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- By Steve Gray Booyens
The stock market has been showing signs of correcting itself after a year of inefficiencies. Many stocks have outperformed the market due to speculative betting instead of value-based investing, and Harley-Davidson has been one of them, which could spell trouble for its share prices. Let's look at why.
Aging consumer base
Harley's consumer base has started aging, and the newer generation hasn't found its products as attractive. The company tried to re-brand with their electronic motorcycle "Live Wire." The brand has since been spun off into a separate entity in an attempt to create a more prominent brand. It will be costly if Harley decides to change its image to match the modern-day consumer, and investors' value might subsequently be diluted.
Inventory turnover ratio is a useful metric to look at as it measures the cost of goods sold with the average inventory on hand. Harley's cost of goods sold has increased at a CAGR of 2.4% over the past 10 years. Still, the inventory turnover ratio has decreased, which means that Harley has managed its inventory inefficiently.
The asset turnover paints a picture of how Harley's revenue hasn't grown quickly enough to match its asset growth over the past 15 years. Harley is an asset-heavy business. If this ratio continues in this downward trend, the company will either have to sell PP&E at less than breakup value or liquidate inventory to survive.
Revenues and profit margins have decreased significantly since 2015. The decrease in earnings growth will need to be reversed if Harley wants to sustain or increase its market share. Harley will most likely have to raise additional capital to reverse the scenario, which might dilute shareholders.
When studying the diluted EPS, Harley has largely diluted their shareholders already. An important factor to note is the disconnect between the diluted EPS and the stock price over the past year. The stock price has usually correlated with the diluted EPS. I think a correction is on its way, where the price and diluted EPS will converge.
If you're an investor and invest capital into an inefficient company, you're probably an optimist, thinking that the tide will turn. I can't judge as you might have a valid premise, but this company's weighted average cost of capital has decreased alongside its return on invested capital. In fact, its ROIC is negative. This means that you're earning negative returns on your investment while the promised residual you'd earn has decreased as well.
Valuation and dividend decline
Harley has a 12-month price target of $48.02 (roughly 2% upside) based on a justified forward price-earnings ratio and a current balance sheet intrinsic value of $48.47 (currently at market value) according to an asset-based valuation model. If you value Harley on its cash flow, it has zero value due to negative cash flows.
Many investors might argue that valuation doesn't matter because they're invested for dividends, but the company has a dividend yield of 1.24% and a negative dividend growth rate (-30.34%).
Harley is one of the stocks which outperformed the market over the past year due to speculative betting in an inefficient market. However, the company's inefficiencies and failure to provide value to shareholders places it on my sell list. The asset-based valuation shows that the company is valued in line with the market, but this is due to Harley being an asset-heavy business. The discounted cash flow intrinsic value indicates that Harley has zero value. Thus, I think Harley is inefficient and overvalued.
Disclosure: I don't own any positions in Harley-Davidson
This article first appeared on GuruFocus.