Company Description:
Harley-Davidson, Inc., incorporated in 1981, operates in two segments: the Motorcycles & Related Products segment and the Financial Services segment. The Motorcycles & Related Products segment includes the group of companies doing business as Harley-Davidson Motor Company and the group of companies doing business as Buell Motorcycle Company. The Motorcycles segment designs, manufactures and sells at wholesale primarily heavyweight (engine displacement of 651+cubic centimeters) touring, custom and performance motorcycles, as well as a line of motorcycle parts, accessories, clothing and collectibles. The Financial Services segment includes the group of companies doing business as Harley-Davidson Financial Services (HDFS). HDFS provides wholesale and retail financing and insurance programs primarily to Harley-Davidson and Buell dealers and their retail customers. HDFS conducts business in the United States, Canada and Europe.
Click here for a full description of the company’s operations (provided by Reuters).
Annual Report Highlights (latest report is for the period ending 12/30/06):
Business Overview
Harley-Davidson, Inc. was incorporated in 1981, at which time it purchased the Harley-Davidson motorcycle business from AMF Incorporated in a management buyout. In 1986, Harley-Davidson, Inc. became publicly held. The Company operates in two segments: the Motorcycles & Related Products segment and the Financial Services segment.
The Motorcycles & Related Products segment includes the group of companies doing business as Harley-Davidson Motor Company and the group of companies doing business as Buell Motorcycle Company. The Motorcycles segment designs, manufactures and sells at wholesale primarily heavyweight (engine displacement of 651+cc) touring, custom and performance motorcycles as well as a complete line of motorcycle parts, accessories, clothing and collectibles. The Company, which is the only major American motorcycle manufacturer, has had the largest share of the United States heavyweight (651+cc) motorcycle market since 1986. During 2006, the Company’s market share, based on retail registrations of new Harley-Davidson motorcycles, was 49.3% in the United States (data provided by the Motorcycle Industry Council).
The Financial Services segment includes the group of companies doing business as Harley-Davidson Financial Services (HDFS). HDFS provides wholesale and retail financing and insurance programs primarily to Harley-Davidson and Buell dealers and their retail customers. HDFS conducts business in the United States, Canada and Europe.
Motorcycles and Related Products
Motorcycles
The primary business of the Motorcycles segment is to design and manufacture premium motorcycles for the heavyweight market and sell them at wholesale. The Company is best known for its Harley-Davidson motorcycle products, but also offers a line of motorcycles and related products under the Buell brand name. The Company’s worldwide motorcycle sales generated approximately 80% of the total net revenue in the Motorcycles segment during each of the years 2006, 2005 and 2004, respectively.
The Motor Company’s Harley-Davidson branded motorcycle products emphasize traditional styling, design simplicity, durability and quality. The Motor Company manufactures five families of motorcycles: Touring, Dyna™, Softail, Sportster, and VRSC™. The first four of these motorcycle families are powered by an air-cooled, twin-cylinder engine with a 45-degree “V” configuration. The VRSC family is powered by a liquid-cooled, twin-cylinder engine with a 60-degree “V” configuration. The Motor Company’s Harley-Davidson engines range in size from 883cc’s to 1800cc’s.
The Motor Company’s 2007 model year line up includes 35 models of Harley-Davidson heavyweight motorcycles, with domestic manufacturer’s suggested retail prices ranging from $6,595 to $20,195. The Motor Company also offers limited-edition, factory-custom motorcycles through its Custom Vehicle Operation (CVO) program. Motorcycles sold through the CVO program are available in limited quantities and offer unique features, paint schemes and accessories. The Motor Company currently has four motorcycle model offerings available through the CVO program with domestic manufacturer’s suggested retail prices ranging from $24,995 to $33,495.
The average U.S. retail purchaser of a new Harley-Davidson motorcycle is a married male in his mid-forties (two-thirds of these purchasers are between the ages of 35 and 54) with a median household income of approximately $81,700. These customers generally purchase a motorcycle for recreational purposes rather than to provide transportation. Nearly two-thirds of the U.S. retail sales of new Harley-Davidson motorcycles are to buyers with at least one year of education beyond high school and 30% of the buyers have college degrees. Approximately 12% of U.S. retail motorcycle sales of new Harley-Davidson motorcycles are to female buyers. (Source: 2006 Company studies)
The Company’s Buell motorcycle products emphasize innovative design, responsive handling and overall performance. Buell currently manufactures and sells ten models, including nine heavyweight models in its XB family, and the Blast. The Buell XB motorcycles focus on superior handling and are powered by either a 984cc (XB9) or a 1203cc (XB12) air-cooled, twin-cylinder engine with a 45-degree “V” configuration. The Buell XB motorcycle models have domestic manufacturer’s suggested retail prices ranging from $8,895 to $11,495. During 2006, Buell produced a limited production “race-only” motorcycle (XBRR) powered by a 1339cc air-cooled, 45-degree twin cylinder boasting a peak output rating of over 150 horsepower. The XBRR domestic manufacturer’s suggested retail price is $30,995. The Buell Blast is smaller and less expensive than the Buell XB models and is powered by a 492cc single-cylinder engine. The Blast, which competes in the standard market segment, has a domestic manufacturer’s suggested retail price of $4,695.
Buell attracts customers in the demographic age range of 25 to 55. The average U.S. retail purchaser of a new Buell XB motorcycle is a male at the age of 42 with a household income of approximately $94,800. Approximately 3% of all new Buell XB U.S. retail motorcycle sales are to females. The average U.S. retail purchaser of a new Buell Blast is at the age of 41, with nearly one-half of them being female. Half of new Buell Blast purchasers have never owned a motorcycle before and 95% of them had never owned a Buell motorcycle before. (Source: 2006 Company studies)
The total motorcycle market, including the heavyweight portion of the market, is comprised of the following four segments:
- standard (emphasizes simplicity and cost)
- performance (emphasizes handling and acceleration)
- custom (emphasizes styling and individual owner customization)
- touring (emphasizes comfort and amenities for long-distance travel)
The touring segment of the heavyweight market was pioneered by the Company and includes the Harley-Davidson Touring family of motorcycles which are equipped with fairings, windshields, saddlebags and Tour Pak luggage carriers. The custom segment of the market includes motorcycles featuring the distinctive styling associated with classic Harley-Davidson motorcycles and includes the Company’s Dyna, Softail, VRSC and Sportster families of motorcycles. The standard and performance segments of the market are served primarily by the Company’s Buell motorcycle line.
In the United States, suggested retail prices for the Company’s Harley-Davidson motorcycles range from being comparable to 50% higher than suggested retail prices for comparable motorcycles available in the market. Although there are some differences in accessories between the Company’s top-of-the line touring motorcycles and those of its competitors, suggested retail prices for these motorcycles are generally comparable. The Company’s larger-displacement custom motorcycles (Dyna, Softail and VRSC) represent its highest unit volumes. The Company believes its larger-displacement custom products continue to command a premium price because of the features, styling and higher resale value associated with Harley-Davidson custom products. The Company’s smallest displacement custom motorcycle (the 883cc Sportster) is price competitive with comparable motorcycles available in the market.
The Company’s 2006 surveys of retail purchasers in the United States indicate that three-quarters of the retail purchasers of its Sportster models either have previously owned competitive-brand motorcycles or are completely new to the sport of motorcycling. The Company expects to see sales of its Sportster models lead to future sales of its higher-priced models.
Since 1988, the Company’s research has consistently shown that retail purchasers of new Harley-Davidson motorcycles in the United States have a repurchase intent at or in excess of 90%. Research completed by the Company in 2006 shows that approximately 52% of all retail purchasers of new Harley-Davidson motorcycles in the United States had previously owned a Harley-Davidson motorcycle.
Marketing
The Company’s products are marketed to retail customers primarily through dealer promotions, customer events and advertising through national television, print, radio and direct mailings, as well as internet advertising. Many of the Company’s marketing efforts are accomplished through a cooperative program with its independent dealers. The Company also sponsors racing activities and special promotional events and participates in many major motorcycle consumer shows and rallies.
On an ongoing basis, the Company promotes its products and the related lifestyle through the Harley Owners Group, or H.O.G. H.O.G. has over one million members worldwide and is the industry’s largest company-sponsored motorcycle enthusiast organization. The Company formed the Harley Owners Group in 1983 in an effort to encourage Harley-Davidson owners to become more actively involved in the sport of motorcycling. This group also sponsors many motorcycle events, including worldwide rallies and rides for Harley-Davidson motorcycle enthusiasts.
International Sales
The Company’s revenue from the sale of motorcycles and related products to independent dealers and distributors located outside of the United States was approximately $1.18 billion, $1.04 billion and $917.3 million, or approximately 20%, 19% and 18% of net revenue of the Motorcycles segment, during 2006, 2005 and 2004, respectively.
Seasonality
Over the last several years the Company has been working to increase the availability of its motorcycles at dealers to improve the customer experience. The Company believes that increased availability results in independent dealers providing wider selections of motorcycles at manufacturer’s suggested retail prices which in turn has a positive impact on the customer experience and better positions the Company to attract retail buyers that are new to the brand or new to the sport of motorcycling. As a result of improving the availability of its motorcycles to customers, the timing of retail purchases is now tracking more closely with the riding season, requiring the Company and its independent dealers to balance the economies of level production with a more seasonal retail sales pattern.
In general, the Motor Company has not experienced similar seasonal fluctuations in its wholesale sales. The Company’s independent dealers typically build their inventory levels in the late fall and winter in anticipation of the spring and summer selling seasons. The availability of floor plan financing helps allow dealers to manage these seasonal increases in inventory. The Company also offers financing assistance to its dealers in the United States as a way to manage seasonal increases in inventory.
Competition
The heavyweight (651+cc) motorcycle market is highly competitive. The Company’s major competitors are based outside the U.S. and generally have financial and marketing resources that are substantially greater than those of the Company. They also have larger worldwide revenue and are more diversified than the Company and compete in all four segments of the market. In addition to these larger, established competitors, the Company has competitors headquartered in the United States. These competitors generally offer heavyweight motorcycles with traditional styling that compete directly with many of the Company’s products. These competitors currently have production and sales volumes that are lower than the Company’s and have considerably lower domestic market share than the Company.
Competition in the heavyweight motorcycle market is based upon a number of factors, including price, quality, reliability, styling, product features, customer preference and warranties. The Company emphasizes quality, reliability and styling in its products and offers a two-year warranty for its motorcycles. The Company regards its support of the motorcycling lifestyle in the form of events, rides, rallies and H.O.G. and its financing through HDFS as competitive advantages. In general, the Company believes that resale values for used Harley-Davidson motorcycles, measured by reflecting the used motorcycle price as a percentage of the manufacturer’s suggested retail price when new, are higher than resale values for used motorcycles of its competitors.
Domestically, the Company competes most heavily in the touring and custom segments of the heavyweight motorcycle market. According to the Motorcycle Industry Council, these segments accounted for 79%, 80% and 79% of total heavyweight retail unit registrations in the United States during 2006, 2005 and 2004, respectively. The larger-displacement custom and touring motorcycles are generally the most expensive vehicles in the market and the most profitable for the Company. During 2006, the heavyweight portion of the market represented approximately 53% of the total U.S. motorcycle market (on- and off-highway motorcycles and scooters) in terms of new units registered.
For the last 19 years, the Company has led the industry in the United States for retail unit registrations of new heavyweight motorcycles. The Company’s (Harley-Davidson motorcycles only) share of the heavyweight market was 49.3% and 48.9% in 2006 and 2005, respectively. This share is significantly greater than that of the Company’s largest competitor in the domestic market which had a 15.1% market share in 2006.
Research and Development
The Company believes research and development are significant factors in its ability to lead the custom and touring motorcycling market and to develop products for the performance segment.
The Company’s Product Development Center (PDC) brings employees from styling, purchasing and manufacturing together with regulatory professionals and supplier representatives to create a concurrent product and process development team. The Company incurred research and development expenses of $177.7 million, $178.5 million and $170.7 million during 2006, 2005 and 2004, respectively.
Employees
As of December 31, 2006, the Motorcycles segment had approximately 9,000 employees. Unionized employees at the motorcycle manufacturing facilities in Wauwatosa and Menomonee Falls, Wisconsin and Kansas City, Missouri are represented by the United Steelworkers of America (USW), as well as the International Association of Machinist and Aerospace Workers (IAM). Unionized employees at the distribution and manufacturing facilities in Franklin and Tomahawk, Wisconsin are represented by the USW. Production workers at the motorcycle manufacturing facility in York, Pennsylvania are represented by the IAM. The collective bargaining agreement with the Pennsylvania-IAM will expire on February 2, 2010, the collective bargaining agreement with the Kansas City-USW and IAM will expire on August 1, 2007, and the collective bargaining agreement with the Wisconsin-USW and IAM will expire on March 31, 2008.
Financial Services
HDFS is engaged in the business of financing and servicing wholesale inventory receivables and consumer retail loans (primarily for the purchase of motorcycles). Additionally, HDFS is an agent for certain unaffiliated insurance carriers providing property/casualty insurance and also sells extended service contracts, gap coverage and debt protection products to motorcycle owners. HDFS conducts business in the United States, Canada and Europe.
Harley-Davidson and Buell
Operating under the trade name Harley-Davidson Credit, HDFS provides wholesale financial services to Harley-Davidson and Buell dealers and retail financing to consumers. Operating under the trade name Harley-Davidson Insurance, HDFS is an agent for the sale of motorcycle insurance policies and also sells extended service warranty agreements, gap contracts and debt protection products.
Wholesale financial services include floorplan and open account financing of motorcycles and motorcycle parts and accessories. HDFS offers wholesale financial services to Harley-Davidson dealers in the U.S., Canada and Europe and during 2006, approximately 97% of such dealers utilized those services. Prior to August 2002, HDFS offered wholesale financing to some of the Company’s European motorcycle dealers through a joint venture with Transamerica Distribution Finance. In August 2002, HDFS terminated this joint venture relationship and began directly serving the wholesale financing needs of some European dealers. The wholesale finance operations of HDFS are located in Plano, Texas and Oxford, England.
Competition
The Company regards its ability to offer a package of wholesale and retail financial services as a significant competitive advantage for HDFS. Competitors compete for business based largely on price and, to a lesser extent, service. HDFS competes based on convenience, service, brand association, dealer relations, industry experience, terms and price.
During 2006, HDFS financed 48% of the new Harley-Davidson motorcycles retailed by independent dealers in the United States, as compared to 45% in 2005. Competitors for retail motorcycle finance business are primarily banks, credit unions and other financial institutions. In the motorcycle insurance business, competition primarily comes from national insurance companies and from insurance agencies serving local or regional markets. For insurance-related products such as extended service contracts, HDFS faces competition from certain regional and national industry participants as well as dealer in-house programs.
Seasonality
In the northern United States and Canada, motorcycles are primarily used during warmer months. Accordingly, HDFS experiences seasonal variations. From mid-March through August, retail financing volume increases and wholesale financing volume decreases as dealer inventories decline. From September through mid-March, there is a decrease in retail financing volume while dealer inventories build and turn over more slowly, substantially increasing wholesale finance receivables.
Employees
As of December 31, 2006, the Financial Services segment had approximately 704 employees. No employees of HDFS are represented by labor unions.
Risk Factors
- The Company has a number of competitors of varying sizes that are based both inside and outside the United States some of which have greater financial resources than the Company.
- The Company’s marketing strategy of associating its motorcycle products with a motorcycling lifestyle may not be successful with future customers.
- Company’s success depends upon the continued strength of the Harley-Davidson brand.
- The Company’s prospects for future growth are largely dependent upon its ability to develop and successfully introduce new, innovative and compliant products.
- The Company’s Motorcycles segment is dependent upon unionized labor.
- The Company’s operations are dependent upon attracting and retaining skilled employees.
- The Company incurs substantial costs with respect to pension benefits and providing healthcare for its employees.
- The Company manufactures products that create exposure to product liability claims and litigation.
- The Company sells its products at wholesale and must rely on a network of independent dealers and distributors to manage the retail distribution of its products.
- The Company and its independent dealers must balance the economies of level production with a more seasonal retail sales pattern.
- The Company relies on third party suppliers to obtain raw materials and provide component parts for use in the manufacture of its motorcycles.
- The Company must maintain its reputation of being a good corporate citizen and treating customers, employees, suppliers and other stakeholders fairly.
- The Company must invest in and successfully implement new information systems and technology.
- The Company is the defendant in several class action and similar lawsuits.
- There is a Securities and Exchange Commission inquiry relating to the Company.
- The Company must comply with governmental laws and regulations that are subject to change and involve significant costs.
- Breaches of security involving consumers’ personal data could adversely affect the Company’s reputation, revenue and earnings.
- The Company’s financial services operations are highly dependent on accessing capital markets to fund its operations at attractive interest rates.
- The Company’s financial services operations are exposed to credit risk on its retail and wholesale receivables, receivables held for sale, and its investment in retained securitization interests.
- The Company is exposed to market risk from changes in foreign exchange rates and interest rates.
Properties The Company has eight facilities that perform manufacturing operations: Wauwatosa and Menomonee Falls, Wisconsin (motorcycle powertrain production); Tomahawk, Wisconsin (fiberglass/plastic parts production and painting); York, Pennsylvania (motorcycle parts fabrication, painting and Softail and touring model assembly); Kansas City, Missouri (motorcycle parts fabrication, painting and Dyna Glide, Sportster and VRSC assembly); East Troy, Wisconsin (Buell motorcycle assembly); Manaus, Brazil (assembly of select models for Brazilian market); and Adelaide, Australia (motorcycle wheel production).
The Financial Services segment has four office facilities: Chicago, Illinois (corporate headquarters); Plano, Texas (wholesale, insurance and retail operations); Carson City, Nevada (retail and insurance operations); and Oxford, England (European wholesale operations). Corporate headquarters will be moving into a new office in February 2007.
Management’s Discussion and Analysis of Financial Position and Results of Operations
Overview
The Company’s net revenue for 2006 was $5.80 billion, up 8.6% over 2005 driven by a 6.1% increase in shipments of Harley-Davidson motorcycles over 2005. Net income and diluted earnings per share for 2006 were up 8.7% and 15.2%, respectively, over 2005. The increase in diluted earnings per share includes the benefit of fewer weighted-average shares outstanding when compared to the prior year. Weighted-average shares outstanding were lower in 2006 than in 2005 as a result of the Company’s repurchases of common stock occurring over the last two years.
The Company’s independent dealer network also reported growth over prior year with increases in retail motorcycle unit sales during 2006. Worldwide dealer retail sales of Harley-Davidson motorcycles were up 8.5% in 2006 over 2005. In the United States, retail sales of Harley-Davidson motorcycles grew 5.9% during 2006 when compared to the prior year. Internationally, retail sales were up 18.6% over 2005 with increases of 14.6% in Europe, 16.3% in Japan and 15.9% in Canada.
Retail sales growth during 2006 was due in part to a positive worldwide response to the Company’s new 2007 models. In July 2006, independent dealers began offering the Company’s new 2007 model year motorcycles. The Company’s 2007 model offering includes the new larger Twin Cam 96 engine and a new six-speed transmission for all Touring and Softail motorcycles, the addition of electronic fuel injection on all Sportster models and a number of new models and features.
Outlook
The Company’s collective bargaining agreement with the Pennsylvania-IAM (Union) covering approximately 2,800 workers at its assembly plant in York, Pennsylvania expired on February 2, 2007. Prior to the expiration of that contract the union voted to reject a proposed new collective bargaining agreement for employees and authorized a strike which began immediately following the expiration of the contract. On February 22, 2007, the Company reached a new agreement with the Union, ending the strike. The new contract with the York Union employees is a three-year agreement expiring in February 2010.
The Company is pleased with the agreement it has reached with its York Union employees. However, the disruption caused by the strike had a significant impact on the Company’s business. As a result of the strike, the Company lost approximately four weeks of production at its York, Pennsylvania assembly facility and interrupted production at some of the Company’s other manufacturing locations. The strike also adversely impacted its suppliers and employees and may adversely impact its independent dealers and retail customers.
As a result of the strike and its related impact, the Company will not meet previously announced guidance for 2007. First quarter 2007 shipments of Harley-Davidson motorcycles had been expected to be between 82,000 and 84,000 units. The Company has lowered its target range by 18,000 units, and now expects first quarter shipments of Harley-Davidson motorcycles to be between 64,000 and 66,000 units. Over the remainder of 2007, the Company expects to make up approximately 4,000 to 5,000 of these motorcycle shipments, resulting in full year shipment plans for approximately 14,000 fewer motorcycles than originally planned. The Company arrived at this decision after carefully evaluating its production constraints, supply chain issues, cost implications, timing of shipments to dealers and the delayed start of 2008 model year production caused by the strike.
The Company’s revised plan for 2007 does not affect its previously stated plan to continue to grow revenue, although revenue growth in 2007 as a result of the strike is expected to be moderate. The Company continues to believe that shipments in its international markets will grow at a faster rate than in the U.S. market. The Company’s growth will be driven by a focus on providing customers around the world with a continuous stream of exciting new motorcycles, surrounded by the unique Harley-Davidson experience. Harley-Davidson customers enjoy a unique lifestyle experience through organized rides and rallies, through membership in the Harley Owners Group (H.O.G.) organization, and through the use of MotorClothes merchandise and Harley-Davidson Genuine Motor Accessories to personalize their experience.
In 2007, the Company will experience inefficiencies and costs associated with the strike and the related make-up plan which will have a negative impact on margins. Therefore, for 2007 the Company has revised its previous guidance of increasing margins and believes 2007 margins will be lower than margins experienced in 2006. The Company believes its manufacturing expertise and focus on operational excellence, and other factors, position it to continue to drive a net income growth rate in 2008 and 2009 that will be in excess of its revenue growth rate.
Operational excellence involves employees and suppliers continuously pursuing process improvements and innovation. Over the last several years, the Company has made considerable strides in manufacturing efficiency and automation and believes there continue to be opportunities for improvement in these areas and across other parts of the organization. The Company also expects that other factors such as increased production, quality, product mix and pricing for features will continue to have a positive impact on margins.
Prior to the strike, the Company had expected to deliver earnings-per-share growth of 11% to 17% annually through 2009 driven by solid revenue growth, margin improvement and the benefits of strong free cash flow. However, as a result of the strike and its related impact to the business in 2007, the Company has revised its expected earnings-per-share growth rate for 2007 to be in the range of 4% to 6%. The Company expects its earnings-per-share growth rate to return to 11% to 17% in 2008 and 2009.
Results of Operations 2006 Compared to 2005
Motorcycle Unit Shipments and Net Revenue
During 2006, the Company shipped 349,196 Harley-Davidson motorcycles, an increase of 20,179 or 6.1%, over 2005 shipments. International shipments grew faster than U.S. shipments with an increase of 21.6% in 2006, compared to a 2006 U.S. shipment increase of 2.5%. As a result, international shipments represented 21.8% of total Harley-Davidson wholesale shipments in 2006, compared to 19.0% in 2005. The increase in international shipments as a percentage of total shipments is consistent with the Company’s expectation that international growth will outpace domestic shipment growth.
During 2006, net revenue for the Motorcycles segment grew 8.6% or $458.5 million over 2005. Approximately $350 million of the increase in net revenue from 2005 to 2006 resulted from the higher shipment volumes of motorcycles and related products. Net revenue also benefited during 2006 from a favorable change in product mix and wholesale price increases. The changes to product mix occurring in 2006 resulted in approximately $70 million of higher revenue and related primarily to an increase in the percentage of shipments consisting of higher-priced touring motorcycles. Touring motorcycles made up 35.4% of shipments in 2006 compared to 33.5% in 2005. During 2006, wholesale price increases on Harley-Davidson motorcycles resulted in approximately $45 million of higher revenue when compared to 2005. Changes in foreign currency exchange rates resulted in approximately $10 million of lower net revenue during 2006 when compared to 2005.
Gross Profit
Gross profit was $2.23 billion for the Motorcycles segment during 2006, an increase of $192.3 million or 9.4% over gross profit in 2005. Gross profit margin for 2006 was 38.5% compared to 38.3% during 2005. During 2006, the increase in gross margin was due primarily to wholesale price increases on Harley-Davidson motorcycles, favorable Harley-Davidson motorcycle product mix and favorable changes in foreign currency exchange rates.
Financial Services
During 2006, HDFS sold $2.33 billion in retail motorcycle loans through securitization transactions resulting in gains of $32.3 million. This compares with gains of $46.6 million on $2.48 billion of loans securitized during 2005. The 2006 gain as a percentage of loans sold was 1.4% as compared to 1.9% for 2005. The 2006 gain as a percentage of the amount of loans securitized was lower than the prior year due to rising market interest rates and the competitive environment for motorcycle lending.
Stock Repurchasing
During 2006, the Company repurchased 19.3 million shares of its common stock at a total cost of $1.06 billion. The Company repurchased 17.2 million shares under a general authorization received from the Company’s Board of Directors in 2005. The remaining 2.1 million shares were repurchased under an authorization from the Company’s Board of Directors that is designed to provide the Company with continuing authority to repurchase shares to offset dilution caused by the exercise of stock options.
In October 2006, the Company’s Board of Directors separately authorized the Company to buy back up to 20.0 million shares of its common stock with no dollar limit or expiration date. No repurchases had been made under this authorization as of the end of 2006.
During 2005 and 2004, the Company repurchased 21.4 million and 10.6 million shares, respectively, of its common stock at a total cost of $1.05 billion and $564.1 million, respectively.
Dividends
The Company paid total dividends of $0.81, $0.625 and $0.405 per share during 2006, 2005 and 2004, respectively, at a total cost of $212.9 million, $173.8 million and $119.2 million, respectively.
Financial Highlights:
Revenue Growth (1-yr): 9.0%
Revenue Growth (9-yr average): 15.1%
Net Income Growth (1-yr): 8.6%
Net Income Growth (9-yr average): 22.3%
Earnings-Per-Share Growth (1-yr): 15.2%
Earnings-Per-Share (9-yr average): 24.1%
Free Cash Flow Growth (1-yr): (29.0%)
Free Cash Flow Growth (9-yr average): 22.2%
Net Profit Margin (current): 16.9%
Net Profit Margin (10-yr average): 13.5%
Return On Equity (current): 35.7%
Return On Equity (10-yr average): 29.8%
Debt Ratio (current): 0.50
Current Ratio (current): 2.22
Financial analysis:
- Company’s debt ratio has stayed fairly consistent throughout the past decade and currently stands at 0.50.
- ROA has also been consistent throughout the past ten years, hovering around the high teens. Currently it stands at 19.1% and 10-yr average is 16.3%.
- ROE is pretty impressive and has consistently been improving: from 22.9% in 1998 to 35.7% in the 2006 fiscal year; 10-yr average is 29.8%.
- All margins (gross margin, operating margin, and net profit margin) have significantly improved over the past ten years. Profit margin is currently at 16.9% and company posted a 13.5% 10-yr average.
- Revenue growth has stayed positive, but it did slow down in the past few years. Nevertheless, the company posted solid growth of 9.0% in 2006 and averaged 15.1% over the past nine years.
- Net income growth was very impressive in the recent past: between 1997 and 2003 the company had growth in the mid-twenties and low-thirties. More recently though, net income growth has slowed down in tandem with the revenue growth figures. The company posted net income growth of 8.6% in the 2006 fiscal year and 9-yr average is 22.3%.
- Free Cash Flow margin is decent at 8.8%. During the past decade FCF margin has stayed relatively consistent in the high single digits and low teens. FCF growth, on the other hand, has not been all that consistent: growth was negative in 2002 and 2006, (2.4%) and (29%), respectively. However, average growth for the past nine years stands at the impressive 22.2%.
- Improved inventory management has cut down average days sales by almost a third: from 36 days nine years ago to 25 days in 2006. Inventory Turnover ratio has increased from 10.02 in 1998 to 14.70 in 2006.
Discounted Cash Flow (DCF) Analysis:
I used discounted cash flow analysis to arrive at the intrinsic value of the company. I estimated that free cash flow would grow at an average rate of 12% per year for the next 10 years and at 3% (trailing GDP growth) perpetually after that. The company’s free cash flow grew at an average rate of 22% during the past nine years, which makes my estimate fairly conservative.
I used a discount rate of 9.5% because Harley-Davidson is a mature company with an established franchise and therefore it commands a below-average discount rate.
Using the assumptions listed above, my intrinsic value of the stock came out to $69.89. My intrinsic value of Harley-Davidson is abut 15% higher than what Morningstar has as a “fair value” for this company. I believe our difference in opinion lies in the fact that Morningstar underestimates this company’s growth potential.
Pros:
- Harley-Davidson brand is of a rare breed that not many companies can boast. It can command premium pricing through strong brand recognition.
- The company has had early success with international sales. Currently 22% of units sold are shipped internationally.
- Harley-Davidson continues to consistently buy back its common stock year after year, which boosts earnings-per-share and subsequently share values.
- The company is in great financial health with virtual zero net debt, which means it can weather an economic downturn just fine.
Cons:
- Harley-Davidson’s core consumer group is aging and it’s unclear whether it will be as successful with the younger generation of motorcycle enthusiasts.
- The company’s financial business is affected by the turmoil in the credit markets and profits are likely to slim down in this unit.
- If there is an economic recession, Harley-Davidson would feel its effects since consumers tend to tighten up discretionary spending during rough times.
Final Decision:
This company has one of the most recognized brands in the world and a solid business model with a network of exclusive dealers. Currently, HOG’s stock trades at $47 vs. $.70 that I have for the intrinsic value of the company. Given my safety margin of 30-50%, it is within my buying price range $35-$49. I’m very excited about this company and although its prospects for the near future are modest, the price certainly doesn’t reflect this company’s worth. I’m certainly adding Harley-Davidson to the list of my final picks.
