Signs That Harley Has Turned a Corner

 | Feb 05, 2016 | 10:00 AM EST
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Harley-Davidson (HOG) has seen more good news within the past week than it arguably did for all of 2015. And that bodes well for the stock in the medium term.

On Wednesday evening, the storied motorcycle manufacturer announced a 20 million increase in the amount of shares it could repurchase. The dividend was lifted by 12.9%.

I was surprised by the timing of the announcement in light of this exchange I had with Harley-Davidson CEO Matt Levatich last week after earnings.

TheStreet: Harley-Davidson repurchased a massive $1.53 billion of its stock in 2015. Will that pace continue in 2016?

Levatich: "For various reasons, we felt like we could take on that level of corporate debt to repurchase shares and not jeopardize our credit ratings. We need good credit ratings to have good costs of funds for our finance subsidiary, which is absolutely critical to us lending to those qualified people who want to ride a Harley-Davidson. We don't believe we can take on more corporate debt without starting to jeopardize those credit ratings. What we have committed to is that our excess cash, we will give it to our shareholders through dividends and share repurchases at a more nominal ongoing rate."

A company spokesman later gave this update: "Harley-Davidson does not have plans to increase debt to repurchase shares. The additional 20-million-share authorization to repurchase shares anticipates repurchases in the normal course of business, and Harley-Davidson intends to return all excess cash the company generates in the form of rising dividends and share repurchases." 

With shares of Harley-Davidson continuing to outperform the market in the wake of better-than-expected fourth-quarter results, it's a good sign the market believes the company has turned the corner. So why shouldn't Harley-Davidson use its free cash flow (or potentially, new debt) to buy its stock back at what appears to be attractive levels? Moreover, why shouldn't the Average Joe investor -- who can easily grasp Harley-Davidson's business model -- invest alongside the company right now?

Here are a few signals this news sends investors:

1. U.S. dollar weakness could help the first quarter. The strength of the dollar pummeled Harley-Davidson in 2015. Japanese bike manufacturers such as Honda and Suzuki used their currency advantage to offer robust discounts in the marketplace, which attracted U.S. consumers. With the U.S. dollar easing up a bit lately, Harley could start to reverse the narrative that plagued its business for the majority of last year. At this point, any relief is welcome news.

2. Dividend hike signals solid product pipeline. A company that is as driven as much on new products as it is on used-bike sales, I don't think Harley-Davidson hikes the dividend 12.9% if it didn't have confidence in its product pipeline. In talking with Levatich last October, I came away with the sense that it's about to unveil a host of market-share-gaining product innovations over the next several years. Some of those innovations could be seen with the recent introduction of new 2016 model-year bikes, which are faster and sleeker. New product development spending is expected to increase by 35% this year. Further, I believe Harley-Davidson is on the verge (within the next two years) of debuting its first electric motorcycle. Polaris (PII) recently introduced its first electric bike, and I don't believe Harley wants its nemesis to get too out in front in this growth category.

3. New plan signals Harley could be ripe for a buyout. I have long believed Harley-Davidson would be an attractive holding for Warren Buffett's Berkshire Hathaway (BRK.A, BRK.B). Buffett could surely understand bike making, Harley is etched in the fabric of Americana and there are durable competitive advantages to the business. Harley is sending signals that it deserves to get a look from a real suitor, not some lame activist investor seeking to get on TV. For 2015, Harley-Davidson repurchased a massive 27.9 million shares of its common stock at a cost of $1.53 billion.  If the company used its entire, new 20 million buyback authorization today, it would amount to spending another $800 million. That would be over $2 billion in share repurchases inside of two years, which is all but akin to a company yelling out that it could have strong new products waiting in the wings (to boost earnings and cash flow) and the market is undervaluing the brand's name and longer-term potential.

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