Harman: If You See This Stock Crockin', Don't Come a Knockin'

I took a small short position in Harman today at $37.77 following yesterday's Q4 earnings report. Although shares of the automotive entertainment equipment maker had already fallen 12% today, the risk reward remains dramatically skewed to the downside and the stock could easily fall into the $20's on a combination of falling analyst estimates and a lower earnings multiple.

First, let's take a very quick look at the macro backdrop. Consumer spending on big ticket items will continue to weaken in the near future, especially in the United States and Europe, which are major markets for luxury automobiles. In fact, BMW and Mercedez-Benz --key Harman customers-- are cutting back production. Plus, I expect home theater installations to stay weak for the foreseeable future due to the weak housing market - a clear negative for Harman's high-end oriented consumer electronics business.

And let's look at one line in Harman's earnings release that speaks volumes for near-term profitability:

"Foreign currency translation positively impacted both full year and quarterly results as the Euro averaged $1.47 in the full year 2008 compared to $1.31 prior year and $1.56 in the fourth quarter compared to $1.35 in the same period last year. As a result, foreign currency translation improved full year sales by approximately $275 million and fourth quarter sales by approximately $82 million. Accordingly, the positive impact on earnings per diluted share was $0.53 for the full year and $0.19 for the quarter."

Okay, so excluding foreign currency benefits, full-year non-GAAP earnings would have come in at $1.82 a share, a full 23% lower than the reported figure of $2.35 a share. Now let's take a look at what the Euro has done vs. the U.S. dollar so far this quarter:

















So even if management does execute on its cost-cutting measures, the weakening of the Euro will be a major headwind to sales and profitability. Combine that with the poor macro outlook, falling automotive production, and the fact that the stock is barely shorted -- and you have a nice recipe for underperformance, especially with the lack of a private equity put these days.