a Dividend Strength score of 75 and a Stock Strength score of 55.

But this struggling business looks just like it did 18 months ago. Sales have remained sluggish so far in 2019, and nothing signals to me that a turnaround is under way.

I believe that dividend investors should avoid Harley-Davidson at any price, as long as the company continues to shrink. While 12x earnings sounds cheap, it is in fact quite expensive if earnings go down year after year.

Source: mad-dividends.com

I will analyze HOG as an income investment, before considering its potential for capital appreciation.

Dividend Strength

As we’ll see, HOG looks like a strong dividend stock at a first glance. Its dividend is well covered, has been increasing healthily for a few years and has an appealing current yield. Yet all of this is undermined by the fundamentals: revenues, earnings, cashflows; which continue to show signs of weakness. If a company’s profitability decreases continually every year, how long before the dividend increases have to stop? How long before other investors throw in the towel, plunging the share price lower?

I can never repeat this enough: There are no strong dividend stocks that don’t have a strong underlying business.

Dividend Safety

Harley Davidson has an earnings payout ratio of 55%. This makes HOG's payout ratio better than 34% of dividend stocks.

HOG pays 25% of its operating cashflow as a dividend, which is better than 55% of dividend stocks.

HOG pays 34% of its free cashflow as a dividend, which is better than 62% of dividend stocks.

28/06/2015

26/06/2016

25/06/2017

01/07/2018

30/06/2019

Dividends

$1.1800

$1.3200

$1.4400

$1.4800

$1.4950

Net Income

$3.76

$3.89

$3.45

$2.97

$2.74

Payout Ratio

32%

34%

42%

50%

55%

Cash From Operations

$5.71

$5.20

$7.69

$6.66

$6.07

Payout Ratio

21%

26%

19%

23%

25%

Free Cash Flow

$4.54

$3.50

$6.26

$5.24

$4.45

Payout Ratio

26%

38%

23%

29%

34%

Source: mad-dividends.com

Now at a first glance this doesn’t look too bad. The company generates enough cashflow to pay its dividend 3 times, which is good coverage.

The thing that bugs me is that earnings have been down sequentially for the past 4 years. And while free cashflow per share is flat when compared to 5 years ago, it is worth remembering that over 5 years, HOG’s share count has decreased by 25%.

Even amid high conviction buybacks, the company hasn’t managed to increase the amount of cash generated for each share.

At least interest payments shouldn’t be too much of a hindrance. HOG has an interest coverage ratio of 19x which is better than 86% of stocks.

Given the coverage and payout ratios, it would seem like HOG’s dividend is ok for now because the company still generates large amounts of cash relative to the amount it pays as a dividend. However dividend growth has already met some resistance and HOG has cut its dividend before. In 2008 it cut the dividend from $0.33 to $0.10. I just wouldn’t sleep at night knowing that my dividends depend on the willingness of a management team who is struggling to turn their business around. The dividend is well covered, and probably won’t be cut for as long as possible, but I can’t go as far as to call the dividend “safe”.

Dividend Potential

Harley Davidson has a dividend yield of 4.40% which is better than 78% of dividend stocks.

Source: mad-dividends.com

In fact, HOG has never yielded as much in this business cycle as it did in the last few months. In 2018, a few greedy dividend investors found the historically high 3%+ yields enticing. As the price continues its descent, the dividend yield gets ever higher.

Yet even a stock yielding 4% needs some dividend growth to be an attractive investment. Mid single digit dividend growth potential is appreciated for this yield. But, the dividend grew by a measly 1% during the last 12 months which is significantly lower than the company's 5 year average dividend growth of 9%.

Source: mad-dividends.com

This is bad news. Especially when you consider that the company bought back 5% of its shares over the past year. Buying back shares should enable a company to increase the dividend without increasing the total amount paid, but HOG went a step further.

The 1% increase on a per share basis, actually implies a 4% decrease in dividends paid by the company.

I see this as a red flag. Trying to sell investors on a dividend increase when the company has in fact reduced the amount of cash it allocates to dividends appears deceiving.

But what can they do? Revenues and earnings continue to edge lower. During the last 3 years, the company’s revenues have decreased at a -4% CAGR, while net income has gone down at a -15% CAGR.

Source: mad-dividends.com

HOG’s future felt shaky 18 months ago. The price has dropped about 20% since then. Nothing appears to indicate that the future will be different.

Dividend Summary

HOG has a dividend strength score of 75 / 100, but the numbers fail to tell the whole story.

For the first time since 2008, HOG has been paying less in dividend that it was the previous years. Because of share buybacks, the amount per share increased by a meagre 1%, but total dividends paid are down 3-4%. I have very little hope that subsequent dividend increases will be generous, with the company trying to minimize the amount of cash it must keep returning shareholders. As such I wouldn’t advise dividend investors to purchase shares of HOG.

Stock Strength

But is there any value in HOG? Is there any potential for significant capital appreciation? I will cycle through 4 factors: value, momentum, financial strength & earnings quality; to assess HOG’s potential for capital appreciation.

ValueHOG has a P/E of 12.45xP/S of 0.99xP/CFO of 5.61xDividend yield of 4.40%Buyback yield of 4.83%Shareholder yield of 9.23%.

According to these values, HOG is more undervalued than 96% of stocks, which makes it look very cheap. However, the stock has been averaging 12x earnings for the past 5 years, as you can see on the chart below. As earnings continue to decline, the share price has followed suit.

Source: mad-dividends.com

HOG has bought back a huge amount of its shares over the past decade. In itself, this is a good strategy for a shrinking business to remain relevant. However, HOG would need to purchase enough shares to offset entirely the decline in earnings, at least until the company hits a trough.

HOG has been buying back about 5% of its shares each year. There is no reason that it shouldn’t continue at this rate. Earnings however, have declined at an annual rate of 15% over the past 3 years.

The buybacks might soften the blow, but they aren’t enough to offset the massive declines in profitability. As long as earnings continue declining, I can’t see any real value in HOG. Once the business hits a trough and revenues stabilize, it might find a spot as a slow and stable blue chip. Not sure anybody will be willing to pay much more than 12-15x earnings for that sort of company though.

Value Score: 96 / 100

Momentum

Harley Davidson trades at $34.11 and is down -4.59% these last 3 months, -15.34% these last 6 months & -22.02% these last 12 months.

Source: mad-dividends.com

This gives it better momentum than 33% of stocks, which makes it borderline uninvestable for me. The stock has continued to underperform, as it has gradually edged lower throughout the past 12 months. The investment community clearly aren’t buying a HOG turnaround yet, maybe you shouldn’t either.

Momentum score: 33 / 100

Financial Strength

HOG has a gearing ratio of 4.6, which is better than 20% of stocks. The company’s liabilities have increased by 5% over the course of the last 12 months. The company’s operating cashflow can cover 10.9% of liabilities. The liability coverage and liability growth is in line with the median US stock. The gearing ratio is quite large, which is mostly attributed to the low equity as a result of numerous buybacks. As we saw earlier, HOG can cover its interest 19x. This makes HOG more financially sound than 48% of U.S. listed stocks, and as such very similar to the median US stock.

Financial Strength Score: 48/100

Earnings Quality

HOG has a Total Accruals to Assets ratio of -11.1%, which is better than 61% of companies. HOG depreciates 98% of its capital expenditure each year, which is better than 45% of stocks.

Finally, each dollar of assets generates $0.5 in revenue, which is better than 49% of stocks. This makes HOG’s earnings quality better than 43% of stocks. As was the case for financial strength, HOG has very average ratios for earnings quality again. This would suggest that while the stocks fundamentals aren’t awful, they aren’t fantastic either. Given the rough times the business is going through, this isn’t super reassuring.

Earnings Quality Score: 43 / 100

Stock Strength Summary

When combining the different factors of the stocks profile, we get a stock strength score of 55 / 100 which isn’t great. Other than the appearance of value, there is nothing particularly attractive about HOG, and wouldn’t be surprised to see the price continue lower.

Conclusion

With a dividend strength score of 75 and a stock strength of 55, Harley Davidson is a subpar choice for dividend investors. Please stay away if you know what is good for your portfolio.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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