Oct 152010
 

In 2009, Harley-Davidson embarked on an aggressive restructuring plan to avoid bankruptcy and retain investors: It shed Buell and MV Augusta; shut down factories; sold off machinery; reneged on promises to develop land and add jobs in a quid pro quo deal involving the museum; cut 2,000 jobs; forced the workers to pay more of their health insurance costs; and turned union jobs into fairly low-paid temp jobs.

The Motor Company’s threat to pull manufacturing from Wisconsin resulted in 25 million in tax credits even as the company throws hundreds onto the unemployment rolls—benefits that come out of taxpayer dollars.

Even though the Motor Company admitted enormous restructuring costs, it presented the 2Q results in an extremely favorable light—look, despite everything, the company rebounded from enormous losses and made a little profit.  And it’s leaner—and meaner—coming out of it.

Some analysts, though, question whether it’s a sound health and if the company will rebound in the future. Some are even recommending short selling the stock:

Seth Jackson, in a Motley Fool article, “Show Me the Money, Harley-Davidson” published after the second quarter results came out found the cash flow was disturbing: “When I say “questionable cash flow sources,” I mean line items such as changes in taxes payable, tax benefits from stock options, and asset sales, among others. That’s not to say that companies booking these as sources of cash flow are weak, or are engaging in any sort of wrongdoing, or that everything that comes up questionable in my graph is automatically bad news. But whenever a company is getting more than, say, 10% of its cash from operations from these dubious sources, I feel obliged to crack open the filings and dig even deeper, to make sure I’m in touch with its true cash profitability.”

Questionable cash sources, he points out, comprises 28% of the cash flow from operations for Harley-Davidson. “Harley has one of the messier cash flow statements out there, full of swings from “retained securitization interests” and other wonders of modern finance.”

In comparison, H-D’s nearest competitors FCF range from 13% (Polaris) to a negative 8% for BMW group. Iow, H-D’s FCF is over twice as much, which isn’t necessarily bad but it’s not necessarily good.

Then there’s the kind of savings that come from restructuring. The Motor Company says it “saved” $135 million to $155 million from the restructuring activities it’s undertaken beginning in 2009. Harley wants us to believe savings could go up to $240 million to $260 million a year.

Jeffery B. Middleswart, President and Director of Research at Behind The Numbers, says restructuring charges tell him a company made a mistake, especially when they come up often.

“They are telling you they screwed something up,” he said.

While huge savings in one year look impressive on a balance sheet, they generally aren’t duplicated again. There’s only so many times they can  borrow $600 million from investors, disassemble plants or throw hundreds into unemployment to look good for Wall Street mavens.

More to the point, Harley’s 2Q profit didn’t come from selling motorcycles—it came from selling off assets, laying off workers and borrowed money—specifically, it came from cleaning up some of the mess in the Financial Services subsidiary. The business of HDFS is primarily motorcycle loans. Making loans is not making motorcycles.

Ultimately, though, a motorcycle manufacturer has to sell bikes if it’s to stay in business. And they aren’t selling many—and the less motorcycles it makes, the less loans.

And such drastic measures surely convey that Harley-Davidson doesn’t believe it will be needing those factories or workers for a long time. And that speaks volumes about the kind of company H-D believes it will be in the future—one that won’t be selling a lot of motorcycles soon.

It’s also going to have $5 billion in net debt after the loans and restructuring costs.

It will take a lot of savings from restructuring and a hell of a lot of bikes sold to pay that back.

Another spot of concern is the increase in short selling of Harley stock. As another Motley Fool article, “Don’t Short These Stocks” by Jordan DiPietro pointed out that “droves” of investors are shorting Harley stock.

Short Selling is the act of borrowing stock to sell with the expectation of price dropping and the intent of buying the stock back to replace at a cheaper price.”

Short interest as a percentage of float, which is a great yardstick for how heavily shorted a stock actually is, typically remains below 5% — anything above that usually indicates a red flag.”

Harley’s short interest percentage of float was 10.7%–or twice what’s considered typical.

Iow, many investors believe Harley isn’t on the road to recovery for many of the reasons we’ve discussed—an aging demographic that’s uncertain about the security of their investments and pensions or are unemployed, massive net debt, questionable cash flow and a profit that came from financing bikes rather than making them.

Beyond all we’ve already talked about, there’s an odd little coincidence that suggests they might be right:

According to an article on the website Seeking Alpha, “Harley-Davidson: Looking for a Good Short? Shed Some Fat”,

The financial services company, BMO Capital Markets, (http://www.bmocm.com/) found that S& P’s Case-Shiller index of house prices correlated with Harley’s stock prices than any other measure such as “the unemployment rate, interest rates, gross domestic product and consumer sentiment scores…to explain the stock’s movements.”

Both existing and new home sales plummeted in July—but home prices were increasing slightly. Still, “While the numbers are upbeat, other more recent data on home sales and mortgages point to fewer gains ahead,” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s.”

Existing home sales rose slightly in August, but were still down not only from June but from August 2009. New home sales were static from July. Case-Shiller results will be announced this coming week.

Harley stock price rose slightly after the unions caved in Wisconsin—this strengthens the correlation with Case-Shiller house prices though one has nothing to do with the other.

However, home sales—either new or existing—speaks of a widespread economic health. And if people can afford to buy a house, they might afford an over-priced motorcycle. It could be that  home sales are bellwether of motorcycle sales, it’s very likely that Harley shipments were soft in the third quarter. We’ll find out on October 19 when the Motor Company releases its third quarter results.

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