Friday, August 25, 2006

Harley-Davidson: High on the Hog

News Analysis
August 25, 2006

Business Week Online

Harley-Davidson: High on the Hog

Shares hit a 52-week high, but can innovations and international interest make up for a drop in the number of boomers with sagging Harley tattoos?

Believe it or not, Wall Street just hosted a motorcycle rally. No, not that kind. On Aug. 18, shares of Harley-Davidson (HOG ) vroomed to a 52-week high of $59.49, a 16.4% gain for the year when adjusted for dividends. The Milwaukee-based motorcycle maker's stock may still have open road ahead of it, though investors, like bikers, should expect to feel some headwinds.

Harley stock has been riding high in recent weeks. On Aug. 15, Harley changed its ticker from HDI to HOG, a long-running nickname for the company's iconic motorcycles. The price of shares climbed a day later as President George W. Bush visited a York (Pa.) Harley factory to talk up the U.S. economy. Shares sputtered lower to $57.99 in afternoon trading Aug. 24.

So what makes Harley run? For starters, the 103-year-old manufacturer has one of the few brand names actually tattooed on its customers' flesh. Investor focus on this powerful brand should help support the stock, according to Standard & Poor's analyst Tom Graves, who has a buy recommendation (see, 8/7/06, "Best Global Brands: Harley Davidson").

INTERNATIONAL JUMP.  Strong industry sales trends may keep the shares in high gear. U.S. motorcycle sales rose 11% in the first six months of the year, on pace for a 14th straight year of gains according to Motorcycle Industry Council statistics. Harley's 23.7% share of the new motorcycle market trailed only Honda's (HMC ) 27.4% stake as of 2004, the most recent year for which the trade group keeps these data.

Harley's most recent earnings report showed solid results. On July 10, it posted a 3% rise in second-quarter earnings, in line with Wall Street expectations, boosted by a 17.1% jump in international sales. "This momentum demonstrates the continued strong appeal of our products and the Harley-Davidson experience," Harley Chief Executive Jim Ziemer said in a prepared statement.

Meanwhile, Harley's 2007 models are getting a positive reception. The new Twin Cam 96 engine and now-standard six-speed transmissions may drive more hog riders to trade up, says RBC Capital Markets analyst Edward Aaron, who has a sector-perform recommendation on the stock. (RBC has a non-investment-banking relationship with Harley.)

BIG BUYBACK.  Goldman Sachs analyst Julia Crowell upgraded Harley from neutral to buy on July 27, citing the strength of this new product line. "Both dealers and consumers continue to praise the new models," Crowell says in an Aug. 13 note following the company's analyst meeting in Sturgis, S.D., where tens of thousands of bikers go hog-wild each summer at an annual motorcycle bash. (Goldman has an investment-banking relationship with Harley.)

Harley has given its shareholders some trade-in opportunities of their own. The company bought back 9.9 million shares in the first half of 2006, at a total cost of $499.5 million. As of July 17, the bike maker had authorization to repurchase about 10 million additional shares. Companies and investors like stock buybacks because they boost per-share earnings and ease stock-options awards.

From a valuation perspective, Harley may also be sitting pretty. Based on analyst estimates for 2007 earnings, the stock is trading at a discount to the Standard & Poor's 500 index, while growing earnings per share at twice the rate of that broad benchmark, A.G. Edwards analyst Timothy Conder says in an Aug. 16 report. Conder gives the stock a buy recommendation. (A.G. Edwards has a non-investment-banking relationship with Harley.)

AGING AUDIENCE.  But there may be some bumps in the road ahead as the impact of demographic trends could be less clear for the motorcycle maker. According to A.G. Edwards' Conder, who defines Harley's core age bracket as mid-40s to late 50s, positive demographics should pump some fuel into demand over the next 5 to 10 years. Conder adds, "Opportunities remain for additional U.S. market penetration via expanding sales to women and ethnic groups."

However, Morningstar analyst Marisa Thompson says Harley's key consumers are really mostly ages 35 to 45. Thompson notes that their numbers are diminishing as affluent baby boomers age, making sales to new and international market groups increasingly vital. She rates the stock two stars out of five. Harley spokespeople failed to return calls prior to deadline (see, 3/29/06, "Hog Heaven in Beijing").

The uncertain economic environment also poses serious risks. Like General Motors' (GM ) Corvette, a Harley is hardly a household necessity—no matter how dramatic the midlife crisis. A sharp slowdown in economic growth or consumer spending could put the brakes on demand for big-ticket discretionary items, analysts say. A cooling housing market may also reduce the amount of home equity available to tap for potential cycle purchases (see, 7/6/06, "The Housing Outlook and Its Impact").

EYES ON THE ROAD.  Paradoxically, another worry is that the 2007 models may be too well-received. "If used bike prices come down significantly because of the new innovations, this may result in less buying power (due to lower trade-in values) for [Harley] customers to purchase the new bikes," says Citigroup analyst Gregory Badishkanian in an Aug. 11 report. He gives the stocks a hold rating. (Citigroup has an investment-banking relationship with and a significant financial interest in Harley.)

Still, the motorcycle maker's stock might not be as, well, cyclical as it seems, others contend. Says A.G. Edwards' Conder: "Shares have historically traded more like a defensive vs. a cyclical name."

A famous brand and popular new products should help the venerable hog merchant cruise along nicely. But if the economic road turns rough, investors might want to put on their helmets.

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