February 02, 2015 Harman International Industries Inc. (HAR-NYSE) Current Recommendation Earnings Update: Harman International Reports Q2 Results SUMMARY DATA NEUTRAL Prior Recommendation Outperform Date of Last Change 04/07/2014 Current Price (01/30/15) $129.63 Target Price $136.00 SUMMARY Harman reported impressive second-quarter 2015 results, beating the Zacks Consensus Estimate for both earnings and revenues. The results were driven by the strength in Infotainment segment. This apart, the company s strong manufacturing capacities, growing product pipeline, solid patent portfolio, new awards as well as product launches remain positives. Moreover, the company continues to expand backed by its partnerships with the likes of Apple and Google, which is a significant positive. However, intensifying competition remains a concern. Moreover, significant exposures to volatile auto industry and customer concentration risk are the other headwinds. We initiate coverage with a Neutral recommendation and set a price target of $136.00. 52-Week High $129.63 52-Week Low $85.36 One-Year Return (%) 26.35 Beta 1.72 Average Daily Volume (sh) 1,029,700 Shares Outstanding (mil) 69 Market Capitalization ($mil) $8,895 Short Interest Ratio (days) 2.31 Institutional Ownership (%) 98 Insider Ownership (%) 1 Annual Cash Dividend $1.32 Dividend Yield (%) 1.02 5-Yr. Historical Growth Rates Sales (%) 11.6 Earnings Per Share (%) 48.3 Dividend (%) 98.6 using TTM EPS 23.7 using 2015 Estimate 22.7 using 2016 Estimate 19.6 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Average, Type of Stock Large-Growth Industry Audio/Video Prd Zacks Industry Rank * 17 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Sep) (Dec) (Mar) (Jun) (Jun) 2013 998A 1,056 A 1,062 A 1,182 A 4,298 A 2014 1,172 A 1,328 A 1,404 A 1,444 A 5,348 A 2015 1,429 A 1,584 A 1,502 E 1,553 E 6,068 E 2016 1,539 E 1,637 E 6,792 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Sep) (Dec) (Mar) (Jun) (Jun) 2013 $0.79 A $0.59 A $0.79 A $0.91 A $3.08 A 2014 $0.95 A $1.09 A $1.12 A $1.25 A $4.41 A 2015 $1.31 A $1.79 A $1.22 E $1.39 E $5.71 E 2016 $1.50 E $1.70 E $6.61 E Projected EPS Growth - Next 5 Years % 17 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
RECENT NEWS Harman International Beats Q2 Earnings, Revenues Up Y/Y- Jan 29, 2015 Harman International Industries reported adjusted earnings of $1.79 per share in the second quarter of fiscal 2015, which beat the Zacks Consensus Estimate of $1.29. Earnings per share soared 64% from $1.09 in the year-ago quarter. Revenues Revenues of $1,584 million beat the Zacks Consensus Estimate of $1,495 million and grew 19% year over year. The year-over-year increase was primarily due to strong sales in the Infotainment segment. Infotainment net sales rose 12% from the year-ago quarter to $774 million, primarily due to expansion of the newly launched platforms, higher automotive production and increased take rates. Lifestyle net sales improved 26% on a year-over-year basis to $541 million due to robust sales in Harman s home and multimedia product lines and car audio business. Professional division net sales increased 29% from the year-ago quarter to $267 million, primarily driven by the acquisition of AMX LLC which added video switching and enterprise automation to the product portfolio. Margins In the reported quarter, adjusted gross margin expanded 155 basis points (bps) on a year-over-year basis due to higher sales volume on fixed production costs along with favorable product mix. Selling, general and administrative (SG&A) expense, as a percentage of revenues, declined 59 bps on a year-over-year basis to 20% on the back of improved operating leverage due to higher sales. Infotainment operating margin expanded 140 bps, partly offset by 20 bps and 250 bps contractions, respectively, in Lifestyle and Professional operating margin. Balance Sheet & Cash Flow As of Dec 31, 2014, cash and cash equivalents were $510.3 million compared with $581.3 million as of Jun 30, 2014. Long-term debt was $198.8 million at quarter-end compared with $219.4 million as on Jun 30, 2014. Guidance For fiscal 2015, the company expects revenues of $6 billion, EBITDA of $715 million and earnings per share of $5.25. Equity Research HAR Page 2
VALUATION Harman shares are currently trading at 23.7X TTM earnings. The shares are trading at 22.7X our forward earnings estimates for 2015, a 20% discount to the peer group average of 28.3X. Harman s price-to-book value ratio in the last quarter was 3.9x, compared to 4.1x for the industry and 5.1x for the S&P 500. Over the last five years, the company s shares have traded in a range of 1.4x to 4.4x of its book value. Therefore, it is currently trading close to the high end of its historical range, which reflects limited upside. Moreover, Harman s earnings per share are expected to grow at 17% over the next 5 years, much lower than peer-group average of 21%. However, we note that Harman s new manufacturing capacities, growing product pipeline, solid patent portfolio, new awards as well as product launches are major positives. Given the mixed signals, we reaffirm our Neutral recommendation and set a target price of $136.00 (23.8X 2015 ). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Harman International Industries (HAR) 22.7 19.6 17.2 19.3 23.7 222.8 11.8 Industry Average 28.3 24.0 21.3 11.8 44.7 207.4 10.5 S&P 500 16.1 15.1 10.7 16.1 18.6 19.4 12.0 Sharp Corp (SHCAY) 32.2 2.4 13.8 600.0 11.9 Toshiba Corp (TOSYY) 6.7 27.6 28.6 27.2 Dolby Laboratories (DLB) 25.0 22.9 7.5 14.1 18.8 31.8 10.4 Skullcandy Inc (SKUL) 27.8 23.5 15.0 33.2 73.1 131.1 6.2 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Harman International Industries (HAR) 3.9 4.4 1.4 18.8 0.2 1.0 19.1 Industry Average 4.1 4.1 4.1-8.2 0.6 0.3 39.8 S&P 500 5.1 9.8 3.2 24.8 2.0 Equity Research HAR Page 3
Earnings Surprise and Estimate Revision History NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET Equity Research HAR Page 4
OVERVIEW Incorporated in 1980, CT-based Harman International Industries Inc. (HAR) is engaged in the development, manufacturing and marketing of audio products, lighting solutions, electronic systems & digitally integrated audio and infotainment systems. The company offers a broad range of products under popular brand names including Aha, Harmon/Kardon and JBL. Harman reported sales of $5.35 billion in fiscal 2014. The core reporting segments are - Infotainment, Lifestyle and Professional. The Infotainment segment (53% of sales) designs, manufactures and markets infotainment systems, which are a combination of information and entertainment components like GPS navigation, bluetooth, wireless Internet access, hard disk recording and MP3 playback. The infotainment segment primarily serves global auto makers like BMW and General Motors. The Lifestyle segment (31%) designs, manufactures and markets automotive audio systems as well as mid to high-end loudspeaker and electronics for home, multimedia and mobile applications. It primarily caters to auto makers like Hyundai, BMW and General Motors. Harman s branded home audio products are compatible with Apple devices as well as other MP3 players. The company also provides transducers and built-in speakers for leading notebook computers such as Dell, Toshiba and Acer. The Professional segment (16%) designs, manufactures and markets an extensive range of information delivery systems that are used by audio professionals in concert halls, stadiums, airports and public spaces. Harman s largest two markets are the United States (30.4% of sales) and Germany (32.2% of sales). In fiscal 2014, approximately 31% of sales was generated in Europe, while 43% was denominated in Euros. Auto-makers BMW, Fiat Chrysler Automobiles, Audi/Volkswagen and Toyota/Lexus accounted for 16%, 13%, 12% and 8%, respectively, of fiscal 2014 sales. Harman faces competition from the likes of Bosch, Panasonic, Bose, Sony, Yamaha, Altec Lansing, and Phillips in most of its operational fields. REASONS TO BUY Harman is expected to benefit from the growing automotive production globally. Strong demand for the company s infotainment and car audio systems is a major positive, in our view. The company s total automotive business backlog stood at $20.5 billion at the end of fiscal 2014. Infotainment backlog of $16.2 billion at 2014-end was at an all-time high for the company. Growing demand for connected cars is ably supported by Harman s leading cloud platform and scalable technology. This, along with the company s powerful brand portfolio, is a major growth driver, in our view. We believe that growing backlog improves sales visibility, which will continue to boost investors confidence over the long term. Harman is known for its diversified product portfolio. The company s strong patent portfolio (approximately 5650) helps it to launch products on a frequent basis across all its segments. In fiscal 2014, the company launched its scalable infotainment system, for the connected car environment. It also introduced Clari-Fi that automatically analyzes and restores the audio quality of all types of Equity Research HAR Page 5
compressed and streaming music sources. We believe that Harman s innovative and diversified product portfolio will continue to drive top line and profitability over the long term. Harman continues to win new customers due to its impressive brand portfolio and global expansion of distribution channels. The company has opened several stores in New York, Moscow and Tokyo to complement the existing ones in Beijing, Seoul and Shanghai. The company won new awards from Japanese auto-makers Subaru, Yamaha and Suzuki. Once inaccessible, Harman s growing penetration in Japan is a major positive. The company also won new contracts from Bentley, Maserati, Scania/MAN (commercial truck), Alfa Romeo, Hyundai, Kia, Toyota, Ford and Daimler Benz. We believe that new customer and contract win will continue to be the key growth catalysts for Harman over the long run. Harman has expanded its business primarily through accretive acquisitions. Over the last three fiscal years (2012, 2013 and 2014), it has acquired six companies for more than $550 million. The recent acquisition of AMX enables Harman to provide complete audio, video, lighting and automation solutions to its enterprise customers around the world. It also helps in establishing Harman as a leading supplier of turnkey AV solutions. With the addition of Yurbuds to its portfolio, the company will be able to develop next generation headphones designed especially for athletes. We believe that Harman will continue pursuing acquisitions that strategically fit its overall business mix over the long term. Harman has ample liquidity to pursue growth opportunities, going forward. As of Jun 30, 2014, cash and cash equivalents were $581.3 million. The company had $445 million available under its revolving credit facility. Moreover, Harman was able to generate cash flow of $592.1 million in fiscal 2014. We believe that this improving liquidity will help the company to increase operational flexibility, allow higher capital expenditure, better fund its growth plans (including acquisitions) and undertake shareholder friendly initiatives over the long term. REASONS TO SELL Harman generates approximately 69% of net sales from the auto makers. This is a significant concern as volatility in the automotive industry, primarily due to economic downturn, has a direct impact on the company s results. Moreover, financial difficulties and bankruptcies negatively impact order volumes, hurting Harman s top-line growth and the overall financial condition. Harman is exposed to significant customer concentration risk with its top four customers accounting for approximately half of its revenues. This is a concern as the loss of any one of these customers to a competitor would hurt revenues significantly. These automakers do not have any long-term contract with the company. Hence, any termination of contract will adversely affect its long-term growth prospects. As part of its growth strategy, Harman has made numerous acquisitions and is likely to continue doing the same. Integration risks are a constant concern, since the competitive nature of the market necessitates acquisitions to maintain growth. Harman faces tough competition in each of its product lines. In order to maintain its dominant market share, the company continues to spend a significant amount on research & development (R&D). In fiscal 2014, R&D expense increased 20.5% year over year to $343.8 million. This was a significant jump compared with a 14% year-over-year decline in fiscal 2013. Although Harman is utilizing R&D more efficiently, we believe that increasing competition will eventually put pricing under pressure. This may hurt margin expansion over the long term. Equity Research HAR Page 6
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of HAR. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1117 companies covered: Outperform - 15.8%, Neutral - 77.2%, Underperform 6.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research HAR Page 7