Harley-Davidson Searches for Fuel as Turnaround Hits Speed Bump

Harley-Davidson's turnaround (HOG) may have hit a speed bump in the second quarter.

The iconic motorcycle maker's second-quarter sales trended down by a low- to mid-single-digit percentage despite increased promotional offers, worse than the 0.5% drop in the first quarter, said KeyBank analyst Scott Hamann in a new note to clients Wednesday. According to Hamann, Harley-Davidson's sales took a hit due to unfavorable weather and the continued popularity of Polaris' (PII) Indian brand. Hamann called Indian a "solid share gainer," and sees second quarter retail sales at Indian increasing by a mid-single digit percentage. 

Hamann trimmed his domestic shipment estimate for Harley-Davidson to a decline of 0.5% from a previous estimate of a 1% increase.

The commentary may add more volatility to Harley-Davidson's shares in what has already been a turbulent few sessions. 

Shares of Harley rocketed as much as 20% on Friday amid speculation of potential takeover interest by private-equity firm KKR & Co. The spike followed a similar move back in December, also due to takeover speculation. Shares proceeded to nosedive about 11% Monday as several Wall Street analysts downplayed the possibility of a leveraged buyout. 

"Harley-Davidson is a poor leveraged buyout candidate for two main reasons such as covenants [existing] on the motor company and Harley-Davidson Financial Services limiting the amount of debt that can be put on either entity and Harley may not produce enough cash flow to de-lever within an adequate private equity time horizon to generate an acceptable return," wrote Barclays' analyst Felicia Hendrix to clients on Wednesday, adding, "We believe the leveraged buyout thesis is unlikely."

But a bunch of suit-wearing private-equity investors owning a motorcyle brand that bleeds red, white and blue may not be as remote a possibility as some Wall Street analysts are pontificating.

"We have no particular insights into the veracity of these reports, but given the company's strong balance sheet, solid cash flow, superior brand name and encouraging new product strategies, we think a leveraged buyout could work," said BMO analyst Gerrick Johnson on Tuesday. He added, "At minimum, a $65 [a share] deal would appear to be sustainable, with cash flow better than potential interest expense -- given an inexpensive valuation, if the acquirer could improve business performance, such a deal could provide value over time, in our opinion."

At Johnson's $65-a-share estimate, Harley-Davidson at a minimum would be worth about $12 billion. The company's market cap stood at roughly $8.76 billion as of Tuesday's close.

Harley-Davidson has built up significant brand equity through the years that is likely not being reflected in its stock valuation, and has worked diligently to re-tool its manufacturing facilities to more efficiently produce bikes. Further, Harley's debt-to-equity ratio is relatively low at 52%, giving a would-be buyer room to add debt to complete a big transaction. Add in that before Friday's pop shares of the bike manufacturer were down about 30% since Jan. 1, 2015, owing to a disappointing stretch of sales, and it's easy to understand why a private-equity firm might be sniffing around.

From Harley's perspective, it may be open to offers as a way to escape Wall Street's scrutiny in what have been several challenging quarters. The operating environment for Harley-Davidson is one that could be best characterized as ultra-competitive. Japanese motorcycle manufacturers such as Honda, Suzuki and Kawasaki have been able to price their bikes more competitively in the U.S. for more a year due to the yen's weakness.

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