Which Growth Rate Implies The Current Share Price Of Harley-Davidson? (NYSE:HOG) (2024)

Harley-Davidson, Inc. is the parent company of Harley-Davidson Motor Company and Harley-Davidson Financial Services. Harley-Davidson Motor Company has been around since 1903 and just imagine what has happened in the world since then. H-D has survived numerous ownership changes, periods of the poor economic environment, intense competition, and at the end, it becomes an iconic motorcycle brand with millions of followers. The Harley-Davidson brand endures and still makes sense.

Moat: If we exclude the fact that the Company has great products, high market shares, well-run operations, and decent management, then we would focus on the following characteristics:

• Brand – Harley-Davidson is a brand which is a synonym for a specific lifestyle. The first association for motorcycles is the name Harley-Davidson in U.S. and many countries abroad.
• Promotion - one of the ways the Company promotes its Harley-Davidson products and the related lifestyle is through the Harley Owners Group (H.O.G.), which has approximately 1m members worldwide and is the industry’s largest company-sponsored motorcycle enthusiast organization.
• Furthermore, Harley-Davidson Riding Academy has trained more than 510,000 riders. This way the Company promotes the Harley-Davidson lifestyle to new riders and compensate for traditional baby-boomer customers aging out of the market. Based on industry data, current 25-to-50-year-olds are more likely to own a motorcycle than baby-boomers were when they were that age. According to Harley, people under the age of 35 are buying more Harleys per capita than the boomers did at the same age.
• Dealers Network - H-D has a network of 1,461 dealers worldwide which offers a high-quality retail experience for the existing and potential customers. H-D wants to increase international share from 38% to 50% over the next 10 years and plans to add roughly 150-200 dealer points from 2016-2020.

To sum up the story about moat it is particularly important to distinguish different types of opportunities that different types of moats present. In this case, I would classify H-D's moat as a combination of Legacy Moat and Reinvestment Moat (H-D has a unique position, solid opportunity to reinvest its cash flow, and ability to pay a dividend or buy-back shares).

Risks: As an investor, the way I perceive investment risk is not the volatility or beta of the stock, but rather the probability of permanent loss of capital. Although there are many operational and financial risks I will focus on a few that are most pronounced in H-D’s case:

1. Slowdown in the domestic and international economic environment could hamper the replacement and adoption rates of H-D’s products;
2. HDFS generates increased financial risk and weak profitability when credit standards tighten or credit markets become less liquid;
3. interest rate increases which could be unfavourable for retail demand;
4. foreign manufacturers could take additional advantage of FX shifts;
5. the Company may not be able to successfully execute its long-term business strategy;
6. the motorcycle industry could become increasingly competitive… and so on.

Outlook: The Company expects its 2017 shipments to be flat to down modestly with lower shipments in the U.S., offset by higher international shipments as it grows its dealer network. The Company believes 2017 global retail sales of Harley-Davidson motorcycles will continue to face headwinds. The Company expects gross margin as a percent of revenue for the full year to be approximately in line with 2016. Capex should be between $200m and $220m.

The Company's ten-year objectives are as follows:

• Build two million new Harley-Davidson riders in the U.S.
• Launch 100 new, high-impact Harley-Davidson motorcycles
• Grow the Harley-Davidson international business to 50 percent of its total annual volume
• Deliver superior return on invested capital for HDMC
• Grow the business without growing its environmental impact.

How should we think about valuation?

Since no firm can grow forever at a high rate many of them face a slowdown. Some of them never achieve the previous status, some of them find a new revenue source, while some of them simply fail. Instead of trying to estimate the growth five or ten years into the future, then determine the proper discount rate and terminal growth rate, I will use reverse DCF model. This method takes the current share price and backs out what is currently implied. Then growth rate estimate can be assessed if it is sustainable or not.

Here is a summary of reverse DCF model:

A Reverse DCF model is not perfect but it helps us in many ways. This model solves the problem of not being able to forecast the future, but it doesn’t tackle the discount rate problems and terminal estimate. To simplify the model I use 10% discount rate and terminal FCF multiple of 15x. Overall, based on the 1-stage reverse DCF model I get implied growth rate of 5.0%.

Putting all pieces together

When a reverse DCF is deployed, obsession with the current price is removed, and then the discussion takes place in terms of growth potential. That way we are not focused on the target price but on the growth of the underlying business.

The key question for H-D investors is the willingness of customers to pay a premium price for H-D’s products over competitors’ products? There is no single answer to this question, but the time would show us the strength of H-D franchise. I believe the H-D has strong fundamentals and healthy business model to achieve premium pricing over its competitors.

Harley-Davidson is an interesting company with a strong market position in the stable industry. Given the strength of the brand and the business’s ability to generate cash H-D is the compelling pitch for the long term investors. Valuation wise, implied growth rate of 5.0% doesn’t provide enough room for mistake, therefore each investor should decide on entry point by its own assessment of required return.