Buy, Sell or Hold: It's Time to Park Harley-Davidson Inc. (NYSE: HOG)

Harley-Davidson Inc. (NYSE: HOG) may well be the ultimate U.S. corporate icon.

The company's motorcycles are certainly American cultural icons: Big, squat, slathered in chrome, they're essentially functional pieces of fine art. Each motorcycle emits a deep, staccato bark at idle, a signature sound that prompted aficionados to christen Harley bikes as "hogs."

The fact that "Hogs" have been owned and ridden by such celebrities as Elvis Presley, Malcolm Forbes Sr., Jay Leno, Mickey Rourke, Tina Turner, Arnold Schwarzenegger and Elizabeth Taylor helped imbue the Harley brand with an aura of desirability and exclusivity.

Little wonder the company has historically generated 5% of its revenue just from the licensing of its logo alone.

After a long run of success, however, Harley is heading for a rough road.

For investors, it's time to sell Harley. And here's why. The company:

  • Faces aging demographics.
  • Has made badly timed investments in future capacity.
  • Has racked up 38 cents in losses in the last 12 months.
  • Substantially boosted its levels of corporate debt.
  • Offers a low yielding dividend.

The Case For Selling Harley

I want to be clear, right up front, that this recommendation is not a comment about the quality and craftsmanship that is put into the bikes.  This is a comment about where management finds itself today. It's about shareholder value and the near- and intermediate-term prospects for Harley's common stock.

The premier manufacturer of large motorcycles in the world, the company has an amazing cult like following. As noted, the company generates almost 5% of its total revenue in just licensing of its logo.  This is an unheard of asset, with no cost to the company.  I would love to invest in a company that held the rights to that logo, but without $6 billion in debt behind it.

The buyers of this brand have a loyalty that cannot be easily replaced; in fact that's the issue.
This would normally be a niche that an investor like us would want to be in.  However, it's their biggest weakness now.

All that remains is a risk of an empty tank. Let me explain why...

Since the lows of March of 2009, the stock has already bounced up by more than 400% in the last 18 months.  The market bounce up from that low is now fully priced into the stock.

However the issues that has confronted management have continued to grow.

Harley-Davidson Motor Co. was started in 1903 by William S. Harley and Arthur Davidson. They offered a race bike, built around an engine designed by Harley at the age of 21.  The company's first major break, as a manufacturer, came during World War I, when up to 20,000 bikes were purchased by the U.S. Army and used for communication and transportation during the last days of the war. In fact, the first American to enter Germany, a day after the Armistice, was riding a Harley-Davidson.

The company continued to grow and expand during the next 90 years.  After the Indian Motorcycle Manufacturing Co. - the only other U.S.-based maker of big American motorcycles - shut down in the early 1950s, Harley had the big bike market to itself in America.

The company was able to grow demand for its product, and for its stock as the market-buying power of its riders increased over the years.  In fact, Harley shares hit an all-time high of $75 in November 2006.  Since then, the stock has been stuck in reverse, and shed nearly 90% of its value by the time it hit bottom in early March 2009.

The stock has bounced from its low of $8.33 in March 2009, to a high of $36.13 in April of this year.  The best part of this move is over, meaning the risk to investors has grown. 

The company has started to report quarterly losses, racking up 38 cents in losses in the last 12 months.  It has started a significant restructuring process, shedding employees, divisions and product lines.

In May 2009, Harley hired a new chief executive, Keith E. Wandell. The glaring hole in his garage disillusioned - and unsettled - the Harley faithful. Yep, it's true; the new CEO of Harley-Davidson didn't even ride one of his own bikes.  He has since rushed out and bought one, and ordered another, but the damage was done. 

Today, the company faces a series of demographic issues that will impact earnings going forward. 

In 2006, 85% of Harley buyers were over the age of 35. The younger generations of riders have moved to a Japanese or Italian GP race bike design.  The company faces a significantly lower run rate, as it faces the prospect of becoming a nostalgia brand. Harley has lost the attention of the follow-along generation. 
Historically, Harley-Davidson intentionally constrained the supply of new bikes. This allowed the company to have a waiting list for some models that was measured in years.  There were tangible benefits to this strategy - especially since it gave the company a buffer of demand to ride out slow periods in the global economy.  This all changed when management embraced production goals that pulled forward future demand.

Harley Davidson invested in building extra capacity, ramping up total production capacity to more than 350,000 bikes per year. The slowdown in customer demand hit just as Harley levered up its balance sheet with new debt.  Today, Harley-Davidson produces less than 200,000 bikes per year.

Harley Davidson paid for that expansion by layering on debt.  In fact, its debt load has swelled to around $6 billion, with a market cap of about $6 billion, giving the firm an "enterprise value" of about $12 billion. (The enterprise value is the theoretical takeover price - calculated by adding the market  cap and debt, and subtracting cash and cash equivalents.)

This makes Harley a fully leveraged company.  In fact, the drop in demand - with the spare capacity - has Harley-Davidson showing red ink for the first time in 16 years.

The losses in the last twelve months are 38 cents, during which time Harley continued to pay its 40-cent dividend.  The hard reality is that - as revenue drops - and the carry cost of its debt eats into the operating cash flow, Harley will have to start to cut back on the dividend.

Even the value of the Harley-Davidson brand has been dropping, according to Interbrand rankings. 

In fact, Harley has dropped from #73 to #98 in the Top 100 Global Brands.  This drop of 24% in one year is a 24% drop in popularity and brand value, and is yet another reason to evaluate holding Harley-Davidson shares in the long term.

"Given the financial focus of the Interbrand rankings, the results aren't really all that surprising," Harley-Davidson spokesman Bob Klein said. "It's to be expected, given the economy and the effect it's had on the motorcycle industry and Harley-Davidson."

Action to Take: Sell Harley-Davidson Inc. (NYSE: HOG) at the market (**).  While the economy is getting ready to roll over into a double-dip event, companies like Harley-Davidson will feel the pain worse than their competitors.  The company is under the management of a bean counter who does not understand the passion of being a "Hog" rider. 

The restructuring will have to address the debt load the company carries.  When you consider that lower production numbers, losses, and layoffs of long-term employees, Harley-Davidson just isn't right now positioned to be a safe harbor in a storm. 

The company will remain a "Sell" until I can see a long-term plan that address the debt loads, the demographics and lack of Harley passion in the front office.

(**) Special Note of Disclosure: Jack Barnes holds no interest in Harley-Davidson Inc. (NYSE: HOG).

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