Valuentum Exclusive Analysis for the Discerning Investor

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Earnings season is picking up. Let’s evaluate a few quarterly reports from some bellwethers.

By Brian Nelson, CFA

Harley-Davidson (HOG) Not Revving Like It Used To

We plan to update our report and fair value estimate of Harley-Davidson following its weak second-quarter report, released July 18. Both revenue and net income faced pressure on a year-over-year basis in the period, with earnings per share falling 4.5%. Management spoke of “challenging market conditions,” and the executive team is right about that: Harley-Davidson worldwide retail motorcycle sales fell 6.7% in the quarter, while Harley-Davidson retail motorcycle sales in the US were down more than 9%. The company’s US market share is holding up (~48.5%), but we are starting to worry about more structural (secular) dynamics that could impact its business over the long haul. Millennials just don’t appear to be getting into the biker lifestyle at the same pace as their parents and grandparents did (see here and here), and that means lower long-term growth for Harley-Davidson. The company’s long-term strategy is focused “on building the next generation of Harley-Davidson riders,” but it’s not going to be easy. We expect a materially downward revision to our fair value estimate of Harley-Davidson in light of recent subpar fundamental performance and expectations for it to continue.

Visit Harley-Davidson’s stock page: https://www.valuentum.com/search2?q=hog&searchtype=symbol&btn=Search

Johnson & Johnson (JNJ) Raises Guidance

J&J reported second-quarter results July 18 that spoke to collective fundamental momentum across its underlying businesses. Operational sales advanced 2.9%, adjusting for negative currency impacts, thanks to strength in non-US sales, while second-quarter earnings per share, adjusted for intangible amortization expense and special items, increased 5.2%, to $1.83. We were most pleased with news regarding J&J’s pipeline, “the submission and approval of several key line extensions,” as well as with comments about its recent Actelion deal. We’re not parting with this newsletter portfolio holding, especially as it raised its sales guidance for the full year to $75.8-$76.1 billion (was $75.4-$76.1 billion) and its full-year adjusted earnings guidance to $7.12-$7.22 (was $7.00-$7.15). For more on our take on J&J, read: “Johnson & Johnson’s Oncology Division A Force to Be Reckoned With.”

Visit J&J’s stock page: https://www.valuentum.com/search2?searchtext=jnj&searchtype=symbol

Netflix (NFLX): Its Market Price Makes Little Sense

There is no reason, in our view, why Netflix’s stock should be trading at ~170 times current-year consensus earnings, now with a market capitalization approaching $80 billion. Through the first six months of 2017, Netflix has generated income before income taxes of $237.8 million, implying shares are trading at 160+ times annualized operating earnings, while free cash flow generation, by Netflix’s calculation, has been -$1 billion (negative $1 billion) during the first half of the year. Net debt stands at $2.67 billion, and management only expects to take on more debt to fund content costs. Negative free cash flow generation and net debt don’t imply significant intrinsic net worth, and ultra-low discount rates may be affording Netflix considerable market capitalization today than otherwise might be reasonable under “normalized” times.

When it comes to Netflix, we think the market is simply focusing on the “wrong” metrics, and we continue to believe that operating earnings and free cash flow are better measures of the value of a business’ operating assets than more-granular metrics such as growth in ‘memberships,’ which could lead to “bubble” creation. Have we already forgotten, for example, how the dot-com bubble was formed, when analysts were more focused on valuing a dot-com on ‘page views’ rather than on underlying fundamentals, namely free cash flow? Netflix’s self-defined free cash flow is expected to be -$2.0 to -$2.5 billion (negative $2 billion to negative $2.5 billion) during 2017, and the company expects to be “FCF negative for many years.” In equity valuation, the time value of money matters, and the negative measures for the foreseeable future add up.

For more on our take on Netflix, read: “Netflix: Is NOW Finally the Time?”

Visit Netflix’s stock page: https://www.valuentum.com/search2?q=nflx&searchtype=symbol&btn=Search