Financial Analysis of Harley-Davidson, Inc. (HDI) for the Five Years 2001- 2005

Financial Modeling & Corporate Finance

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Brief Background on Harley-Davidson, Inc.

The founders William A. Harley and Arthur Davidson built their first motorcycle in 1903 in a

woodshed turned ‘factory’ in Milwaukee, Wisconsin. By 1907, the company was incorporated,

and five years later Harley-Davidson’s dealer network included 200 domestic retailers and

exports to Japan. The company’s steady growth was fueled by innovative design and a reputation

for rugged performance. More than 100 years later, Harley-Davidson has evolved from a

transportation provider to the market-leading manufacturer of recreational cycles.

Harley-Davidson, Inc. (HDI) operates in both, the manufacturing and sale of motorcycles, and

the financing of products to dealers and retail financial services including insurance, warranty

and private-label credit cards. For purposes of this analysis, the combined financial statements of

both operations will be used in presenting our assessment of HDI’s financial condition and the

significant changes that occurred in the years 2001-2005.

Company Performance – Sales and Growth

Employing more than 9,700 world-wide, Harley-Davidson is lead by James L. Ziemer. Mr

Ziemer started with the company in 1969 and spent 14 years as its Chief Financial Officer,

where he was responsible for Harley-Davidson’s steadily increasing revenues and for

orchestrating HDI’s entrance into the financial services industry. Harley-Davidson is ranked

number 380th

in the Fortune 500, and in 2005 reported a 20th

consecutive year of record revenues

of 5.34 Billion USD and a U.S. market share of 49.5%.

Harley-Davidson’s profit ratios are strong with steady increases in both revenue and net income

from continuing operations. Profit ratios have increased each year in the period studied and

trend in line with both, return on assets and return on equity. HDI’s profit margin of 18% in 2005

is more than double that of both, the 6.5% industry average and 8.3% for the S&P 500 average.

However, Net Income and Revenue have seemed to level off in 2005. In fact, the graph below

shows the percentage year over year growth in Sales, Gross Profit, COGS and Net Income and it

is clear that the growth rate is slowing. On the positive side, management appears to be

controlling costs as indicated by the decline in the growth of COGS. More evidence of cost

controls will be presented later.

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Figure 1 Year over Year Percentage Growth

Harley-Davidson’s market value ratios are consistent with that of a mature industry competitor.

Though the PE ratio of 15.04 would normally indicate a low potential for continued growth,

when compared with the industry average PE ratio of 20.8, HDI’s stock appears somewhat

under-valued. In 2004, HDI common stock sold for 19.83 times its overall return. This ratio

took a hit in 2005, when HDI’s stock price softened reacting to the cancellation of 10,000

production units at the end of the 1st Quarter, sending a warning that Harley-Davidson may have

miscalculated demand forecasts and would not meet projected 2005 revenues. The 2005 fiscal

year closed with a PE ratio of 15.04, indicating a potential slowdown for both demand and future

revenues.

The Market/Book Value or Price/Book ratio has varied widely in the period studied, with a low

of 4.68 in 2005 and a high of 9.08 in 2001, while Book Value per share has been steadily

increasing.

Cash Management and Stockholder Value -

A comparison of the 2005 Current and Quick ratios of 3.6 and 3.35 respectively, indicates that

HDI carries a low percentage of inventory as current assets, in this case approximately 7%. This

business model is unique to Harley-Davidson within this industry with competitors carrying and

average of 50% of current assets as inventory. Harley-Davidson maintains a tighter control on

inventory levels, keeping it fairly stable from 2002 – 2005 after spiking in 2001.

Examination of the current ratios and quick ratios, reveal a steady increase in these ratios,

demonstrating that Harley-Davidson is in a strong liquidity position with both ratios substantially

greater than one. Looking at the entries on the income and balance statement, accounts

receivables increased by a modest amount between 2004 and 2005, however, inventories fell

during the same period. It is worth noting that in 2005, finance receivables accounted for over

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25% of total assets and while a small percentage, HDI management will continue to rely upon

financing as a stable source of secondary income.. In figure-1 below, both Inventories and

Accounts Receivables declined and stabilized over the period while Net Receivable increased

from 2003 to 2005, due in part to increases in financing activities. Net Receivables constitutes a

significant percentage of total assets of the company.

Figure 2 Receivables vs. Inventory

Harley-Davidson had a cash ratio of 1.2 in 2005 which has decreased slightly from 2004 and

2003, but it is still greater than one and therefore at an acceptable level. The ratio of networking

capital to total assets percentage is at 43%, another indication of good liquidity. The Interval

measure shows that Harley-Davidson can operate for 347 days with no new cash inflows, this is

another positive sign. Finally, Harley-Davidson has held its average payment period to its

suppliers close to 30 days over the period, another indication of its strong cash flow position.

In recent years, management has introduced a policy to increase cash on hand and pay higher

dividends. In 2005 Harley-Davidson paid a dividend of $.63/share. The dividends paid out have

risen sharply, averaging 55% per year over the period analyzed. This is a substantial increase

over prior periods which paid and average dividend of roughly $0.098 per share. Although

management referenced the increased dividends in the 2004 and 2005 Annual Reports, there was

little explanation on the seemingly dramatic shift in the dividend policy. Resulting shareholder

profit has increased consistently during the stated period and has outperformed industry and S&P

500 averages of 18.8% and 12.4% respectively. Shareholder profit rose from 23.01% in 1999 to

27.65% in 2004, resulting in an overall increase of 4.64% and a five-year average of 27.4%.

Common stock valuation has remained stable in part due to the recent re-purchase of $1.05

Billion of stocks in 2005 and $564 Million in 2004. Management indicated this was in response

to 2002 and 2003 exercised options of more than 4.6 Billion shares and was intended to prevent

dilution of stock values.

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Financial Leverage –

Increasing profit, steady liabilities and shareholder equity ratios indicated in the increased sales

reports are a result of true growth, as opposed to re-valuations or other potentially misleading

calculations. While long-term debt has increased slightly over the period, other markers

including total debt have remained stable. Upon examination of the common size balance sheet,

it is notable that current liabilities in 2005 actually fell from 21.39% to 16.61% from the prior

year, while total liabilities remained steady at 41.3% of total assets. Also important is the post

retirement health care benefits expense, which decreased by nearly 60% in 2005 to only 1.16%

of total assets, demonstrating management commitment to controlling costs. In order to compare

to industry data, we used the “Finance Debt Ratio” which is slightly different than the textbook’s

long term debt ratio. Using this measure, Harley-Davidson is at .32 while the industry average is

a bit lower at .26 and the S&P 500 is significantly higher at 1.04. Based on the steady increase

in borrowing (financed debt) from 12% of assets in 2001 to 19% of assets in 2005, Harley-

Davidson appears to be taking on more debt for long term investments. There is some evidence

of expansion overseas, especially in China and this may be reason for the increase in borrowing.

However the long term debt ratio in 2005 is only .24 and is still very reasonable.

Of potential interest are the Times Interest Earned (TIE) ratios and Cash Coverage ratios. In

2005, these ratios seem to have plummeted to 42.11 and 47.49 respectively, falling about 32%

each. However, this is still twice the industry average of 21.6 and 14 times greater than the S&P

500 average of 3.3 (see figure-2)

Figure 3 Leverage Ratios

Asset Management, Turnover –

Harley-Davidson makes efficient use of assets in production of motorcycles. Inventory turnover

is on the rise and with a value of 14.9 in 2005 bested industry averages of 8.1 by 84%.

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Inventory ratios are decreasing as management increased focus on supplying adequate dealer

inventory and more efficient supply chain management. A noticeable decrease in days of

inventory supports management’s strategy to move inventory to dealers/customers more

efficiently eliminating back-orders and poor customer satisfaction feedback. Days of inventory

have decreased consistently from 29.3 in 2001 to 24.5 in 2005.

Accounts receivables turnover is consistently high, this is due in large part to HDI’s policy of

selling loans to move them off the balance sheet, freeing up additional capital. Simple ratios

using stated HDI accounts receivables are not necessarily an accurate measurement with this

company, due to Harley-Davidson’s policy of asset-backed securitization, which moves current

accounts receivables off the balance sheet each year.

At year end 2005, HDI held 8.34 days of sales in loaned funds and maintained a receivable

turnover ratio of 3.5, which is low compared to the industry’s average turnover of 7.4.

The Total Asset Turnover Ratio stays generally around one. This measures the number of

dollars of sales generated by a dollar of a firm’s assets. Total asset turnover of 1.06 in 2005 is

lagging behind the industry average of 1.6 or every 5 months The S&P trailed both at 0.4. The

Fixed asset ratios were also fairly consistent while the net working capital ratio, a measurement

of return on capital is fluctuating and moving downward in the period from a high point of 3.59

in 2001, to a rate of 2.00 at year end 2004 but picking up a little in 2005. Total asset turnover in

2004 of .97 and 1 in 2005 are lagging behind the industry average of 1.6 or every 5 months. The

lag in this number could be as a result of the cancelled order of 10,000 units in 2005 after a

disappointing first quarter report.

Harley-Davidson reported total earnings of 959 Million in 2005. Recent capital expenditures

include the expansion of the Harley-Davidson product development center in Milwaukee,

Wisconsin in 2003. Since this time, HDI trimmed expenditures to compensate for the increased

debt obligations and this appears to be working to maintain adequate ratios.

Profitability Measures –

Harley-Davidson is unquestionably profitable, however, as mentioned earlier, profitability

growth has begun to slow by 2005. Looking at the trends for Net Profit Margin, Return on

Assets, Return on Equity and Earnings per share shows an upward trend over the period with Net

Profit Margin flattening towards the end of the period. HDI’s ROA of 18.3% and ROE of 31.1%

are considerably better than industry averages of 10.8% and 20.6% respectively, and 2.8% and

16.1% for the S&P 500. In looking at 5 year averages, HDI is consistently well ahead of the

Industry and S&P 500 in terms of these profitability measures.

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Figure 4 Profitability trends

Market Value Ratios Analysis –

Figure-4 shows a summary of the Market value ratios. As can be seen, the P/E ratio has declined

rapidly since 2005 with HDI price below both the industry average and the S&P 500, which

indicates the stock is undervalued at this time. Notice the Market Value to Book ratio is

declining in concert with the PE, while the book value per share has risen until 2005. The

Earnings per Share has risen steadily over this period.

Figure 5 Market Value Ratio Trend

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DuPont Analysis –

By breaking the return on assets and equity into the components of these ratios, analysts are able

to use this formula to determine operating efficiency, asset use efficiency and financial leverage.

In the case of Harley-Davidson, the return on equity is stable throughout the period and can be

represented by the following formula:

ROE= Profit Margin x Total Asset Turnover x Equity Multiplier

Calculating Harley-Davidson’s 2005 ROE

ROE = 17.96% x 1.02 x 1.70 = 27.57

ROE = 31.1%

An expanded DuPont Analysis will uncover more detail about the components of ROE and can

be a useful tool in determining future course of action by management to improve profit,

maximize financial leverage and improve efficiency.

Figure 6 DuPont Analyses

Plus

ROE

31.1%

Equity

Multiplier

1.7

Multiplied by ROA

18.3%

Profit Margin

17.96%

Total Asset Turnover

1.02

0.97

Multiplied by

Sales

5342214

Divided

by Net Income

959604

Total Costs

4382610 Subtracted

from Sales

5342214

Sales

5342214

CoGS

3301715

Depreciation

205705

Selling &

Gen Admin

310845

Interest

36190

Taxes

528155

Fixed Assets

2109972

Divided

by Total Assets

5255209

Current Assets

3145237

Net

Receivables

& Deferred

& Prepaid

1763853

+

61285

+

52509

Cash

1046172

Inventory

221418