Dueling Fools Dueling Fools
Harley Hoarse
December 2, 1998

Harley Bull's Pen
by Bill Barker (tmfmax@aol.com)

If you're talking about Harley Davidson (NYSE: HDI), the first phrase that may come to mind is "kickin' butt and takin' names." Take a gander at the 10-year chart for HDI, and understand that that definitely translates into a monster butt-kickin' that Harley handed the S&P 500 and then let's move onto the "takin' names" section of this little lesson. Coke, Berkshire Hathaway, The Gap -- those are just some of the names of companies you may have thought were great investments over the last ten years. By comparison though, Harley's left them all in the dust, and the good news for potential purchasers is, Harley is still a lot cheaper than any of those others.

Harley Davidson manufactures and sells heavyweight, touring, and custom motorcycles and motorcycle parts, accessories and clothing, as well as providing financing to its dealers. Harley is the only major American motorcycle manufacturer, and has held the largest share of the U.S. heavyweight motorcycle market since 1986. "The Motor Company," as it is affectionately known by its legion of extremely loyal customers, has been just about the smoothest growth machine imaginable over the last decade.

There are, literally, no numbers which do not look spectacular for this company. At the top-line, sales are growing at a steady 15% per year, and Harley can't build bikes fast enough to meet the demand. So great is the constant wait list demand, that year-old Harleys sell for 25% more than the list-price for a new vehicle. Woah. I know if you've read the How to Buy a Car section of the Fool's school, you know to never think of a car as an "investment," but a Harley is a vehicle that breaks the rule.

Moving down the income statement from the well-oiled top-line sales growth, Harley's ever-increasing efficiency has produced ever-improving margins. Whereas gross margins were around 28% at the beginning of the decade, they moved up to 33% in the middle of the decade, and currently are at nearly 40% over the last twelve months with no signs of anything but further improvement.

In a 1997 Fortune article, part of the reason for Harley's increased efficiency was explained: "In-house, a rigorous quality-control program kick-started talk at all levels of the company. With every employee involved in some form of variable compensation, [Harley's CEO Richard] Teerlink has 5,000 people talking about how to improve the place and its products."

Variable compensation? Doesn't that mean options? Is this company diluting shareholder value with explosive option grants. Hardly. There has been no dilution of shares over the last six years, as Harley has employed a measured buyback program that has allowed it to keep compensating its satisfied employees very well without diluting shareholder value at all. The company plan is to continue to repurchase the number of shares issued in connection with the exercise of stock options each year. Additionally, the company is authorized to repurchase up to 1% of all outstanding shares beyond that, an authorization that allows the company to take advantage of momentary weakness in the stock price, as occurred during the recent market "correction."

All of this has translated into one of the absolute best investments on the planet, bar none. According to a Fortune article entitled Killer Strategies That Make Shareholders Rich, an article which explicitly discusses investments in great investments in terms of their being rule breakers (cf. Rule Breakers, Rule Makers: A Foolish Guide to Picking Stocks), Harley is one of only nine companies that produced a total annual return to shareholders between 1986 and 1996 of over 42%, just barely trailing Intel's record over the same period.

Ah, but that's in the past you say. "We know Harley has been kickin' butt -- but what about the future?" Harley has now completed construction on its two new engine plants, and is expected to roll out its first major engine redesign in over 60 years. The new Twin Cam 88 engine is expected to supercharge sales, pumping this year's 148,000 units up to approximately 200,000 per annum by 2003.

With all of these stunningly good numbers set out, I expect two half-hearted arguments out of my worthy Dueling opponent here. First, that motorcycle sales are just a fad, and secondly, that the stock is overpriced.

To take the fad argument apart first, understand this -- Harley owners are fanatically loyal, obsessed even, with their machines. As CEO Teerlink has said, "There's a high degree of emotion that drives our success. We symbolize the feelings of freedom and independence that people really want in this stressful world." Freedom. Independence. Those are pretty good feelings to associate with your product, right? Those are concepts that are about as far from ever falling out of style as anything I can possibly imagine. People aren't riding Harleys because they saw some guy too sexy for his shirt riding one. Exactly the opposite. Harleys are the antithesis of a fad -- they're nostalgia. And with flush baby boomers just hitting 50, the demand for Harleys has got nothing but clear road ahead.

As to the valuation, I just hope I don't see another one of those "higher P/E than its growth rate" arguments. Assuming a 15% growth rate over the next ten years (that's a more conservative assumption than consensus expectations) and 5% thereafter (extremely conservative), on the basis of the trailing earnings and a 10% discount rate, on a discounted cash flow basis HDI currently has an intrinsic value of about $65 a share. So Harley is trading at about a 40% discount to its intrinsic value based upon some pretty conservative assumptions.

If you want to assume the 17% growth rate accorded by analysts, and that worldwide demand is not going to be basically quenched 10 years from now, and the fact that the remarkable stability of Harley's earnings could justify an even lower discount rate, this stock starts looking remarkably cheap.

Next: The Bear Argument

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