Harley-Davidson, Inc. - Boyar Research...Harley-Davidson,Inc. - 2 - However, the firm’s long-term...

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May 29, 2015 Volume XLI, Issue V - 1 - Harley-Davidson, Inc. NYSE: HOG Dow Jones Indus: 18,010.68 S&P 500: 2,107.39 Russell 2000: 1,246.53 Trigger: No Index Component: S&P 500 Type of Situation: Business Value Overview Harley-Davidson, Inc. (“Harley-Davidson,” “HOG,” or “the Company”) is a well established provider of motorcycles and related products. It has an operating history of over a century, made possible by a strong brand, distinctive products, and a highly loyal customer base. The firm now generates over $6 billion in revenue, and possesses over 50% share of its domestic market. The Company has also expanded its reach into several other established and emerging markets during recent years, and over one-third of its annual motorcycle sales are now derived from outside of the United States. The Company’s strong position is further illustrated by attractive margins, ample cash flow, and a solid balance sheet. Despite an impressive competitive position and history, recent stock performance has been disappointing (down about 25% over the past year). Price competition within the U.S. motorcycle industry has intensified during recent quarters, and several of HOG’s competitors have cut prices. These cuts have been particularly pronounced by overseas competitors, reflecting currency exchange considerations and less robust fundamentals in other developed markets. Given the strength of the U.S. dollar in past quarters, foreign providers have been able to capture market share via discounting. HOG has historically resisted discounting as a means of preserving market share; consequently the Company’s financial results and near-term outlook have been under pressure. Price: $ 53.48 Shares Outstanding (MM): 210.6 Fully Diluted (MM): 211.8 Average Daily Volume (MM): 2.5 Market Cap (MM): $ 11,263 Enterprise Value (MM): $ 15,965 Percentage Closely Held: Insiders < 1% 52-Week High/Low: $ 72.78/53.04 5-Year High/Low: $ 72.78/21.86 Trailing Twelve Months Price/Earnings: 13.6x Price/Stated Book Value: 3.9x Net Debt (MM): $ 4,702 Upside to Estimate of Intrinsic Value: 44% Dividend: $1.24 Yield: 2.3% Net Revenue Per Share: 2014: $ 29.38 2013: $ 27.83 2012: $ 26.33 2011: $ 25.06 Earnings Per Share: 2014: $ 3.88 2013: $ 3.28 2012: $ 2.72 2011: $ 2.33 Fiscal Year Ends: Company Address: Telephone: CEO: December 31 3700 West Juneau Avenue Milwaukee, WI 53208 414-343-4782 Matthew Levatich Clients of Boyar Asset Management, Inc. do not own shares of Harley- Davidson, Inc. common stock. Analysts employed by Boyar’s Intrinsic Value Research LLC do not own shares of Harley-Davidson, Inc. common stock.

Transcript of Harley-Davidson, Inc. - Boyar Research...Harley-Davidson,Inc. - 2 - However, the firm’s long-term...

May 29, 2015 Volume XLI, Issue V

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Harley-Davidson, Inc.

NYSE: HOG

Dow Jones Indus: 18,010.68

S&P 500: 2,107.39 Russell 2000: 1,246.53 Trigger: No Index Component: S&P 500 Type of Situation: Business Value

Overview

Harley-Davidson, Inc. (“Harley-Davidson,” “HOG,” or “the Company”) is a well established provider of motorcycles and related products. It has an operating history of over a century, made possible by a strong brand, distinctive products, and a highly loyal customer base. The firm now generates over $6 billion in revenue, and possesses over 50% share of its domestic market. The Company has also expanded its reach into several other established and emerging markets during recent years, and over one-third of its annual motorcycle sales are now derived from outside of the United States. The Company’s strong position is further illustrated by attractive margins, ample cash flow, and a solid balance sheet.

Despite an impressive competitive position and history, recent stock performance has been disappointing (down about 25% over the past year). Price competition within the U.S. motorcycle industry has intensified during recent quarters, and several of HOG’s competitors have cut prices. These cuts have been particularly pronounced by overseas competitors, reflecting currency exchange considerations and less robust fundamentals in other developed markets. Given the strength of the U.S. dollar in past quarters, foreign providers have been able to capture market share via discounting. HOG has historically resisted discounting as a means of preserving market share; consequently the Company’s financial results and near-term outlook have been under pressure.

Price: $ 53.48 Shares Outstanding (MM): 210.6 Fully Diluted (MM): 211.8 Average Daily Volume (MM): 2.5

Market Cap (MM): $ 11,263 Enterprise Value (MM): $ 15,965 Percentage Closely Held: Insiders < 1%

52-Week High/Low: $ 72.78/53.04 5-Year High/Low: $ 72.78/21.86

Trailing Twelve Months Price/Earnings: 13.6x Price/Stated Book Value: 3.9x

Net Debt (MM): $ 4,702 Upside to Estimate of Intrinsic Value: 44%

Dividend: $1.24 Yield: 2.3% Net Revenue Per Share:

2014: $ 29.38 2013: $ 27.83 2012: $ 26.33 2011: $ 25.06

Earnings Per Share: 2014: $ 3.88 2013: $ 3.28 2012: $ 2.72 2011: $ 2.33

Fiscal Year Ends: Company Address: Telephone: CEO:

December 31 3700 West Juneau Avenue Milwaukee, WI 53208 414-343-4782 Matthew Levatich

Clients of Boyar Asset Management, Inc. do not own shares of Harley- Davidson, Inc. common stock.

Analysts employed by Boyar’s Intrinsic Value Research LLC do not own shares of Harley-Davidson, Inc. common stock.

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However, the firm’s long-term fundamental outlook, competitive position, and profit potential have not been impaired by the recent headwinds in our view. HOG has faced similar challenges in past periods, but ultimately regained market share and sales momentum during the years that followed. Although near-term financial comparisons are likely to remain depressed, we believe management’s focus on preserving the Company’s brand and long-term profitability is an appropriate strategy from a shareholder point of view.

In assessing HOG’s outlook and valuation, we believe it is necessary to utilize more normalized assumptions about the industry environment. By our estimates, HOG should be capable of generating EBITDA of approximately $1.8 billion in 2-3 years (a 15% improvement from the most recent year). These projections imply EPS of approximately $5.00, 25% above investor expectations for the current year. In order to be relatively conservative, our multiple assumptions (11x EV/EBITDA, 16x EPS) are toward the lower end of HOG’s historical range. These assumptions produce an estimated intrinsic value of $77 per share, implying total return potential of approximately 46% during the next 2-3 years. In the event HOG shares remain depressed for an extended period, it could also be increasingly likely that the firm becomes the target of private equity investors given the many attractive traits of Harley-Davidson.

Background & Business Overview

Harley-Davidson’s origins trace back to the early 1900s, started by William Harley and Arthur Davidson in Milwaukee, Wisconsin. Its early products were essentially motorized bicycles powered by small engines with less than 10 horsepower. Similar to the fledgling automobile industry, the motorcycle industry initially consisted of scores of competitors seeking to capitalize on the technology revolution within transportation. Harley-Davidson eventually distinguished itself with the development of a new model featuring a V-twin engine, capable of reaching a previously inconceivable speed of 60 miles per hour. Harley-Davidson motorcycles gained popularity with police departments, and later with the U.S. military during World War I. By 1918, nearly half of all Harley-Davidson production was dedicated to military orders. Harley-Davidson continued to develop new models for the growing U.S. consumer class during the post World War I era, and the brand was bolstered by the strong performance of Harley bikes in several well recognized motorcycle events. The number of players within the industry shrank significantly during the following decades, and Harley-Davidson was among only 2 motorcycle companies to survive through the Great Depression period. The Company went on to play a significant military role in World War II and received several awards for excellence from the government for its wartime production of motorcycles. Harley-Davidson enjoyed continued success and growth during the following decades, supported by product innovation and strong motorcycle race performance. The 1950s and 1960s were an important time for Harley, as many other industry players faded away and a new era of motorcycle culture and enthusiasm for Harley-Davidsons began to take shape. The Company completed an IPO in 1965, but it was acquired by American Machine and Foundry (a leisure equipment firm known as AMF) just 4 years later.

The following decades were a more mixed period for Harley-Davidson. After holding a near monopoly in the U.S. motorcycle market (80% share in 1969), Japanese companies began to gain market share by the 1970s. Japanese motorcycles eventually gained a reputation for greater reliability and affordability relative to Harley-Davidson. By the 1980s the Company found itself at a crossroads, and senior management purchased the firm back from AMC in 1981. Measures were taken to revitalize Harley’s competitive position, and specific initiatives included implementing new approaches for manufacturing, inventory management, and marketing (including formation of the first Harley Owners Group in 1983). Harley-Davidson had regained positive momentum by the late 1980s, and the firm once again became publicly traded in 1987. During the 1990s, the Company continued to expand its product line and global presence, and total annual sales exceeded $3 billion by 2001. Harley-Davidson had clearly regained a dominant market share position, supported by high-quality products and an increasingly loyal customer base. However, the Company continued to face challenges that would sometimes impact profits. Issues such as economic recessions, aggressive importing, underperforming acquisitions (Buell Motorcycle), and labor disruptions have been among the headwinds the firm has occasionally faced. However, the Company has largely navigated such challenges successfully, and Harley-Davidson’s sales and profits have continued to grow over time.

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Sales and Profits 2010-2014

2010 2011 2012 2013 2014 5-year avg.

Sales growth 1.6% 9.5% 5.1% 5.7% 5.6% 5.5%

Gross margin 37.9% 37.3% 38.7% 39.6% 40.5% 38.8%

Operating margin 11.5% 15.6% 17.9% 19.6% 20.6% 17.0%

ROE 12.0% 23.7% 25.1% 26.4% 28.5% 23.1%

EBITDA growth 59.5% 36.2% 14.4% 13.6% 10.4% 26.8%

Today, Harley-Davidson remains a dominant player within the motorcycle industry. During 2014, HOG generated over $6 billion in sales derived from Motorcycle and Related Products (89%) and Financial Services (11%). Within the Motorcycles and Related Products segments, 79% of 2014 sales were derived from motorcycles, and the balance was derived from other categories such as parts and accessories, merchandise, and licensing. The U.S. market remains HOG’s largest source of revenue (about 64% of units sold), followed by Europe (14%), Asia-Pacific (11%), Latin America (4%), Canada (4%) and Middle East/Africa (3%). Within the industry, motorcycles generally fall within 5 classifications: Standard, Sportbikes, Cruisers, Touring, and Dual use (on-road/off-road). HOG has motorcycle manufacturing operations in both North America and overseas, and the segment has approximately 5,900 employees (2,600 unionized). Harley-Davidson products are distributed through a global network of independent dealers who typically focus on the Harley-Davidson brand exclusively. Motorcycle demand tends to have a seasonal pattern that reflects rider activity: peaking in warm months and softening in colder months. The Company’s financial services segment (HDFS) provides financing to both dealers and retail customers.

Harley Davidson: 2014 Revenue Mix Sales Within Motorcycle Segment

Motorcycles

& Related

Products

89%

Financial

Services

11%

Parts &

Accessories

16%

Motorcycles

79%

General

Merchandise

5%

Harley-Davidson’s product line includes a wide range of price points, but HOG generally operates within

the premium segment of the marketplace, and attempts to achieve differentiation via styling, performance, customer service, and reliability. Engine displacements for Harley-Davidson motorcycles range from 494cc (cubic centimeters) to 1802cc, but most models have displacements of over 600cc (typically classified as “heavyweight bikes”). Harley-Davidson’s products are largely focused on the Touring and Cruiser Segments. Within the U.S. motorcycle industry, these two categories account for over 70% of sales (models over 600cc). The Cruiser category features distinctive Harley-Davidson designs, and includes models such as Dyna, Softail, V-Rod, Sportster, and Street motorcycles (generally priced in the $7K-$20K range). Touring motorcycles are a category that was originated by Harley-Davidson, and seek to balance styling and performance with features that allow for comfortable traveling over long distance (windshields, luggage compartments, etc.). Touring models include Road King, Street Glide, and Electra Glide, and starting prices for these models typically exceed $20,000. During 2014, Cruising motorcycles accounted for 55% of shipped units, and Touring motorcycles for 45%. HOG’s core customer is Caucasian men over 35 years old in the United States, and the average annual household income of a Harley-Davidson customer is about $93,000. HOG has made a significant effort to diversify its customer base during recent years (discussed later in this report). Within the U.S. market, HOG has

Total Revenue: $6.2 Billion Total Segment Sales: $5.6 Billion

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specifically targeted other demographic groups as “outreach customers.” New customer groups of particular interest include Caucasian women over 35 years old, young adults (18-34), African-American adults over 35, and Latino adults over 35. Part of HOG’s success has been driven by the loyalty of its customer base: approximately 2/3 of its sales are derived from repeat customers.

The HDFS segment provides financing to HOG’s dealers and retail customers (primarily in North America). Management views its financing operations as a competitive advantage that is strategically valuable within its wholesale and retail channels. During 2014, 100% of dealers in North America utilized HDFS at some point, supporting wholesale demand for motorcycles, parts, and accessories. Over half of all purchases in the U.S. retail channel are financed via HDFS, and this figure is closer to one-third within the Canadian retail channel. As of the most recent quarter, HDFS had $6.98 billion in finance receivables outstanding (80% retail /20% wholesale). HDFS’ retail customers have a solid credit profile, with about 80% of originations classified as “prime.” Since 2011, annualized losses relative to loans for retail channel customers have remained below 2%. During the most recent quarter, HDFS completed a $700 million asset-backed securitization at an average interest rate of 1.2%, and a 5-year medium term note offering with a 2.2% coupon rate. During 1Q, HDFS also paid a $100 million dividend to Harley-Davidson Incorporated. HDFS has approximately 600 employees.

Management

HOG’s management team consists of experienced executives with a mix of experience accrued at both Harley-Davidson and other well-known outside firms. The firm completed a scheduled transition for the CEO role this May as Matt Levatich (previously HOG’s COO) succeeded the retiring Keith Wandell. Wandell (age 65) had been President & CEO of HOG since 2009. Levatich (age 50) has been with the Company since 1994, and had an engineering and manufacturing background prior to joining the Company.

Executive Officers Background

Matthew Levatich, President & CEO Appointed CEO in 2015, held several senior posts since 1994

John Olin, CFO Joined Harley in 2003 as controller, previously at Kraft Foods

Mark-Hans Richer, CMO Held numerous marketing positions at GM prior to joining in 2007

Lawrence Hund, President of Financial Services 3 decades of industry experience, 17 years at Heller Financial

Michelle Kumbier, Senior VP: Operations Has held several senior operations roles at HOG since 1997

Recent Developments

Harley-Davidson reported its 1Q-2015 on April 21st, and its results reflected an increasingly competitive industry environment. Although Company EPS actually exceeded investor projections, sales were less than projected and management elected to reduce its motorcycle shipments guidance for the full year. The stock sold off about 10% in response to the earnings report, and shares are now down about 25% over the past year. Competition within the U.S. motorcycles industry has intensified during recent quarters. Several of HOG’s competitors have cut prices. These cuts have been particularly pronounced by overseas competitors, reflecting currency exchange considerations and less robust market fundamentals in other developed markets (i.e. Europe, Japan). Given the strength of the U.S. dollar in past quarters, foreign providers have been able to capture market share via discounting (the U.S. dollar value of the Euro and Yen declined over 15% during the past year). In addition, many foreign players are seeking to reduce inventory levels, exacerbated by the weak consumer fundamentals in their respective home markets. Consistent with HOG’s long-term strategy, it has not engaged in price discounting in response to the environment, and this has led to an erosion in HOG’s market share. It warrants mention that HOG has experienced similar market share declines in past periods, and such scenarios typically prove to be temporary from a long-term perspective.

“This is not the first time we’ve experienced a period of extreme discounting by our competitors and it likely won’t be the last. However, we will continue to protect our premium brand. We will not take a short-term view of the current competitive situation and compete by discounting. We will continue to manage the Harley-Davidson brand for the long term.”

– Harley-Davidson CFO John Olin (1Q-2015 conference call)

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HOG reported 1Q EPS of $1.27, a 5% year over year increase and $0.02 above expectations. However, revenue from motorcycles and related products declined by 4% and were somewhat weaker than expected. As a result of the previously discussed headwinds, HOG’s share of the U.S heavyweight motorcycle market declined by over 4 percentage points to approximately 51%. Management also cited challenging weather and a difficult comparison to 1Q-2014 as additional factors. However, both the gross margin and operating margin for the motorcycles business increased year over year, reflecting favorable sales mix, effective expense management, and disciplined pricing. Despite some of the market headwinds (currency reduced gross margin by 120 basis points), HOG’s 1Q gross margin represented a new 15-year high according to management. Pockets of sales strength included new products in the U.S. market, and healthy demand in several emerging markets. Financial comparisons for HDFS were modestly positive from a year over year perspective, aided by higher net interest income and an increase in non-lending income. HOG continued to return cash to shareholders via dividends and buybacks during 1Q, and shares outstanding declined 4% year over year. In response to the competitive environment (which management expects to continue for several quarters), the Company provided updated guidance for 2015 (see following table). In terms of currency impact on profits, management expects year over year comparisons to bottom in 2Q but gradually recover during the second half of 2015.

2015 Expectations Update Following 1Q Report

Source: Company presentation, April 2015

Industry Overview

The global motorcycle industry is estimated to be roughly $75 billion according to RnR Market Research. Yet, the diversity of the sector makes it challenging to draw broad-based conclusions across the entire world marketplace. Rather, a more meaningful analysis should make distinctions about factors such as geography and demographics when assessing fundamentals and growth potential of a given market. For Harley-Davidson and its competitors, each respective market presents its own challenges and opportunities. Trends related to demand and pricing can periodically fluctuate for the sector or for a specific market depending on the economic backdrop or the competitive dynamics at a given time. In our view, this is an inevitable reality of operating within this industry. However, considerations such as brand strength and new product development have competitive relevance across the entire sector in our view, and such issues can help determine success for industry players from a longer-term perspective. Overall, we believe the industry offers a relatively attractive growth profile during the coming years for companies that possess a strong competitive position. As is the case with many other industries, the motorcycle business should continue to become increasingly global in nature, and firms must adapt their respective strategies to this evolving market landscape.

For Harley-Davidson and many other industry players, the North American market remains a key driver of sales and profits. North America has faced its share of challenges during recent years, and competition has gained additional intensity during the past couple of quarters. The entire North American market experienced a downturn during the economic recession that followed the financial crisis of 2008. Within the U.S. for example, sales volume for heavyweight motorcycles declined by more than 50% during the 2006-2010 period. Volumes

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have begun to gradually recover, but 2014 heavyweight motorcycle sales were still more than 40% below 2006 levels. Yet this recovery has been complicated by the previously discussed uptick in aggressive discounting by some players. Companies such as Honda have been reducing prices by 20% or more in tandem with significant cash-back offers as firms react to the strong U.S. dollar and excess inventories. Such headwinds will likely persist for several quarters, and this type of environment periodically arises in the industry (and eventually abates). In our view, it is inappropriate to assume that the current challenges represent a long-term deterioration in fundamentals for the North American market. Taking a longer-term view, pricing trends should eventually normalize and volume growth in the low-mid single-digits should be a realistic expectation for the region. Although the U.S. is a developed market with more moderate long-term economic growth, several demographic factors should provide a meaningful tailwind for demand. The retiring “baby boomer” generation offers a growing potential demand source with incomes that will be increasingly allocated to leisure activities. Moreover, U.S. motorcycle customers are becoming gradually more diverse over time with greater representation from women and minority groups. According to the Motorcycle Industry Council, women now account for 12% of heavyweight motorcycle customers (up 30% during the past decade).

Other key developed markets that warrant mention include Europe and Japan. In Europe, the size of the motorcycle market is slightly bigger than the United States. However consumer preferences in that region place greater emphasis on Sportbikes, which is the leading motorcycle category in Europe (accounting for 38% of heavyweight motorcycles). To provide some context, Sportbikes only account for 10% of the market in the U.S. The Touring category (a very prevalent category in the U.S), represented only 26% of total sales in the region in 2014. Consequently, Europe has a different market share profile reflecting this consumer preference for different models (HOG’s market share is only 12% there). Recent sales trends in Europe have been mixed at best, and reflect underlying economic challenges across much of the region. A significant recovery appears improbable in the near-term, but the size of this market and the potential for low-mid single-digit demand growth over the long-term will continue to keep Europe relevant within the motorcycle industry. Japan is another key developed market that continues to hold relevance within the industry (3rd largest source of motorcycle sales for HOG after the U.S. and Europe). However, growth in Japan has also been modest, and many local providers look to export to the U.S. and emerging Asian markets as a means of bolstering growth and addressing increasing inventory levels.

Growth rates in several emerging markets are significantly more promising for motorcycle providers. Countries such as China, India, and Brazil have generally offered higher economic growth relative to developed markets. Moreover, rapidly expanding middle classes provide a strong demographic tailwind for future demand. According to Ernst and Young, 3 billion people across the globe are expected to enter the middle class by 2030 (largely driven by emerging market economies). In general, we would expect demand growth from these markets to materially exceed the U.S. and other developed markets, making annual sales growth of at least 5%-10% a feasible expectation for these markets during the coming years. Several well-established operators (including Harley-Davidson) have made emerging markets a key strategic priority, and have begun to build critical mass via expanded dealership presence and investment in local manufacturing capacity.

Harley-Davidson Retains a Strong Competitive Position

HOG has established an impressive record of growth and profitability over several decades, helping to illustrate the firm’s strong competitive position. Although near-term headwinds within the industry may persist during the coming quarters, we do not believe this reflects any material impairment in the Company’s standing in the industry or in its long-term profit potential. It is important maintain a long term view of this business, and recognize that periods of heightened price competition or softening demand will occasionally occur. In our view, management has taken an appropriate approach to the current environment, as HOG seeks to preserve its profitability and premium brand rather than attempting to stimulate near-term sales via discounting. HOG’s strategy is designed to be customer-centric, and is summarized by management in the following terms:

Grow International Faster than Domestic

Grow Domestic Outreach Faster than Core

Flexible Manufacturing

World-Class Product Development

Unrivaled Retail Experience

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The Company continues to possess a very strong position from a market share perspective. As discussed earlier, recent price competition has led to some erosion in its share of the domestic motorcycle industry (down 400 basis points in 1Q-2015 to 51%, but still the clear industry leader). It is important to recall that HOG has experienced pull-backs during recent periods of heightened price competition, but this share is typically recaptured in relatively short order. In fact, this type of scenario has played out on 2 different occasions within the past 15 years. HOG’s market share declined about 300 basis points in 2000, but this share was restored within 2 years. HOG also lost a similar magnitude of market share during 2008, but regained 850 basis points of share by the end of 2009 (and HOG shares staged a meaningful recovery as well). During times of heightened competition, management has consistently resisted discounting as that strategy is viewed as potentially harmful to long-term profitability and potentially harmful to the Harley-Davidson’s premium brand position. Rather, HOG sometimes elects to bolster its marketing efforts as a means of addressing heightened competition to reinforce the brand and communicate the uniqueness of Harley-Davidson products. It is also worth noting that HOG has remained consistently profitable during these more challenging periods, and HOG actually achieved record margin levels in 1Q-2015 despite the current industry headwinds. Over its recent history, HOG has also built leading share positions among “outreach” customers outside of its core customer demographic. For 7 straight years, HOG has been the leading seller of on-road motorcycles to young adults, women, African-Americans, and Hispanics within the U.S. market.

HOG has also built a significant presence in several overseas markets. The Company holds a 12% share of the European motorcycle market, and it is gradually bolstering its presence in several important emerging markets. For several years, HOG has been building its global reach by establishing dealerships and manufacturing facilities. In 2009, the Company announced a goal to add 100-150 new international dealerships by the end of 2014. As of the end of 2014, 136 new international dealerships had been added. The Company now has over 1,600 dealerships worldwide (independently operated), and 51% of these dealerships are outside of the United States. HOG’s manufacturing footprint has also taken an increasingly global profile. In addition to the 7 facilities HOG owns in the U.S. for manufacturing and product development, it leases manufacturing space in 3 overseas markets (Australia, Brazil, and India). HOG has implemented surge manufacturing capabilities at several of its domestic manufacturing facilities so that production can better match the seasonal demand pattern for motorcycles. Overseas, HOG utilizes a system of warehouses to adjust for seasonal sales patterns and to prevent significant inventories at the dealer level. Flexibility is also incorporated into HOG’s agreements with suppliers and labor so that the Company’s operations can effectively respond to market conditions.

The Company could not have achieved its position and success without a unique product valued by customers in the motorcycle marketplace. Harley-Davidsons differentiate themselves from other motorcycles via characteristics such as classic design, a reputation for solid performance and quality, and its distinctive engine sound (which HOG unsuccessfully tried to trademark in 1994). HOG is constantly investing in the development of product improvements and new models, as well as enhancing the speed and efficiency of its manufacturing process. During the last 3 years, HOG’s annual research and development expense has averaged approximately $140 million. Part of the appeal and distinctiveness of Harley-Davidson products relates to customers’ ability to customize their motorcycles. Customers often make modifications to Harley-Davidsons to reflect individual preference for performance, styling, and general functionality. The customers’ ability to customize is actively supported by Harley-Davidson via guides and instructional videos on the Company’s web site, and a wide range of parts and accessories are included in HOG’s product line. During 2014, HOG sold $875 million worth of parts and accessories, over 15% of total sales for its motorcycles segment. In our view, HOG’s distinctive products represent a long-term competitive advantage that cannot be easily replicated by other industry participants. Moreover, HOG’s products have helped to create a loyal customer base: 2/3 of Harley-Davidson motorcycle sales come from repeat customers. In our view, this level of consumer engagement also helps to provide a greater degree of long-term visibility for Harley Davidson’s future sales.

In our view, Harley-Davidson’s most valuable competitive advantage is the strength of its brand. Although this asset is difficult to quantify, the importance of the brand to the Company’s long-term success cannot be ignored and has been well recognized by many independent observers. Just recently, Harley-Davidson was named “2015 Motorcycle Brand of the Year” by Harris Poll Equitrend (a firm that specializes in branding assessments). However, the loyal following connected to Harley-Davidson’s products goes well beyond brand recognition and its rate of repeat customers. Harley-Davidson has built an enduring community of users that strongly identify with its products. In a recent survey conducted by Progressive Insurance, 93% of Harley-Davidson owners possessed some type of clothing or artwork that displayed the brand of their

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motorcycle (more than 3 times the rate of other motorcycle owners). In fact, merchandise has become a meaningful business for Harley-Davidson. HOG generated over $280 million in revenue last year from merchandise (about 5% of total sales for the motorcycle segment), and the Company has developed its own line of apparel in support of this called “Black Label.” The Company also started a motorcycle enthusiast organization in 1983 called Harley Owners Group (H.O.G.), which now has 1 million members. Harley-Davidson sponsors a wide range of rallies and events that help to reinforce customers’ connections with the brand. In an agreement struck earlier this year, Harley-Davidson was named the official motorcycle of the Sturgis Motorcycle Rally (agreement is in effect until the year 2090). This event has been held in Sturgis, South Dakota for 75 years, and has become an increasingly popular destination for motorcycle enthusiasts (over 400,000 attendees last year).

Earnings Power Masked by Current Industry Conditions

In our view, investors should not place undue emphasis on current sector challenges when assessing HOG’s long-term earnings power. As past periods have demonstrated, HOG has a successful record of navigating competitive price environments so that profitability and market share is preserved from a long-term perspective. Investors are likely overlooking the Company’s underlying profit potential, as well as HOG’s catalysts for growth during the coming years. We expect competitive conditions within the industry to eventually normalize during the coming years, which should allow the Company to eventually reap the benefits of increased shipments and profits. Utilizing normalized assumptions for shipments (annual motorcycle shipments of 300,000 units, with margins roughly comparable to current levels) HOG should be capable of generating EBITDA of approximately $1.8 billion in 2-3 years by our estimates (a 15% improvement from the most recent year). These projections imply EPS of approximately $5.00, 25% above investor expectations for the current year. It is important to note that this level of shipments would still be more than 15% below the peak levels achieved prior to the recession. In addition to a gradual normalization of sector fundamentals, HOG’s increased international exposure, new product launches, and outreach to new demographic groups should be among the firm’s primary growth drivers during the coming years.

Increased International Exposure: During the most recent year, international markets accounted for 36% of retail sales within HOG’s motorcycles segment. Lack of significant growth in developed markets such as Western Europe and Japan will likely remain a challenge during the coming quarters, but modest growth from these areas should be attainable assuming economic fundamentals eventually regain positive momentum. Even with relatively anemic conditions in some overseas markets, HOG managed to grow its retail sales of motorcycles by 5.4% in overseas markets last year, well above the 1.3% rate achieved in the U.S. HOG has made international growth a strategic priority, and recent expansions of dealerships and manufacturing capacity should allow HOG to gradually gain market share. With time, emerging markets such as China, India, and Brazil should become more prominent contributors to HOG’s international business, and offer materially higher growth potential given the rise of middle-class consumers in those areas. In a matter of just a few years, overseas markets will likely account for over 40% of HOG motorcycle sales, and this should materially benefit the Company’s overall growth prospects during the coming years.

New Products: HOG’s capacity to develop new products that respond to its customers has been a key driver of its competitive position, and should offer a catalyst for future profit growth. HOG launched several new models during 2014 that should provide meaningful sales growth opportunities during the coming quarters. In particular, HOG’s Project Rushmore models have been well received, and are a key element of the Company’s Touring category. HOG’s new Street models have also gained positive momentum, benefitting its Cruiser category. Longer term, Harley Davidson’s Project LiveWire could eventually become a significant source of growth. Project LiveWire represents HOG’s initial entrance into the electronic motorcycle market. The technology associated with this category is still developing, and HOG has not yet begun to sell electronic motorcycles. Rather, it is gradually introducing the concept to customers via demonstrations, and it could eventually become a viable category once the technology can meet consumer expectations for performance and longer-distance traveling.

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New Customer Outreach: Expanding its demographic reach remains an ongoing priority for Harley-Davidson, and represents a potential means of market share growth within the U.S. market. As mentioned earlier, HOG has been expanding its presence beyond its core customer demographic (male Caucasians 35 and older). It has adjusted its product line to include models (such as the Street models) with styling, price points, and ease of use that assist in this outreach to new riders and demographic groups (women, Millennials, minority groups, etc.), and HOG expects sales growth from these groups to exceed rates achieved among its core demographic. Customer outreach efforts are also supported by the presence of Harley-Davidson Riding Academies, which offer various levels of rider education and training at Harley-Davidson dealerships in both the U.S. and several overseas markets. These academies have provided training to over 400,000 riders since 2000.

Balance Sheet and Financial Position

Harley-Davidson has maintained a solid financial profile that enabled both meaningful investment in growth and consistent return of cash to shareholders. The Company reported net debt on its balance sheet of approximately $4.7 billion as of the most recent quarter, and $270 million in future obligations related to pensions and post-retirement healthcare liabilities. The Company has been assigned bond ratings of A- at S&P and A3 at Moody’s. It is firm policy to maintain at least 12 months of liquidity on its balance sheet via cash and credit facilities and to return any excess cash beyond that to its shareholders. At the end of the most recent quarter, HOG held cash, securities, and available credit lines totaling $3.1 billion.

HOG has a well established record of returning cash to shareholders via stock repurchases and a growing dividend. Since 2010, HOG has more than tripled its dividend to $1.24 per share (2.3% yield), and it has allocated approximately $1.8 billion toward share repurchases. During the most recent quarter, $183 million of shares were repurchased (representing over 6% of HOG’s market value on an annualized basis). HOG views maintenance of its investment grade balance sheet as a strategic priority. However, the management has recently expressed a willingness to add financial leverage in order to fund a more aggressive share repurchase program given the stock’s depressed valuation. Despite some of the industry headwinds, HOG remains a solid generator of cash flow. During the past 3 years, HOG’s annual free cash flow has averaged approximately $765 million (implied free cash flow yield of about 7%). Harley-Davidson expects 2015 capital expenditures to total $240-$260 million, which will be entirely funded by Company cash flow.

Corporate Governance

Insider ownership at HOG is fairly low (under 1%), but the Company does utilize stock options and other incentives to align management compensation with shareholder interests. As of the end of 2014, HOG disclosed $3.5 million in unrecognized compensation costs related to stock options (option-related dilution is offset by share repurchases). The Company also has minimum stock ownership requirements for both board members (15,000 shares) and senior executives (15,000-200,000 shares depending on position). It is firm policy that a majority of its board members be independent from the Company. As the following table depicts, 8 of the Company’s 10 board members are considered independent from Harley-Davidson. Board members must be re-elected by shareholders on an annual basis.

Harley-Davidson, Inc.

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Board Member Independent Background

John Anderson Former CEO of Levi Strauss & Co.

Richard Beattie Senior Chairman of Simpson Thacher & Bartlett

Michael Cave Former Senior VP of The Boeing Company

George Conrades Chairman of Akamai Technologies

Donald James Co-founder and CEO of Fred Deeley Imports (dealer)

Matthew Levatich President and CEO of Harley-Davidson

Sara Levinson Co-founder and Director of Kandu Inc.

Thomas Linebarger Chairman & CEO of Cummins Inc.

George Miles Chairman Emeritus, Chester Engineers

James Norling Chairman of Globalfoundries, Inc.

Jochen Zeitz Director at Kering

Valuation & Conclusion

HOG shares have clearly been out of favor with investors during recent quarters. The stock has declined by approximately 25% over the past year, and shares have declined by nearly 30% from early-2014 highs. Just within the past year, HOG has underperformed the S&P 500 by 35 percentage points. In our view, this poor performance largely relates to the challenges associated with the current motorcycle industry environment and the corresponding declines in market share and sales at HOG. However, the firm’s long-term fundamental outlook, competitive position, and profit potential have not been impaired by the recent headwinds in our view. As discussed in this report, HOG has faced similar challenges in past periods, but ultimately regained market share and sales momentum during the years that followed. Although near-term financial comparisons are likely to remain depressed, we believe management’s focus on preserving the Company’s brand and long-term profitability is an appropriate strategy from a shareholder point of view. Assuming the stock fails to achieve significant appreciation in the near-term, this could present an opportunity for management to further explore the possibility of taking on some additional financial leverage in order to ramp-up its share repurchase activity.

Source: YCharts

HOG’s recent performance reflects increasingly negative investor sentiment. As the above charts help to illustrate, HOG’s valuation levels are establishing multi-year lows, likely accounting for perceived risk of additional declines in profits and sales guidance. The near-term challenges cannot be disregarded, but we believe the stock’s poor performance largely reflects these headwinds. Moreover, it could be argued that investors have begun to place undue emphasis on current industry conditions, and are placing a low probability on any recovery for the foreseeable future. In our view, this short-term mindset creates an attractive risk/reward scenario for investors who possess a multi-year time horizon.

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HOG Estimate of Intrinsic Value

FY 2017 (normalized) Value ($MM)

P/E 16.0x $78.16

EV/EBITDA 11.0x 19,823

Net Debt (1Q-2015) (4,702)

Retirement Obligations (271)

Equity 14,855

Shares Outstanding (FY17) 198

Intrinsic Value Per Share $75.03

Blended Intrinsic Value Per Share $77.00

Implied Total Return Potential 46%

In assessing HOG’s outlook and valuation, we believe it is necessary to utilize more normalized assumptions about the industry environment. As illustrated by multiple cases in the past, HOG has demonstrated a capacity for maintaining profitability and recapturing market share following downturns in the motorcycle sector. Our estimate of intrinsic value is based on a 2-3 year time horizon, and assumes Company shipments that are approximately 8% above current levels (but still under peak levels achieved prior to the recession). In our view, this produces a more accurate assessment of long-term profit potential, and helps to underscore the possibility of significant improvements in financial results during the coming years. In order to be relatively conservative, our multiple assumptions (11x EV/EBITDA, 16x EPS) are toward the lower end of HOG’s historical range during recent years. These assumptions produce an estimated intrinsic value of $77 per share, implying total return potential of approximately 46% during the next 2-3 years. Assuming industry conditions eventually normalize within this time frame, our estimate of intrinsic value could prove to be relatively modest.

Although near-term fundamentals are far from robust, we continue to view HOG as a well-managed firm in an attractive industry. The returns and margins achieved by HOG help to demonstrate this point (5-year average ROE of 23%, 5-year average operating margin of 17%, etc.). The Company continues to possess a strong financial position, with ample cash flow to fund internal investment, dividends, and share repurchases. As management has stated, more aggressive share repurchase activity could be a feasible option, which could provide downside support and a potential catalyst for appreciation. These considerations, along with HOG’s still strong market share, well-recognized brand, and loyal customer base are becoming increasingly disregarded by the current pessimism. Moreover, the growth initiatives HOG is pursuing are largely being ignored by investors at this stage, and represent additional catalysts for profit growth and multiple expansion during the coming years. In the event HOG shares remain depressed for an extended period, it could also be increasingly likely that the firm becomes the target of private equity investors given the many attractive traits of Harley-Davidson. Overall, we believe the stock’s discounted valuation offers an attractive opportunity for long-term investors to purchase a high quality business with several sustainable competitive advantages.

Risks

The Company’s primary risks include:

Competitive pricing trends within the industry could continue, having additional negative effects on HOG’s market share and financial results.

A strong U.S. dollar or restrictions on international trade could reduce profitability of overseas operations.

A pull-back in economic conditions could materially impact consumer fundamentals and demand trends for motorcycles.

Harley-Davidson, Inc.

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HOG’s exposure to organized labor within its work force increases the potential risk of work stoppages and supply disruptions.

The Company’s reliance on third party suppliers provides less control over HOG’s supply chain.

A disruption in financial markets could negatively affect HOG’s financing operations.

Product distribution is largely dependent on independent dealers, and dealer inventories can be impacted by market factors such as used motorcycle supply, seasonality, and general consumer fundamentals.

Launches of new Harley-Davidson motorcycles may fail to meet expectations.

Domestic demand growth for Harley-Davidson could stagnate without a successful expansion of its customer demographics.

Harley-Davidson products are subject to environmental regulation, and future changes in such regulations could adversely affect the Company’s products or financial results.

Analyst Certification

Asset Analysis Focus certifies that the views expressed in this report accurately reflect the personal views of our analysts about the subject securities and issuers mentioned. We also certify that no part of our analysts’ compensation was, is, or will be, directly or indirectly, related to the specific views expressed in this report.

Harley-Davidson, Inc.

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HARLEY-DAVIDSON, INC. CONSOLIDATED BALANCE SHEETS

(In thousands)

ASSETS Dec. 31, 2014 Dec. 31, 2013

Current assets:

Cash and cash equivalents $ 906,680 $ 1,066,612

Marketable securities 57,325 99,009

Accounts receivable, net 247,621 261,065

Finance receivables, net 1,916,635 1,773,686

Inventories 448,871 424,507

Restricted cash 98,627 144,807

Deferred income taxes 89,916 103,625

Other current assets 182,420 115,492

Total current assets 3,948,095 3,988,803

Finance receivables, net 4,516,246 4,225,877

Property, plant and equipment, net 883,077 842,477

Prepaid pension costs — 244,871

Goodwill 27,752 30,452

Deferred income taxes 77,835 3,339

Other long-term assets 75,092 69,221

TOTAL ASSETS $ 9,528,097 $ 9,405,040

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:

Accounts payable $ 196,868 $ 239,794

Accrued liabilities 449,317 427,335

Short-term debt 731,786 666,317

Current portion of long-term debt 1,011,315 1,176,140

Total current liabilities 2,389,286 2,509,586

Long-term debt 3,761,528 3,416,713

Pension liability 76,186 36,371

Postretirement healthcare liability 203,006 216,165

Deferred income taxes — 49,499

Other long-term liabilities 188,805 167,220

Shareholders’ equity:

Preferred stock, none issued — —

Common stock 3,442 3,432

Additional paid-in-capital 1,265,257 1,175,052

Retained earnings 8,459,040 7,852,729

Accumulated other comprehensive loss (514,943) (332,676)

Treasury stock, at cost (6,303,510) (5,689,051)

TOTAL SHAREHOLDERS’ EQUITY 2,909,286 3,009,486

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 9,528,097 $ 9,405,040

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Asset Analysis Focus is not an investment advisory bulletin, recommending the purchase or sale of any security. Rather it should be used as a guide in aiding the investment community to better understand the intrinsic worth of a corporation. The service is not intended to replace fundamental research, but should be used in conjunction with it. Additional information is available on request. The statistical and other information contained in this document has been obtained from official reports, current manuals and other sources which we believe reliable. While we cannot guarantee its entire accuracy or completeness, we believe it may be accepted as substantially correct. Boyar's Intrinsic Value Research LLC, its officers, directors and employees may at times have a position in any security mentioned herein. Boyar's Intrinsic Value Research LLC Copyright 2015.

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