#buybacks

Harley-Davidson- Delinquencies vs Denial

Harley-Davidson (HOG) announced 2Q figures overnight. Shares rallied 6.42% on the back of awful numbers in 1Q. In a nutshell:

Motorcycle revenue fell 6% vs 2Q 2018 and group operating income crashed 26%. US retail sales fell 8.0%. Operating margin fell from 16% to 12.6% in 2Q. 11% for 1H down from 14% in 1H 2018. Supposedly these were better than market expectations.

-Market share in 2Q 2019 down 1.8% to 46.6% in domestic market, and European market share at 8.8%, down 1.6%. No doubt Trump to blame for this.

-Volumes down 5.3% for 2Q and 6.5% for 1H

-Operating margin down. HOG expected 8-9% in 1Q. This has now been lowered to 6-7% in the 2Q statement for the full year.

– weak volume guidance unchanged at 217,000-220,000. This marks 5 years of straight volume declines.

– 30+ day delinquencies on finance up again to almost a 9 year 2Q high to 3.3% of the book. Note HOG in Q1 delinquencies at 3.73%.

– 2Q annualized loss experience up to an 8 year high to 1.82%

Never mind the company embarked on a $42.9m share buybacks in Q2 and $95.5m for the year so far. Happy days.

The company’s presentation pack still smacks of denials with all the mystical customers that aren’t being converted into new customers.

GE still $15 billion in negative equity

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While GE might have rallied back above $10 on the back of its 1Q results released overnight, the company’s goodwill shrunk $5.5bn but the company remains deeply in negative equity to the tune of $14.7bn. Why do analysts perpetually focus on the revenue and profit, rather than look at the elephant in the room? Especially as we are at the top of an industrial cycle with warning signs that global growth is already slowing faster than originally anticipated. GE is heavily indebted.

Of the $53.2bn in goodwill and $ $17.1bn in intangible assets, GE shareholder’s equity (including non-controlling interests) is at $55.6bn. The gap is c. $14.7bn.

One of the interesting notes in the 10Q regarding the goodwill Oil & Gas accounts for 42% of the total. GE noted in point 8.

While the goodwill in our Grid reporting unit, Hydro reporting unit, and Oil & Gas reporting units is not currently impaired, the power and oil and gas markets continue to be challenging and there can be no assurances that goodwill will not be impaired in future periods as a result of sustained declines in BHGE share price or any future declines in macroeconomic or business conditions affecting these reporting units.

We can celebrate the short term but when an industrial stock, one which was the largest company by market capitalisation almost 20 years ago, has such an awful balance sheet (354% debt: equity) and blew $45bn in buybacks in recent years, one has to wonder how investors can look at GE as a paragon of value? Reminiscing on the halcyon days of a stock is not a method of sensible investing when staring at reality.

Harley has another Howler

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Harley-Davidson (HOG), perhaps the most iconic form of discretionary spending, came out with a howler set of Q4 numbers.  Revenue down 9% and operating losses in the last period. FY operating income fell 30% on revenues that finished 1% up. Domestic sales for the 2018 year fell 10% while international sales were flat. Worse was guidance pointed to unit sales falling between 217,000 & 222,000 units down from 228,000 in the fiscal year just past. This new range of unit targets would mean a decline for five consecutive years. If this pattern continues into 2020, luxury competitor BMW, which targets 200,000 units, will likely even up the tally, despite being less than half HOG was in FY2012.

Operating margin guidance for the motorcycle segment is forecast at 8-9% in 2019 down from 12% in 2017.

In June 2018, CM wrote, ““Harley-Davidson (HOG) is the classic case of a divine franchise. While still the world’s largest maker of cruiser motorcycles, it is being swamped by new competition. HOG’s EBIT performance has slid for the last 4 years and is even below the level of 2012…Sadly for HOG, 1Q 2018 has revealed even worse numbers. Global unit sales were 7.2% down on the previous year and 12% down at home.  Japan and Australia were soft. Looking at the strategy it looks like throwing spaghetti at a wall and hoping it sticks.

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Harley may have a grand master plan to incubate 2,000,000 new riders and launch 100 new bikes out to 2027, but all the while they remain stuck in a design studio, the competition, including the Japanese, keep stealing sales away from the Milwaukee icon.

The strategy looks completely unrealistic because growing 200,000 new bikers a year for a decade in the domestic market would mean that based on 2019 global unit sales projections,  92% of customers would need to be brand new, not repeat or existing. However the plan is to grow in the US where it had 138,000 sales in 2018 that would mean new customers would need to be 145% of all current sales in the US. No auto maker on the planet has ever had such pie in the sky assumptions for cultivating new customers, much less at that pace for 10 straight years. How can the board of HOG honestly think this is even remotely achievable? Sadly the company has been too eager conducting buybacks to flatter EPS. Net income for HOG was +1.8% for FY2018, diluted EPS was +5.6%. Time to stop playing games and properly delivering for shareholders.

Why discontinue?

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This is a chart of the change in the US Fed balance sheet, a series that has just been discontinued. Is this because the Fed is about to step up its activity and offering wider disclosure on tapering activity might spook markets? Given that 72% of the growth in S&P earnings has been driven by buybacks since 2012, it stands to reason the market is not exactly providing the type of confidence inducing organic lift the index reflects. Bank of America revealed that “net buying of Tech sector in the 1H was entirely buyback-driven.” 

Kind of reminds CM of the day Bernanke’s Fed announced it would no longer report M3 money supply a year before the financial markets headed into the GFC. CM estimated on p.4 of a report several years ago that M3 money supply by 2018 on constant long-term growth rates would turn into around $35 trillion from the $10 trillion at the time it was discontinued.

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Nothing to see here? Throw a deteriorating fixed income market with fewer buyers and corporates that have binged on cheap credit to fuel buybacks, it doesn’t look like the stuff dreams are made of. The chart below shows that quarterly pre-tax US profitability is struggling since 2011. Earnings (E) are not doing so well. It is by the grace of falling number of traded shares (S) that makes the EPS look flattering.

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We took the liberty of comparing corporate profitability since 1980 and correlating it to what Moody’s Baa rated corporate bond effective 10yr yields. An R-squared of almost 90% was returned.

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Why not use the Aaa spread instead? Well we could do that but looking over the last decade the average corporate debt rating profile looks like this. We have seen a massive deterioration in credit ratings. If we look at the corporate profitability with Baa interest rates over the past decade, correlation climbs even higher.

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We shouldn’t forget that the US Government is also drunk on debt, much of it arriving at a store near you. $1.5 trillion in US Treasuries needs refinancing this year and $8.4tn over the next 3.5 years. Couple that with a Japan & China pulling back on UST purchases and the Fed itself promising to taper (but now hide the results of) its balance sheet. So as an investor, would you prefer the relative safety of government debt or take a punt on paper next to junk heading into a tightening cycle?

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Discontinuation of series always carries a sense of deep cynicism for its true intention. It is not an onerous data set to cull. Sure we can fossick around and try to find it hidden in the archives of the Fed website but the idea is that they probably don’t want to publicise how much more they intend to flog.

GE’s Angolan Kwanza exposure

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Sell-side analysts rarely read through the fine print of an annual report. Hidden away in the prose, one can find some pretty eye-opening paragraphs. From GE’s 2017 Annual Report,

“As of December 31, 2017, we held the U.S. dollar equivalent of $0.6 billion of cash in Angolan kwanza. As there is no liquid derivatives market for this currency, we have used Angolan kwanza to purchase $0.4 billion equivalent bonds issued by the central bank in Angola (Banco Nacional de Angola) with various maturities through 2020 to mitigate the related currency devaluation exposure risk. The bonds are denominated in Angolan kwanza as U.S. dollar equivalents, so that, upon payment of periodic interest and principal upon maturity, payment is made in Angolan kwanza, equivalent to the respective U.S. dollars at the then-current exchange rate.”

On that basis the marked to market figure is actually another $250mn hole in 2017. One wonders what the exchange rate will be in 2020? Furthermore at what level will Travelex or Thomas Cook exchange that for? It would be safe to assume the ‘bid/offer’ spread will be horrendous. GE might find it more useful to run a Nigerian mail scam to hedge the expected losses. For a company as large as GE, potentially losing $850mn should look like a rounding error unless the company is bleeding as the monster is. GE took a pretax charge of $201mn on its Venezuela operations.

We shouldn’t forget that “GE provides implicit and explicit support to GE Capital through commitments, capital contributions and operating support. As previously discussed, GE debt assumed from GE Capital in connection with the merger of GE Capital into GE was $47.1 billion and GE guaranteed $44.0 billion of GE Capital debt at December 31, 2017. See Note 23 to the consolidated financial statements for additional information about the eliminations of intercompany transactions between GE and GE Capital.

As 13D Research noted, “GE spent roughly $45 billion on share buybacks over 2015 & 2016  despite the shares trading well above today’s levels all the while ignoring the $30 billion+ shortfall in its pensions. Management disclosed in a recent analyst meeting that it would have to borrow to fund a $6 billion contribution to its pension plans next year, as well as chopping capex by 26% in 2018.

As mentioned yesterday, there are some who have faith in the sustained turnaround in medical. Indeed it has seen some top line and margin improvement but management seems more concerned with focusing on cutting costs than pushing innovation. Efficiency drives should be part and parcel of all businesses but one must hope CEO John Flannery has far bigger hopes for its market share leading product line (which GE admits facing pricing pressure in some segments) than trimming the staff canteen cookie tin.

GE remains a risky investment. Flannery has it all to prove and to date his performances have been anything but inspiring. GE feels like a business suffering from the divine franchise syndrome synonymous with former CEO Jack Welch. That dog eat dog culture seems to be biting its own tail.