Harley Davidson may be limited by their size. It’s competitors have many more resources and products. The diverse product lines offered by the competition may allow them to make a lower profit on some products in order to gain market share. These companies may subsidize entry-level motorcycles with the goal of attracting these same customers into more profitable motorcycles due to customer loyalty. It may be very hard for Harley Davidson to attract this type of new customers due to their high entry prices.
Threats
Harley Davidson’s main competitive threats are Honda, Kawasaki, Suzuki and Yahama. Domestically the competitors include Polaris, Excelsior and Indian. Polaris is a leader in the snowmobile market and has recently entered the motorcycle market with its Victory brand of motorcycles (10). The famous Indian motorcycle has recently been re-introduced, however, its re-introduction is still in its infancy (11). However, Indian motorcycles have a history that could allow it to create a strong brand image and cultural following similar to Harley Davidson. As the only major U.S. manufacturer of motorcycles, Harley Davidson success may result in increasing competition from other domestic manufacturers in the future as the try to mimic Harley Davidson’s marketing success.
The post baby boomers have been the main customers for Harley Davidson throughout the 1980’s and 1990s. As this segment of the population age, their purchasing power will decrease. Shifting of the demographics will force Harley Davidson to rely on a portion of the population that will be declining. This will force Harley Davidson to target new customers. Buell motorcycles was purchased in the late 1990s to allow Harley Davidson to sell the Buell line of performance motorcycles, which appeals to younger customers (3). However, the Buell line of motorcycles has not gained any significant domestic market share of performance motorcycles.
Woman constitutes roughly have the population. However, Harley Davidson on has approximately 3% of its sales from women customers (3-7). Competitors have been able to entice woman into buying their products by offering smaller, more woman specific motorcycles. With only a specific product line, Harley Davidson may be alienating future customers.
Opportunities
Harley Davidson has much strength that can lead to great opportunities for the future. They include introducing more products for woman and expanding their product line to compete internationally.
The international competition in the heavyweight motorcycle (651+cc) industry is competitive. Harley Davidson only had 8% market share in Europe compared with 49% market share domestically in 2003. Harley Davidson even had a 26% market share in this segment in Australia/Japan (7). This heavyweight Harley Davidson motorcycles that are popular domestically does not have the same appeal internationally. Harley Davidson should also heavily promote the Buell line of motorcycles to increase market share in the sport motorcycle sector that the Japanese competitors have succeeded in. Harley Davidson could look at further increasing its international manufacturing expansion to instill its wildly successful brand identity with foreign consumers.
Harley Davidson could entice more women into their products by offering a wider variety of motorcycles. Women only consist of just over 3% of sales (3-7). This growing market could be penetrated if the right type of motorcycles were manufactured. By utilizing their strong brand image, the female market could leader very lucrative for Harley Davidson.
II. Financial Statement Analysis of Harley Davidson
Adjustments to Harley Davidson’s Financial Statements:
In order to conduct a time-series analysis the income statements for Harley Davidson for the year 1999 to 2003 were converted into common size statements, and were adjusted for the following unusual and non-recurring items:
- Goodwill from acquisitions was amortized during the 1999, 2000 and 2001 taxation years. Starting in 2002 Harley Davidson began to test its goodwill for impairment on an annual basis. Goodwill does not relate to Harley Davidson’s current operations, and therefore the amortized goodwill of $3.3 million in 1999, $3.3 million in 2000, and $3.5 million in 2001 were added back to the income statement to normalize earnings.
- Stock options are not reflected in Harley Davidson’s net income, and it can be argued that these options are part of the corporation’s operational period costs. As a result, these stock option costs were added into operating expenses. The stock option costs (net of tax) were $6,742,000 in 1999, $9,256,000 in 2000, $11,797,000 in 2001, $12,191,000 in 2002, and $13,415,000 in 2003.
- Interest Income that was not generated by Harley Davidson’s Financial Services Division was not included when calculating earnings. This interest income is not related to the fundamental business of Harley Davidson.
- “Other” expenses were not included when calculating earnings, as these expenses were not related to the fundamental business of Harley Davidson. Most of the expenses in “Other” expenses were for charitable donations.
- In October 2000 Harley Davidson sold its interest in the “Chrome Visa Card’ business. The sale resulted in a pre-tax gain of approximately $18,915,000 (or $6,900,000 net tax). As this sale was non-recurring in nature it was not included in our earnings calculation for 2000.
i) Time Series Analysis
The results of the above adjustments to the income statement are shown in Appendix #1. Revenue has continued to grow each fiscal year as a result of continued market share growth, along with wholesale price increases. As shown, the cost of goods sold has continued to decrease as a percentage of sales, resulting in an increase in gross profit margin from 34.25% in 1999 to 36% in 2003. The increase in gross profit margin is not a result of improved efficiency, but is more the result of continued increases in wholesale prices that have taken place. The overall operating margin has also continued to increase from 16.34% in 1999 to 24.02% in 2003. These impressive results are the result of: 1) Continued efficient operations, 2) Continued market share growth in the north American market, 3) the company’s ability to increase wholesale prices in the north American market, 4) the continued revenue growth of the Harley Davidson Financial Services division.
The consolidated statement of cash flows indicate that the company’s cash flow from operations have increased every year from $431,642,000 in 1999 to $935,553,000 in 2003. Cash flows from investing activities are mainly the result of securitizations of their accounts receivables. Cash flows from finance activities consist primarily of finance debt activity. Overall, Harley Davidson has shown impressive growth in cash flows from operations, and the cash flows from operations have been sufficient in every year (except for 2002) to cover the cash needed for investing and finance activities.
The common sized balance sheets shown in Appendix #2 were converted to FIFO inventory flows. The common sized balance sheets indicate that cash as a percentage of assets have grown significantly from 8.68% in 1999 to 28.87% in 2003. In addition, the inventories have steadily decreased form 8.96% in 1999 to 4.575 in 2003. The common sized balance sheet clearly shows how Harley Davidson has continued to improve and get stronger.
ii) Cross-Sectional Analysis
Harley Davidson is the #1 seller of heavyweight (650+CC) motorcycles in the United States. Harley Davidson has been built on the strength of its brand and its customer’s loyalty. For the cross-sectional analysis Harley Davidson was compared to two companies who produce similar heavyweight motorcycles, namely Honda and Yamaha. In 2003 Harley Davidson had control of the North American market with a 48.1% market share, with Honda controlling 18.6% and Yamaha 9.1%. The European market is lead by Honda holding 16.7% of the market share, Yamaha hold 16% and Harley Davidson ranks 6th with a 8.1% market share. The Asia/Pacific market is lead by Harley Davidson with a 25.8% market share, Honda controls 17.8% of the market, with Yamaha controlling 11.4%. Because Honda and Yamaha are large multinational firms, the available segmented financial information did not provide detailed financial information regarding the motorcycle divisions. In addition, the Honda motorcycles division is also responsible for lightweight motorcycles, ATV’s and scooters. Therefore, the nets sales of Honda and Yamaha also included revenues from “other” motorcycle products. In order to improve the comparability between the three companies the Harley Davidson Financial Services income was not included in the common sized statements.
Common sized income statements are presented for the 2002 and 2003 taxation years, for all three companies, in Appendix #3. It is clear that Harley Davidson has a superior gross profit margin for both the 2002 and 2003 taxation years, as Harley Davidson’s gross profit margin in 2003 was 36.02% compared to Honda’s 5.99% and Yamaha’s 3.79%. In 2002 Harley Davidson’s gross profit margin was 34.66% compared to Honda’s 7.35% and Yamaha’s 2.04%. The operating margin was equally as lopsided for both the 2002 and 2003 taxation years, as Harley Davidson’s operating margin in 2003 was 20.39% compared to Honda’s 5.99% and Yamaha’s 3.79%. In 2002 Harley Davidson’s operating margin was 18.16% compared to Honda’s 7.35% and Yamaha’s 2.04%.
Based on the cross-sectional analysis it is clear that Harley Davidson definitely has an advantage over its closest competitors. These impressive results for the 2002 and 2003 taxation years are the result of: 1) Continued efficient operations within Harley Davidson, 2) Continued market share growth, especially in the North American market, 3) the company’s ability to consistently increase its wholesale prices in the North American market, 4) the continued revenue growth of the Harley Davidson Financial Services division.
III. Financial Ratio Analysis
Activity Ratio
The company manages its inventory quite efficiently. In the more recent history, Harley-Davidson has employed its version of “just-in-time” inventory called M.A.N. (Materials as Needed). While it is important to have the production lines continuously moving and not waiting on parts, having less capital tied up in component and supplies inventory has helped Harley-Davidson produce more motorcycles as well as increase their bottom line by holding less inventory.
The low receivable turnover indicates that company is ineffective in its credit-granting and collection activity. Harley’s asset turnover is below Honda and Suzuki, as its major competitors dominate the field with their excellent manufacturing efficiencies.
Profitability Ratio
The profitability ratios measure the overall performance of the firm and it’s efficient in managing assets, liabilities, and equity. Harley’s strong product differentiation drives its high ROE and Profit Margin, which largely outperforms its major competitor Honda, Yamaha, and Suzuki. This may benefit from having one of the world's most recognized and respected brand names in heavyweight motorcycle. Its customers have average annual income of about $79,500. Since they pay more attention on high quality product and brand reputation, and are less sensitive on price, Harley can charge a high premium on its product.
Current Ratio
Current ratio measures short term solvency- the ability of the firm to meet its debt requirements as they come due. From the five year average data, Harley is also better than its major competitor. Other notable trends in the Harley-Davidson balance sheet are as follows: Cash on Hand in 2003 increased by 189% over 2002. Having the additional cash has improved the Current Ratio by 37%.
Leverage Ratio
The company maintains relative stable leverage ratio during five year period and the five year average is similar to its competitor Yamaha. A high leverage ratio will lead to more risk in bankruptcy, at same time a low leverage ratio mean companies are not sufficiently benefit from tax saving by leverage. Normally there is an optimal leverage ratio existed to balance the risk and benefit for one company or one industry. So the fact, that stable leverage ratio during five years and similar to its major competitor, may imply that management consider these number as optimal ratio for Harley Davidson.
IV. Valuation
Comparable Company Valuation Model
Our valuation analysis based on the firm multiples of comparable companies indicate a price range of $40 to $60. This price range constitutes a benchmark that would be used to get a critical analysis on the other valuation analysis.
It appears that the P/S ratio undervalue the H-D intrinsic value. The P/BV is the morte volatile multiples. With the 2003 actual values, we see a $50 average on 3 of the five multiples. With the 2004 estimates values we see a $60 average on 3 of the five multiples. The lowest implied value is about $40.
The comparable companies
Because of its dominant position and the diversification of its primary competitors, we could not compare H-D to them. Other criteria must be applied to identify comparable companies. The choice of them is determined by the product category, the value they convey and the market position. With these criteria, a group of seven companies has been identified.
The products are deferrable products with a high cost. The companies are leader of their market and get an important brand image within it.
The implied values for H-D
With the 2003 actual values :
With the 2004 estimates :
Discounted Cash Flows Valuation Model
The following points are a discussion over the main drivers of the DCF applied to H-D :
The Revenue
The Drivers of the Harley-Davidson Revenue :
Projection of the drivers
In the current economic situation, the most influenced driver is the overall state of the economy especially the U.S. economy. 82.3% of the 2003 sales came from the U.S.. Therefore, the dependence to its economy is critical. The current trade deficit that, in the short term, implies a weak USD – that is positive for H-D : for its exportation and U.S. position vs. its foreign competitors. However, the risk on the mid and long term on the inflation, interest rate and the purchasing power could decelerate the H-D growth rapidly.
The current market share of H-D shows the resistance of the H-D market position to the economic factors and the decrease in the registration growth rates. However, this over-growth is not sustainable on a long term horizon because of the limit of the market – risk of saturation. Therefore, we project a sustainable growth rate that tend to the industry growth in the next three years.
The demographic factor
According to H-D, the 2003 purchasers are as below :
The ageing of the population and the risk on their future income – projection of the GDP per capita and the retirement pension projection – could decrease the sales of new motorcycles and parts and accessories sales.
With the different factors that drive the H-D revenues, we could conclude that :
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in term of volumes : Motorcycles are a deferrable purchase ,that are vulnerable to economic slowdown. The sales in Europe could be injured by the high Euro that slowdown a current low economic growth rate. This could annihilate the potential growth in sales of the Buell Motorcycles. On the long term, the expectations from the U.S. trade deficit are critical to the worldwide economic growth. The European motorcycle registrations are steady about 300,000. The overall market is pulled up by the North American registrations. The growth in volume is forecasted at 7% to 9% in the next five-seven years.
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in term of prices : the change in product mix represent a standard deviation in the growth in volume. Four category of product are sold : custom, touring, performance and standard. We see, in all markets, an increase of the standard motorcycle market that is a low price segment. The custom market segment is steady and resist to the fluctuations and is a high value product that also push up the parts and accessories sales. Therefore, the increase in prices in the custom or performance products would be offset by the increase of the standard sales porportion.
The Margin and earnings
With the conclusion made above, the increase in prices will improve the operating margin from 36.2% to 36.7%. The cost of goods sold has been stabilized and would be difficult to lower without any innovative change in the manufacturing process. Moreover, the projection of the inflation – increase of the supply costs and wages – could offset some cost improvement in the H-D manufacturing lines.
The most important driver of earnings is the financial services activity that grow fast – 60% between 2002 and 2003 - and generate important margin – 60% in 2003. The assumptions made are therefore critical in the projection of future earnings. The CAGR over hte five past years indicate a compound growth rate of 16% for the financial services income and 1.2% for the expenses. We will retain these rate for our projections except for the expenses. Because of the most probable increase in interest rates, we projects a growth rate of 4% (the growth rate between 2002 and 2003).
The Cost of Capital
The beta estimates is derived from a regression analysis over 64 monthly period against the S&P 500.
The Terminal Value
For estimating the terminal value, we derived the EBITDA multiples obtained in the previous analysis. We use a multiples range from 9 to 12.
Results and Sensitivity
We believe a fair value of the company is in the range of $50 to $59.
Abnormal Earnings Valuation Model
The estimates and assumptions are the result of the income statement projection (see in the appendix) used also for the DCF valuation model.
The implied value for H-D range from $40.65 to $87.75. At the cots of equity projected, the price range is $49.33 to $62.22 that meet the conclusions made with the others valuation models. However, we see the volatility that result from the cost of equity deviation. In our projection, we assume a steady debt to equity ratio that appear as an optimal debt structure for the company. Any change made on the debt ratio will have an impact on the discount rate (by the beta adjustment).
The model :
APPENDICES
1. Adjusted Income Statement
2. Adjusted Balance Sheet
3. Cross Sectional Analysis
4. Projected Income Statement
- Discounted Cash Flow Valuation Model
Appendix #1: Adjusted Income Statement for Harley Davidson
Appendix #2: Adjusted Balance Sheet for Harley Davidson
Appendix #3: Cross Sectional Analysis
Appendix 4. Projected Income Statement
Appendix 5. Discounted Cash Flows Valuation Model
A750 Financial Statement Analysis -
Bloomberg, “ Ratio analysis for Harley Davison”
Reuters, “Ratio for HDI.N”, http://yahoo.investor.reuters.com/MG.aspx?target=/stocks/financialinfo/ratios/valuation&ticker=HDI
