FOOL ON THE HILL: An Investment Opinion
Last night Harley released its quarterly earnings, which were, as usual, superb. The fact that Harley is almost boring in the predictability of its exceptional performance might be preventing this company from getting the attention that it deserves.
And what is good, Ph�drus,
And what is not good...
Need we ask anyone to tell us these things?
You may not need me to tell you these things, but I'll tell you what's good anyway -- the quarterly earnings reports of Harley-Davidson (NYSE: HDI). Always.
The second-quarter report released last night was no exception. Harley may have recently failed to patent the classic signature "vroom" sound produced by its legendary vehicles (I'm not making that up), but it seems to have nearly patented something far more important: approximately 20% annual sales growth with improving margins and no share count dilution.
By now, the story of Harley coming in with tediously predictable quality earnings reports is nearly an office joke. "Why cover the Harley earnings report? Didn't we cover that one about two years ago? Couldn't we just re-run the stuff we wrote before, and update one or two of the numbers?"
Well, just about. I looked up a Dueling Fools bull argument I penned a bit more than a year and a half ago, and a Stocks for Dad take I did just over a year ago. To tell a complete and accurate story about Harley, I wouldn't need to change anything but a couple of the numbers in the articles to satisfy the needs of this column. How many other companies have such entrenched competitive advantages, combined with immaculate management, that you can say that about? In fact, I consider Harley's history and earnings reports nearly perfect models for any beginning (or advanced) investor to study in detail in order to gain a better understanding of both Harley itself, and other companies generally.
For the most recent quarter, Harley announced fully diluted earnings per share of $0.29, up 33.4% from last year's second quarter. Sales across most divisions were up in the neighborhood of 21% to 23%, and gross margins eased to 34.1% from 35.0% the year before, but the company's tax rate improved, and 1.5 million shares were repurchased, making the bottom line improvement markedly more impressive than the still impressive top-line growth.
Sales growth in the high teens or low-20% range is very predictable for the company, and though the margins were down just a hair this quarter due to weakness in European currencies as well as a higher mix of lower margin product lines such as the clothing division, the long-term trend on gross margins has been a delight for Harley shareholders. Whereas gross margins were 30.9% in 1994, they moved up to 32.0% in 1996, 33.5% in 1998, and today stand in the aforementioned 34-35% range. It is the combination of steady top-line strength, multiplied by incremental margin improvement that has delivered the bottom line success.
The Art of Long-Term Earnings Growth Maintenance
Looking at that bottom line success, we see a very pleasing trend:
Other 10-year historical numbers can be acquired courtesy of Multex -- free with registration -- and show the similar gradual and relentless improvement of gross and pretax margins.
Additionally, Harley-Davidson's fine bottom line earnings per share numbers are a product of the fact that management simply doesn't let the share count grow. There were (split-adjusted) 303.08 million shares outstanding at the end of 1992 and there are 303.34 million outstanding today (308.1 million fully diluted). Harley has funded its extraordinary growth over the last 10 years almost entirely through cash generated from operations, rather than through constantly issuing new equity, either through secondary offerings or excessive option grants to employees.
While Harley does cut employees in on the equity success of the company's stock through option grants, it has simultaneously been out in the market repurchasing shares at the same rate its employees have been earning them. Over time this means that a greater and greater degree of Harley is owned by its employees -- something that is sure to give other shareholders a high degree of comfort about the company's operations.
Why Don't We See More About Harley?
I can make the case that Harley-Davidson is perhaps the only company that fits comfortably into any one of the four local actively managed portfolios: the Rule Breaker, Rule Maker, DRiP or Boring ports.
A Fortune article written in 1997 talks explicitly about Harley-Davidson as a Rule Breaker. Harley passes a sufficient number of the Rule Maker metrics, and certainly makes the rules in its industry to a far greater degree than a number of the other holdings of that portfolio. Harley has a very popular dividend reinvestment plan, qualifying it for DRiP purchasers. Regarding its qualifications as a value investment for the Boring portfolio, I can't cover everything necessary here, but as an extremely brief starting point, I would note that it trades for just over 30x next years' earnings, and it just showed an earnings growth rate of higher than 32%. It doesn't need a growth rate of even half that amount to justify its current price according to most any discounted cash flow model that I would likely run for the company.
I could go on and on about the company and the simple beauty of its numbers. But to end where I began, much as Pirsig's novel demonstrated that beauty is perceivable within the workings of the engine of a motorcycle, the same is true about 10-year financials. Take some time inquiring into the value of Harley's past, present and future and I think you'll agree -- there's a real beauty in those numbers.
Learn more on the Harley discussion board.