December 2, 1998
Harley Bear's Den
by Paul Larson (email@example.com)
Harley is cool. You won't find me debating the quality of the Harley brand, for it is truly one of the most prized in the world. An argument to the contrary would probably have me laughed out of Folly. However, we are not dueling about brand quality. We are dueling about the investment worthiness of the company's stock. I pick my fights wisely, and this is certainly a battle the bears can win.
A motorcycle is not exactly an inexpensive, repeat-purchase product, and for the vast majority it is nothing more than a luxury item. As such, Harley's products are sensitive to economic downturns. It's easy to get lulled asleep during booming economic times into thinking that cyclical companies and industries are suddenly no longer cyclical. Allow me to act as an alarm clock and remind everyone that the cycle business is cyclical, figuratively as well as literally!
The company has had the run of the roost for many years since essentially it has been the only American motorcycle company competing with imports from the like of BMW, Yamaha, and Suzuki. A strong part of the brand's strength has been the perception that Harley is more American than Levi's jeans and apple pie. Unfortunately, it won't be long before Harley will be sharing this particular stage. There is not just one truly American competitor suiting up for battle, but there are two.
One of those entering the market is a Minnesota-based company best known for its line of snowmobiles, Polaris Industries (NYSE: PII). If the deep pockets of Polaris is not enough competition, one of Harley's oldest competitors, Excelsior-Henderson (Nasdaq: BIGX), is also being rejuvenated. I somehow doubt that hard-core Harley fans are going to jump ship any time soon, but the increased competition will assuredly eat away at the fringes of Harley's market. Remember, there hasn't been an American alternative to Harley in many years. Will Harley be able to compete when it isn't the only game in town anymore? Time will tell.
Not only does the company face increased competition domestically, but Japanese motorcycles, which were the primary cause of the company's problems back in the 80s, are relatively inexpensive these days courtesy of the Asian economic crisis and the strong dollar/weak Yen situation it has brought. Having to compete against cheaper and cheaper imports is certainly not helping the company.
Bulls might be enamored with the company's past revenue and earnings growth, but peeking at Harley's financial engine shows an organization that is not exactly fuel-efficient. Some important metrics of operating efficiency such as Days Sales Outstanding, Receivable Turnover, Inventory Turnover, and Total Asset Turnover are all below par for the industry. Meanwhile, inventory as a percentage of sales, often a good indicator of future Trouble, has been ticking up slightly.
Is Harley a Cash-King? Hardly. Cash-Guzzler would be a more apt moniker. To say that Harley operates in a capital intensive industry would be an understatement. In other words, it costs a lot of dough to maintain and constantly upgrade the company's factories. Just how much cash does this organization need to survive? Let's turn to the recent statements of cash flow to see just how much green is being burned.
Harley Davidson Annual Statement of Cash Flows
1997 1996 1995 Net Operating Cash Flow 309.7 228.3 169.1 Net Investing Cash Flow (406.5) (213.8) (185.0) Net Financing Cash Flow 101.8 96.5 (10.5) Net Change in Cash 5.0 111.0 (26.4)
Harley Davidson Quarterly Statement of Cash Flows
Sept. 98 June 98 Mar. 98 Dec. 97 Net Operating Cash Flow 212.8 166.7 36.2 309.7 Net Investing Cash Flow (265.1) (177.4) (132.9) (406.5) Net Financing Cash Flow 27.0 17.7 44.4 101.8 Net Change in Cash (25.3) 7.0 (52.2) 5.0
Notice anything about these numbers? When I look at them I see that the cash the business is generating, net operating cash flow, is less than what the company is spending when buying tools, plants and the like, net investing cash flow. Having a positive number for the financing cash flows is also not good because it means that the company is making up the difference from outside sources, such as carrying increased debt. Simply said, the company is expending cash, not piling it up.
No story is complete without looking at valuation. At the time of this writing the stock was at 32x trailing profits. Considering that the highest multiple of earnings the company has ever traded at was the 35x, trailing profits achieved at the market's height back in July, the prospect for multiple expansion looks slim. The historical PE multiple over the past ten years is in the mid to upper teens, far below where it is today. At over 3x trailing sales at 6x book value, Harley has been granted a premium valuation unusual for such a capital-intensive industry. If the company does not execute flawlessly, contraction looks like a distinct probability.
I would be remiss if I did not mention that the company was mere moments away from bankruptcy back in 1985 when there was a highly publicized restructuring that bailed out the then lone domestic motorcycle maker. I think the saying goes something along the lines of "Those that forget history are bound to repeat it." Of course, that was some time ago, and the company is quite different now than it was in the 80s. Nevertheless, the near-bankruptcy just goes to illustrate just how difficult the motorcycle business can be.
Go buy a Harley, the motorcycle that is. It just might make for a better investment than the stock at these levels.
Next: The Bull Responds