| 2023 | 2024 | ||||||
| Price: | 32.00 | EPS | 4.15 | 4.92 | |||
| Shares Out. (in M): | 144 | P/E | 7.7 | 6.5 | |||
| Market Cap (in $M): | 4,636 | P/FCF | 0 | 0 | |||
| Net Debt (in $M): | -100 | EBIT | 779 | 901 | |||
| TEV (in $M): | 4,736 | TEV/EBIT | 0 | 0 | |||
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Please refer to the 2021 write-up detailing the new CEO and his strategy.
Harley's stock has underperformed the market and the powersports category for several reasons:
I believe all of the above issues are now priced in. Interest rates are already reflected in 1H results and the 2023 guidance. Market share losses reflect substantial product realignment and geographic exits over the last several years, but market share in core heavy cruiser/touring categories has remained stable.
Lastly, the finco has seen peak delinquencies in 1H (Q2 was sequentially lower than Q1 even) and guidance reflects normalization of finco profitabilty to mid-cycle levels. The Finco is 85% prime and earns an average interest rate yield of 10%, more than ample to compensate for any defaults. We expect HDFS operating income to decline from $318M to $170M in 2023, then recover to $252M/year on roughly flat balance sheet. This is below the trailing nine-year average annual operating income of $290M and a result of normalization of tax-adjusted Return on Equity from 23.0% to 17.7%.
My long term bullish outlook on H-D is predicated on three secular drivers:
The combined result is that I expect EPS to grow from $4 to $6, reducing P/E ratio to just 5x. Since H-D has no net debt (I exclude HDFS non-recourse debt and interest expense from the cap table/EBIT calcualtions), the company already generates an 8% FCF yield, and we expect that to increase to 20%/year.
My valuation of $40 assumes a 7x P/E on the $6 EPS. HOG generated $3 of FCF/share in 2022, which is returned to shareholders through buybacks/dividends. As the thesis plays out, we expect to see growth in capital return that will serve as the catalyst for stock appreciation.
Until Jochen's arrival, apparel was an after-thought for the company. Apparel was run by a former GM of the parts business. Jochen recruited Erika Boullard from Nike to join H-D and lead the apparel business. Our industry checks have all uniformly stated that the quality and design of the apparel has made a generational leap in the past several years, especially for female riders. When Jochen first joined the company, he observed that there were vintage H-D gear selling on eBay for thousands of dollars, but the current merchandise for sale was not very impressive. While apparel is only $287M revenue in 2023, the contribution margins on apparel are likely ~50% vs. 29% on motorcycles. Apparel revenues were declining prior to 2020, but have since grown at 20%+ rates. Anecdotally, news reports from H-D's 120th anniversary bash in Milwaukee noted long lines for H-D merchandise and suggested replacing some of the bars with merch stores for next year's event.
Licensing is in an even worse state, generating only $33M of revenue (100% margin) in 2023, most of it from a 3rd party t-shirt manufacturer. Ferrari's licensing revenue is 10x larger than H-D. While at Puma, Jochan struck a lucrative licensing deal with Ferrari so this is again an easy opportunity to generate incremental profits. In 2023, H-D announcing a licensing deal with Hero Motorcycles in India. Hero designed and manufactured a $3k ASP motorcycle with the H-D logo, and this bike sold out with 25k pre-orders within weeks of launch. We estimate just this one deal to have generated a recurring stream of $8M/year (assuming 40k/year units).
We believe apparel and licensing business could double over the next 5 years and increase from $300 to $600M revenue. Assuming 50% incremental margins on apparel and 100% incremental margins on licensing, this would add ~$200M to operating income or ~$1.00 of EPS after tax.
H-D unit sales have declined from 262k to 187k 2016-2023. We believe most of this decline was intentional, as laid out in management presentations over the last several years. H-D exited 60+ global markets where it had very low market share. H-D also discontinued 25% of it's model line-up, eliminating lower priced bikes where it lost money on every bike. It shrunk the number of platforms from 5 to 2. The result was a significant increase in average revenue per motorcycle (excluding parts/apparel/etc) from $16k in 2020 to $20k in 2023. It also meant that the bike business (excludings parts/etc) went from losing money on average bike sold to making a 29% gross margin. Of course that meant giving up units as competitors took over in markets or model categories where H-D no longer offered a product.
While the stock trades on units/market share in the near term, motorcycle revenues have been growing through Covid and guidance expects it to grow again in 2023.
We believe the leading indicator of H-D unit sales will be driven by demographics and continued appeal of the brand.
The average age of a new H-D purchaser is 45 years old, which has been unchanged over the last 25 years. 60% of purchasers are 35-54yo, 18% are <35, and 22% are 55+. US Census data shows that the US male population in the 35-54yo category declined by 0.5%/year from 2010-2019. Since 2019, the target demo has grown by 3.1% through 2021. The Congressional Budget Office (CBO) 2023 population forecast expects the target demographic to continue to grow at 0.7% CAGR through 2033. According to an industry expert, most first-time H-D purchasers are moderately wealthy, are settled in their home life, and are going through “a mild mid-life crisis.”
A significant risk for H-D is its current popularity among middle-aged individuals, which may not necessarily extend to future generations. Data from S&P Mobility estimated that H-D US ridership – a metric that tracks unique people, rather than motorcycle registrations – has grown at 1.1% CAGR since 2015. Unfortunately, there is no detailed demographic data available on H-D ridership. As an alternative, we analyze fatality and crash data from the National Highway Traffic Safety Administration.
It is crucial to note that the average age of riders involved in fatal crashes should not be directly interpreted as the average age of H-D riders overall, since younger riders are generally more likely to be involved in fatal accidents compared to older riders. However, if the average age of H-D ridership had trended significantly upwards over the last decade, it would be statistically improbable for the average age of rider fatalities to remain constant. Consequently, we can utilize this data to demonstrate that the average age of H-D ridership has remained stable over time.
Our findings reveal that the average age of H-D fatalities increased rapidly between 2007 and 2011 before leveling off, and then began to decline since 2019. In comparison, the average age for fatalities involving other motorcycles exhibited similar trends but did not experience a decline after 2019. Additionally, we observed an overall growth in total fatalities for H-D motorcycles across all age groups, suggesting an expanding appeal of H-D motorcycles across generations despite the lackluster new unit sales. It is important to note that total fatalities are also influenced by other factors such as rider safety and gear.
We expect the core motorcycle business to be flat in units and revenue over the next 5 years. Motorcycles do not last forever (average bike on the road is 13 years old), and all the evidence points to slight growth in number of H-D bikes used in the field. H-D bikes have improved significantly in terms of weight, performance, and efficiency, and dealers are generally optimistic about the future of the brand. Down to just 2 platforms, we don't expect any further model eliminations or exits from geographies.
LiveWire is H-D's electric motorcycle brand. It currently has minimal revenue but a significant amount of product development expenses for the upcoming DelMar motorcycle launch. After Jochan came in, he orchestrated the offering of LiveWire to 3rd party investors, with 89% still retained by H-D. While the market value of that stock is $1.5B+, this is misleading due to the small float. The borrow rate on LVWR is 140%/year, for example.
What is not accurately reflected is that H-Ds EPS should not reflect continued investment into LiveWire in perpetuity. We expect LiveWire investment to peak at $132M of operating losses plus $30M of capex in 2024. We then model the entire investment being written off as a loss in 2026, with no further investment beyond 2025 but also no recovery on previous investments. This contrasts with the current market value of LVWR shares retained by H-D of $1.5B. LiveWire spin-off allows for externalization of EV investment and SPAC projections expected the unit to be FCF breakeven in 2026E. LVWR has $250M of available cash that should fund the business for the next 2 years, but it is able to sell shares to 3rd parties to raise additional capital. Removing the 2023 LVWR losses from H-D income statement would increase operating income by $121M and increase EPS by $0.50.
While H-D has traded entirely on the core motorcycle business / financing company, we believe the street is missing that you don't need to underwrite growth in motorcycle units for the stock to work at current levels. The non-core apparel and electric bike business improvements alone can get FCF into $5/share or 20% yield. Meanwhile, at current valuations the margin of safety is quite high, as the motor company and HDFS are generating strong free cash flow and expected to maintain high market share and brand loyalty in the core base.
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