The BMW Method
Weighing the HOG

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By ponch73
January 4, 2008

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light. How are these posts selected? Click here to find out and nominate a post yourself!

First off, I'd like to thank Phil (devropr) for taking the time (as a newbie, no less) to share some of his research on HOG. It's easy to post a throwaway opinion on a thread (as many often do), but taking the time to compose a post with actual research takes a lot more time and effort (note to self: add Phil to favorite fools). Surely, his post deserves more than 9 recs?

In any case, HOG presents us with an excellent opportunity to apply our knowledge of the EV/FCFu multiple. In Phil's post, he points out that HOG currently trades at an EV/FCFu multiple of 10. At a 10% discount rate, this would imply forward growth of 0%. So, we as investors would be getting any growth from Harley Davidson for free. Yowza, time to back up the truck, right?

Well, here's the thing. The EV/FCFu multiple isn't a blind buying indicator. Rather, it suggests a POSSIBLE buying indicator. So, after reading Phil's post yesterday, I cruised on over to the SEC website and began building my own spreadsheet on HOG.

Looking at the numbers, what jumps off the page is that HOG has generated nearly $1.368 billion in operating cash flow in the first 9 months of 2007. In the prior three 12-month fiscal years, it never managed to crack even $1 billion! This suggests that HOG's business is just killing it right now, or that something else is at play.

Diving into the cash flow statement, we unfortunately see some extraordinary items that may not continue going forward. In the first 9 months of 2007, HOG enjoyed a $370 mil benefit from net finance receivables collection (net change in wholesale receivables plus collections on retail receivables). In the prior three fiscal years, it had negative full-year cash flow impacts from these items. In addition, HOG enjoyed a $98 mil benefit from working capital in the first nine months of 2007. This again contrasts with the prior three fiscal years when working capital had negative cash impacts.

So, is the market really suggesting that HOG is trading at 10x unlevered free cash flow or is it assuming (like I did) that the $468 mil of the $1.368 billion isn't sustainable?

Reworking the numbers gets me to $748 mil in unlevered free cash flow over the first 9 months of 2007. Grossing this up to 12 months on a straight-line basis gets me to $997 mil, which is more in line with the results over the past three years. With a $45 stock price and a $12.2 billion enterprise value (which adds in pension and postretirement health care liabilities), HOG's EV/FCFu multiple looks to be closer to 16. So, the market may not be giving us HOG's growth for free.