Expecting a Wild Ride for this American Symbol
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Harley-Davidson (NYSE: HOG) is a famous and iconic American brand, and the company has a long track record of growth and profitability fueled by demand from its extremely loyal customer base. Harley is certainly a company to watch if you are interested in high quality businesses with strong competitive advantages, but the timing doesn't seem right at current levels. Perhaps patience is not the most widespread virtue among Harley-Davidson fans, but investors may want to slow down a bit before making a purchase decision in the stock.
Harley has many valuable competitive advantages; the fact that people are willing to tattoo the brand in their skin says some important things about the relevance of such a brand. There is clearly an added value in the Harley-Davidson brand, and the company has successfully produced extraordinary profitability levels by capitalizing on the pricing premium that the brand commands. The company has a wide distribution network and a more than 50% market share in the US market, so the business is fundamentally solid.
Harley reported very strong numbers for the last quarter with a 17% increase in revenue and an outstanding 45% increase in earnings per share. In fact, the last year has been very good for Harley and its investors, particularly considering how tough the economic scenario has been: Domestic unit sales increased by 5.8% for Harley in 2011, versus a 4.3% rise in industry unit sales; even in Europe Harley showed better numbers than its competitors.
This resiliency during hard economic times is clearly worth noting since Harley sells big ticket items in the premium pricing segment. The fact that the business is doing quite well in an unexciting economic climate is a very positive sign about the quality of the company and its competitive advantages.
The company has a double exposure to the business cycle -- sales of high end motorbikes are quite sensitive to consumers' mood, and Harley also has a financial division that finances nearly 50% of sales. During 2008-2009 Harley had to face some additional losses due to the rise in nonperforming loans in its financial segment, so investors in this company should know that volatility is to be expected in case we see more economic trouble.
Harley-Davidson is also facing some important demographic headwinds; the company’s products target the 35 to 54 year old demographic group, which is growing at a slower rate than in the past since baby boomers are entering their retirement stage. An abundant inventory of used Harleys may also be detrimental to revenues, since it could incline customers to choose lower priced used bikes at the expense of new models.
Management is well aware of this demographic trend and is working to overcome the difficulties that it may bring. Harley has been targeting different age groups and expanding its operations geographically, it may take a while but the company has the competitive strength to venture successfully into new markets.
Looking at sales per region however, Harley still gets more than 70% of sales from the US. If its main markets starts showing some weakness the company will have a hard time replacing those lost sales with higher growth in other markets, since they are still too small in comparison. Growth in Asia and Latin America has been really strong lately, and that trend should continue in the future, but Harley still depends heavily on US demand.
Harley-Davidson is trading at a P/E ratio of 19 which is in line with historical averages for the company. Competitor Polaris (NYSE: PII), for example, is trading at a similar P/E ratio of 21. Polaris has achieved better growth rates in recent years, with a 10% annual increase in sales for the last five years and 19% more in earnings per share annually for the same period, while Harley has negative numbers for both sales and earnings in the area of a 3% annual decline in sales and a 10% fall in earnings.
Polaris is much smaller than Harley, so higher growth rates are easier to achieve, but the demographic issue and the growing inventory of used bikes may still be a factor behind Harley's underperformance. Looking beyond comparisons, both Harley and Polaris are strong companies that should do well in the middle term, but not cheap enough to deserve fresh money at P/E ratios near 20.
Ford (NYSE: F) is clearly not in the exact same business as Harley, but it still has a powerful brand and the company delivered various financial and operational improvements over the last years. Ford has been launching some very competitive products in the past few years, and the company is regaining the prestige it lost many years ago. At a forward P/E of 6, Ford looks much more compellingly valued than Harley.
I'm not bearish on Harley-Davidson for the middle term, in fact it’s an outstanding company. But at current levels, alternatives like Ford offer much more value for fresh funds and I would rather put my money in a recovering automaker trading at dirt cheap valuations than a high end motorbike company at fair price levels. There will be a time to buy Harley, but at this point I would wait for a better opportunity to jump on the bike.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford and Polaris Industries. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.