Harley-Davidson

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Harley-Davidson is a global motorcycle manufacturer, primarily known for its iconic brand and lifestyle, that also offers financial services related to motorcycle purchases.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Harley-Davidson’s business model is built upon selling motorcycles, parts and accessories, apparel, and providing financing options, mostly in the US and Canada, creating a strong and emotional bond with its customers and cultivating a distinctive brand image associated with a lifestyle of freedom, adventure and a love for riding.

Business Overview

Harley-Davidson’s business is multifaceted, encompassing several segments. The most significant are:

  • Motorcycles and Related Products (HDMC): This segment includes the design, manufacturing, and sale of Harley-Davidson motorcycles, plus related parts and accessories. It’s the core of Harley-Davidson’s operations. Sales are mainly made in U.S. through a network of dealers, with a smaller amount made in EMEA and APAC.
  • Financial Services (HDFS): This segment provides financing and insurance products to dealers and customers. It assists in purchasing motorcycles as well as provides insurance and protection products.

The motorcycle industry is experiencing several key trends:

  • Electrification: The motorcycle industry, similarly to the automobile industry, is moving toward electrification. Harley-Davidson is attempting to capitalize on this through its LiveWire brand. However, the shift is proving slow due to a lack of charging infrastructure and higher upfront costs.
  • Changing Demographics: The customer base for traditional motorcycles is aging, leading to fewer new riders entering the market. To offset this, companies like Harley-Davidson are trying to adapt and appeal to a broader and younger audience with more modern and affordable bikes.
  • Shift in Demand: The demand for different types of bikes is shifting. The interest in cruising and touring motorcycles remains strong but a wider variety of bikes including off-road and electric models is increasing.
  • Supply Chain Issues: The motorcycle industry has seen considerable supply chain issues that stem from COVID, and even before. A shortage in raw materials and parts has led to high costs and reduced production. This impacts sales numbers and revenues.
  • Increased Inflation: Inflation is impacting all costs, most notable materials and operational. This increases prices for consumers, with potential negative impacts on demand. It remains to be seen whether costs or prices are sticky in the coming future.
  • Rising Interest Rates: Rising interest rates increase costs for potential borrowers and make it harder for lenders to give out low-rate loans. This will negatively affect the finance and sales industry.

Competitive Landscape

The motorcycle market is intensely competitive, comprising a diverse spectrum of manufacturers, including major international brands. These firms compete on the basis of performance, reliability, innovation, marketing, and brand image. Harley-Davidson is particularly strong in creating its brand image and building long-lasting consumer relationships. However, the company faces competition in multiple areas: * Brand alternatives: New and old companies are building brands that aim at different subsegments in the motorcycle industry. These companies might take sales away from HOG * Price competition: The cost of new and used bikes are highly price sensitive and therefore the cheapest alternatives will attract more sales * Innovation: HOG is somewhat resistant to change and innovation and other companies may be better able at capitalizing new trends in the industry such as electrification or autonomous driving

Moat Analysis

HOG possesses a moderate, or narrow, moat, which makes the business moderately difficult for competitors to fully encroach on:

  1. Brand Loyalty and Image: Harley-Davidson has a robust brand image and a fiercely loyal consumer base. It’s more than just a motorcycle; it’s a lifestyle for many enthusiasts. The company’s iconic design, a rich history, and a distinct, almost rebellious persona are deeply rooted in its marketing and resonate with customers. This results in greater pricing power and a higher average selling price than the competitors. However, a strong brand does not provide a foolproof guarantee.
  2. Customer Lock-in Through a Network Effect: Harley-Davidson has built a strong dealer network that benefits from the company’s brand and therefore a strong ability to source parts, repairs and maintenance quickly. This provides value for customers, which are highly sensitive to repairs times. A dealer network of such size has been hard for competitors to replicate.
  3. Intangible Assets: Intellectual Property: While HOG’s patents and proprietary technology protect its production, it is by no means a large moat. Competitors are always capable of creating similar alternatives that may render those patents as obsolete. HOG cannot rely on these patents to ensure pricing power or repeat sales.
  4. Customer Switching Costs: While not as strong as those in other industries, buyers of a Harley-Davidson are more likely to stay and not buy an alternative brand because of the community and lifestyle that accompanies owning a HOG.

Moat Rating: 3/5 While the brand strength gives Harley-Davidson a significant and robust moat, the company is not infallible. Strong and lasting brands can disappear in time. Competitors are constantly trying to improve and take market share.

Legitimate Risks That Can Harm The Moat

Harley-Davidson faces several risks:

  1. Brand Image Deterioration: A brand is not a static entity and must be protected and improved to last through the ages. The brand can be damaged by events that are out of the company’s control or bad decisions by management. HOG should also be aware of how they portray themselves in marketing and always keep a pulse on consumer needs.
  2. Changing Consumer Preferences: The shifting tastes of a new generation of riders can negatively impact Harley-Davidson. The shift to younger demographics, as well as sustainability, can lead to a reduction in revenue unless HOG is able to adapt.
  3. Competition: Intensified competition from lower-cost manufacturers, particularly in emerging markets, threatens HOG. A failure to innovate and improve will hurt the business’ long-term potential.
  4. Dependence on North America: A significant portion of Harley-Davidson’s revenue is from the U.S. and Canada. Over-reliance on a particular region may make the company vulnerable to adverse economic conditions or other unforeseen events in that specific market.
  5. Product Liability and Legal Risks: The motorcycle industry inherently carries product liability risks. Therefore, HOG faces the risk of costly lawsuits and high insurance premiums, which in turn hurts profitability.
  6. Supply Chain Disruptions: A reliance on parts from other providers might hinder production and thus sales. Supply chain problems have shown their ugly face during the recent years.
  7. Pricing Power: While HOG enjoys some pricing power due to its brand, they can only increase prices to a certain degree. If they overshoot, they may start to loose sales.
  8. Innovation and R&D: Harley-Davidson is notoriously slow at adapting and has struggled to come up with innovations that appeal to newer demographics. They should be able to develop new technologies, particularly in electrification, to remain competitive.

Financial Health

  1. Revenue: Harley-Davidson’s revenue is heavily reliant on its motorcycle segment. HOG has struggled to grow revenues in the past years, seeing a small growth between 2017 to 2021. But in 2022 they had a huge boost in sales. This is reflected in the 2022 yearly revenue of $5.8 billion, a 13% increase from the previous year. And a nearly 30% increase from 2020.
  2. Margins: Harley-Davidson’s gross margins on average are about 30%, while net income margins tend to fall anywhere from 6 to 11% as a result of operating and finance expenses. Both operating and net income margins have improved considerably in 2022.
  3. ROIC: Harley-Davidson has been seeing a gradual decline in ROIC (return on invested capital) over the last couple of years (from 18.6% in 2015 to 13.6% in 2019). However, its ROIC jumped considerably to 16.7% in 2022, showing that the company’s ability to generate value has increased compared to the prior years.
  4. Cash flow: Free cash flow has increased greatly to 1137.9 million from 780 in the previous year, indicating that the business is now generating more and more cash to fund itself.
  5. Balance Sheet: Harley-Davidson is highly reliant on debt to finance both their lending arm, and their core business. It has around $4.9 billion in debt while having around $2.6 billion in cash and cash equivalents. This does not render the company unviable, however, it creates considerable risks related to refinancing, and changing interest rates.

Balance Sheet Health: 3/5 The financial health of Harley-Davidson is at a moderate level. There is concern over high levels of debt. There was, however, recent improvements in operating profits, ROIC and cash flows.

Understandability

Harley-Davidson’s business can be quite hard to understand since a lot of value is derived from the brand’s perceived value, consumer’s emotional connection and a certain lifestyle. Therefore understanding the company from a solely economic and financial perspective is difficult. The various methods that HOG uses to create value is somewhat unique and might be hard for a new comer to the business or value investing to understand.

Understandability: 2/5 The company’s fundamentals are quite understandable, but it is very difficult to understand all aspects of the business, especially given the “brand’s perceived value” and intangible assets that it is built upon.

Recent Controversies and Issues

HOG faced challenges in the past couple of years, particularly with the COVID-19 pandemic, which resulted in supply chain disruptions, and reduced production output, as well as rising input costs. However, the company is recovering from the pandemic and is shifting focus towards improving production efficiencies and improving its customer base. HOG, however, still remains dependent on the North American market, but has attempted to increase its overseas sales. HOG has focused on building their electric motorcycle department, LiveWire. It is yet to be seen if they are successful in doing so.

In recent earnings calls, management has stated a focus on enhancing their core business, but also trying to expand in new and growing markets, especially with its new EV motorcycles. There were also announcements for cost controls and improving manufacturing process. Management continues to state that their production levels are rising, and they expect to fully meet customer demands. The new management at HDFS has created new plans to improve the financing side of the business and increase revenue, with focus on reducing risks. They emphasized the importance of growing customer base, and especially appealing to new demographics.

Overall analysis

Harley-Davidson is a complicated business, that is primarily driven by its powerful brand, image, and the lifestyle that accompanies owning a HOG. The company should continue to produce strong profits as long as it continues to improve its brand and customer relations. However, there is an intense need to adapt to the changing trends in the industry and to bring new innovations to the market. The company should try to diversify its market and become less reliant on North America, and also focus on growing revenues, and improving its profitability. The large amount of debt makes the company fragile, and in the case of a economic turndown or unforeseen events, this might cause the downfall of HOG. The company also remains highly vulnerable to bad publicity or damage to their brand. HOG should, therefore, focus on improving operations, paying down its debt, and continuing its work on improving brand image and innovation.