Investment Jungle

Investment Jungle reader Jochen has suggested that I have a look at Harley-Davidson Inc. which has had a selloff recently. This stock trades on the NYSE under the most appropriate ticker symbol of HOG.

This is a stock that is featured in Phil Town’s Rule #1 book. It was a Rule #1 stock back when the book was written. Is it still a Rule #1 stock? Let’s find out.

Company Profile:

From Yahoo Finance

Harley-Davidson, Inc., through its subsidiaries, produces heavyweight motorcycles, and various motorcycle parts and related accessories in the United States and internationally. It operates in two segments, Motorcycles & Related Products, and Financial Services. The Motorcycles & Related Products segment engages in the design, manufacture, and sale of primarily heavyweight touring, custom, and performance motorcycles, as well as a line of motorcycle parts, accessories, clothing, and collectibles. It offers its products under the Harley-Davidson and Buell brand names. The Financial Services segment provides wholesale and retail financing and insurance programs. It engages in financing and servicing wholesale inventory receivables and consumer retail loans primarily for the purchase of motorcycles.

Market capitalization is $11.98B.

Fundamental Analysis:

Looking at management’s performance, they definitely deserve a standing ovation. They have been able to steadily increase their return on invested capital by more than 13% since 1997. Back in 1997, management was achieving ROIC’s in the 15% range. It has been steadily increasing and last year’s ROIC came in at 28.8%. The 5 year average is 23.6%.

The return on equity numbers demonstrate this as well. The 10 year average is 25.8%. The 5 year average ROE comes in at 29.15%.

Unfortunately, that seems to be where the good news ends as we start looking at the 4 key growth rates.

The equity growth rate has seen a massive decline over the last 10 years. The 9 year rate is 18.85%. The 5 year rate drops to 13.49%. The 3 year rate gets crushed at 2.89%. And last year’s rate came in at -5.07% (that’s right, negative!).

The earnings per share growth rate has been trending downwards. The 9 year rate is 25.62%. The 5 year rate drops slightly to 22.11%. The 3 year rate drops to 16.01% and last year’s EPS growth rate holds steady at 15.25%. A definite decrease from the earlier days of 28% to 32% EPS growth rates.

Sales growth rates have not been hit as hard, but definitely trend downwards. The 9 year rate is 14.91%. The 5 year rate drops to 11.13%. The 3 year rate comes in at 7.91% and last year’s sales growth rate rebounded slightly to 9.02%.

And as you might have guessed, the cash flow growth rates have also declined from the 9 year rate of 23.12% down to last year’s cash flow growth rate of 14.6%.

Definite turnaround in all the growth rates. And not in the Rule #1 investors favour!

Stock Analysis:

Let’s see if we can put a sticker price on this one.

For my future EPS growth rate, I will be generous and use the 5 year equity growth rate of 13.49%. Although I usually like to use the more conservative values, this would force me to a negative equity growth rate (as experienced last year). However, analysts have forecast only 11%. So I will use their more conservative estimate.

For my future P/E, I will use the current P/E of 11.45 which is considerably lower than the 10 year average P/E of 23.87 or the 5 year average P/E of 18.67.

With these numbers, my sticker price works out to $32.64. At the current price of $46.50, Mr. Market is demanding a premium of 42.48%!

Here are my Rule #1 calculations for HOG.

Here is the 1 year stock price chart for HOG:

Wow. This stock has had quite the pullback since November 2006.

Conclusion:

Well, this stock illustrates that a company does not necessarily remain a Rule #1 company forever. All the growth rates are clearly headed in the wrong direction. I would no longer classify this a Rule #1 company.

Interestingly enough, the earnings yield on HOG is 8.73%! Warren Buffett definitely likes to look at a business where the yield is much higher than the long term bond yield (currently sitting at 4.46%).

With the current turmoil in the US housing market and the credit market, I have a feeling that the boomers won’t be lining up to purchase these expensive toys over the next couple of years.

Full Disclosure: I do not own shares in HOG.

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