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Wall Street Takes Harley-Davidson to the Woodshed: What You Need to Know

By Rich Smith – Apr 19, 2017 at 11:03AM

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The motorcycle maker beat on earnings -- then got beat with a stick.

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

It's earnings season on Wall Street, and the upgrades (and downgrades) are coming fast and furious. Today, we're going to look at Harley-Davidson (HOG), which reported its Q1 2017 results on Tuesday -- and was immediately flogged by Wall Street.

At last count, is showing no fewer than four separate analysts making price target cuts on Harley stock since it reported Q1 results. Here are three things you need to know about that.

Line of parked motorcycles.

Wall Street put Harley-Davidson stock in "Park" after earnings. Image source: Getty Images.

1. What Harley-Davidson said

Let's start with the numbers.

Harley-Davidson earned $1.05 per diluted share on $1.5 billion in revenue last quarter. That works out to a 23% decline in profits on a 14% decline in revenue. Unit sales of motorcycles declined 4.2% year over year.

Although technically, Harley beat estimates for the quarter's profits, it missed on sales. Nevertheless, CEO Matt Levatich said the numbers were broadly in "in line with our projections," and reiterated guidance for the rest of this year. While Harley's U.S. sales were down, Levatich pointed out that "overall U.S. industry" sales were likewise "down for the same period." Harley's results were apparently less bad than others experienced, because it gained market share in the U.S. throughout the decline, now claiming a 51.3% share in large bikes in the U.S.

2. What comes next

The company also noted that in order to give its dealers time to sell through accumulated old inventory, it cut shipments of new motorcycles to dealers by 15% in the first quarter, and expects "full-year motorcycle shipments to be flat to down modestly in comparison to 2016."

On bikes that actually sell after being shipped, management expects to earn gross and operating profit margins roughly equal to the 35.3% gross and 17.8% operating margins (per data from S&P Global Market Intelligence) that the company earned in 2016.

Assuming revenue recovers from Q1's decline, and track shipments to end the year roughly "flat to down modestly" as well, this implies that Harley-Davidson should end up earning something less than $692 million this year ($3.83 per share).

Free cash flow, on the other hand, could improve modestly. Last year, Harley-Davidson spent $256 million on capital investments, but management says it will spend only $200 million to $220 million this year. Assuming roughly equal levels of operating cash flow this year and last, this implies that Harley could end the year generating positive free cash flow of $950 million or more.

3. What analysts say

So how are analysts reacting to all of the above? Wedbush Securities took its cue from guidance to cut its earnings expectation -- which had called for a small rise in profits -- to a small decline instead. The analyst now predicts Harley-Davidson stock will earn only $3.73 per share this year, and Wedbush is cutting its price target to $53 a share, with a neutral rating.

Deutsche Bank took a similar position, cutting its price target by $2 to $50, combined with a hold rating. Barclays maintained its neutral rating but cut a dollar off its price target to $52.

Meanwhile, the most optimistic of the analysts, Stifel Nicolaus, also cut its price target -- but only to $61 a share. And Stifel, too, says the stock is a hold.

The most important thing: Valuation

I think they may be making a mistake.

Consider: Viewed in the light least favorable to Harley-Davidson, Wedbush's prediction of $3.73 per share in profits values Harley-Davidson stock at just 14.2 times earnings (on the $53 price target that Wedbush is projecting), or 15.2 times earnings (on the $57 price Harley stock currently carries). Neither of those valuations seems particularly high to me, especially given that the average S&P 500 stock now costs 26.4 times earnings.

Furthermore, if you look at Harley-Davidson stock under a more favorable light, the company currently boasts a $9.9 billion market capitalization. But if my estimate of free cash flow is correct, the company will generate positive free cash flow of perhaps $950 million this year -- resulting in a price-to-free-cash-flow ratio of just 10.4 on the stock. It doesn't take an insanely high growth rate to justify these kinds of valuations, and in fact, most analysts still predict that Harley-Davidson stock will post profits growth rates of 12.2% annualized over the next five years.

Call me an incurable optimist, but with Harley-Davidson planning to introduce 50 brand-new motorcycle models over those same five years, I think that growth target is eminently achievable.

Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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