Harley Davidson - the Premier Brand in the Motorcycle Industry - Case Study Example

Running Head: Harley Davidson Harley Davidson [The of the appears here] [The of the appears here] Table of contents Company Profile 3 Industry Overview 4 Corporate Strategy 6 Quality of Earnings Analysis 8 Profitability Analysis 9 Key Risks 10 Company specific risks 11 conclusion 12 Harley Davidson Company Profile: A 105 year old US leading auto company, Harley Davidson which is a leading motorcycle designer, manufacturer and distributor. Harley Davidson Inc manufactures five families of Harley Davidson brand motorcycles: Sportster, Dyna, Softail, Touring and VRSC. The company's 2006 model year line-up included 33 models of Harley-Davidson heavyweight motorcycles, with domestic manufacturers suggested retail prices ranging from $6,595 to $20,685. Harley Davidson is a premier brand in the motorcycle industry and has a market share of approx. 55% in US and 25% in other parts of the world. In 2005, HDI shipped 329,017 Harley-Davidson brand motorcycles, up from 317,289 in 2004. In addition, HDI manufactures and sells Buell motorcycles, of which HDI shipped 11,166 units in 2005, up from 9,857 in 2004. (Harley Davidson.com) As Harley Davidson is the market leader through a differentiation strategy and unique customization ability and because of high costumer loyalty as company's wide sponsored events and close interactions with its customers. Most market leaders are companies focused on low cost, mass production capacity in which the firm takes advantage of its economies of scale. Harley Davidson's continuous improvement in design, engineering and processes allow for such a leadership through customization and results in operational excellence. Harley Davidson has a grate net work of its dealer ship and has over 1300 dealers through out the world. In 2005, Harley Davidson motorcycles were sold in over 60 countries, with an international sales growth of 15%. The company is listed in stock exchange in the year 1986. Industry overview: For the first six months of 2006, motorcycle sales were up 11 percent and interest continues because of the high gas prices according to the Motorcycle Industry Council. In 2004, the most recent year data was available, the industry posted $7.6 billion in sales of 725,000 on-highway bikes, up from nearly $4.7 billion in 2000 with 471,000 bikes sold. Harley-Davidson brand bikes represented 48.9% of the approximate 517,600 total new U.S. registrations in 2005, down slightly from a 49.5% market share in 2004. In 2005, there were about 252,900 new U.S registrations of the brand's heavyweight motorcycles, up from about 244,500 in 2004. Harley Davidson's closest competitors in U.S. market share in 2005 were Honda (16.6%) and Suzuki (12.4%). Because of Harley Davidson's dormant market share and strength of its brand name, there is little direct price competition. There are High Barriers to Entry to the market. The first is the length of time it takes to build up technical capabilities. The second barrier to entry is the enormous dealer networks that the entrenched players have. There are fairly few but highly competitive brands the motorcycle industry. Most of Harley Davidson's competitors are outside of the US where they hold a dominant share of the market. There is an emotional connection to owning a motorcycle that diminishes the threat of substitution In fact, the motorcycle industry has been cited as a beneficiary of the rise in oil and gas prices and thus has become a more viable substitute to automobiles. Harley Davidson motorcycles represent a niche lifestyle product that buyers will want to purchase regardless of the price so HDI is able to pass on increased costs to its customers. The rise in aluminum, steel and oil could continue to impact production costs over the next several quarters. However, we expect this rise to be moderate as the raw material industries are fragmented and competitive. Corporate Strategy: HDI always focused on the brand name recognition since its inception and desirability of its products. It is the most recognized brand of motorcycle in the world Leverage on its Strong Brand Name and Market Leadership. HDI benefits from the strength of the Harley Davidson brand. HDI promotes its products through the Harley Owners Group, H.O.G, which as of 2006 has more than 1 million members globally. Through the sponsorship of racing events and participation in many of the motorcycle consumer shows and rallies, HDI is able to further increase brand awareness and strengthen its brand name. Focus on Existing Customers. HDI also has a great focus on the existing customer and According to HDI's website, 43% of buyers previously owned a Harley Davidson motorcycle. HDI builds brand loyalty through numerous incentive programs and sponsorship of H.O.G activities. HDI has aggressively targeted the female and younger generation through several programs such as the Rider's Edge Training Program (designed to attract younger riders and women). According to data from the HDI's website, 11% of new retail sales of new Harley Davidson motorcycles in the U.S. in 2005 were to female buyers. We expect this to be a key growth driver for HDI. We expect HDI's marketing focus to include the international markets where the opportunities for growth are much stronger than in the US market. In 2005, HDI's international exports totaled $1.04 billion, up from $917 million in 2004. In terms of motorcycles, HDI shipped 266507 units in the US and only 62510 units for export. We believe that HDI will focus on its strong brand name to penetrate the European and Asian markets. Extensive changes such as the new engine/transmission on big twin models (75% of units), redesigned power train and stylistic improvements in Model Year 2007 releases have driven sales. Comments from dealers indicate that additions and changes to MY 2007 have effectively implemented frequent customer input. We expect to see HDI making a sizeable profit related to financial services that it provides to independent dealers and to retail customers of those dealers. During 2005, HDFS financed 45% of new Harley Davidson motorcycles retailed by independent dealers in the U.S. compared to 40% in 2004. HDI's management is focusing on the relationship with the suppliers and distributors, operational leverage and ability to sell all bikes produced have allowed HDI to enjoy steadily improving operating margins (27.5% in 2005). Quality of Earnings Analysis: The Company follows GAAP guideline in recognizing revenue. Sales are recorded when products are shipped to customers and ownership is transferred. Research and development expenses were $178.5 million, $170.7 million and $150.3 million for 2005, 2004 and 2003, respectively. The Company expenses the production cost of advertising the first time the advertising takes place. During 2005, 2004 and 2003 the Company incurred $66.5 million, $48.8 million and $50.8 million in advertising costs, respectively. On January1, 2005 the Company early adopted SFAS No.123 (revised 2004), "Share-Based Payment," which requires the Company to recognize the cost of its employee stock option awards in its income statement. Total stock compensation expense recognized by the Company during 2005, including stock option and non-vested stock awards, was $23.0 million, or $14.5 million net of taxes. As a result of adopting SFAS No.123 (revised 2004) on January1, 2005, the Company's income before income taxes and net income for 2005 were $21.1 million and $13.0 million lower, respectively, than if it had continued to account for stock option awards under APB Opinion 25, "Accounting for Stock Issued to Employees," and related Interpretations. The allowance for doubtful accounts deducted from total accounts receivable was $8.5 million and $10.3 million as of December 31, 2005 and 2004, respectively. Inventory obsolescence reserves deducted from FIFO cost were $16.7 million and $14.5 million as of December31, 2005 and 2004, respectively. No material change in inventory obsolescence deductions was observed. The Company is subject to lawsuits and other claims related to environmental, product and other matters. In determining required reserves related to these items, the Company carefully analyzes cases and considers the likelihood of adverse judgments or outcomes, as well as the potential range of possible loss. The required reserves are monitored on an ongoing basis and are updated based on new developments or new information in each matter. Profitability analysis: Harley-Davidson's ROE has been stable over the past 5 years. ROE showed an improvement, from 28.8% to 30.5%, between 2004 and 2005. Compared to historical trends of ROE in the U.S, Harley earns excess returns relative to both the historical trends in ROE in the U.S economy as well as its own cost of equity. (12.82%) The increase in ROE is slight increase in net profit margin and higher asset turnover. However, Harley's asset turnover has declined over the years. This is an indication of Harley's overall strategy to differentiate its products - i.e. focusing on profit improvement hence increased profit margins albeit lower asset turnover.(Harley Davidson.com)(see appendix). Key risks: The U.S. economy has entered into a mid-cycle slowdown. Real GDP growth rate has slowed to 2.9% in 2Q06 from 5.6% 1Q06. According to the Bloomberg economist consensus, domestic economic growth will continue moderate to about 2.7% in 2H06. Energy prices will remain volatile and high. Driven by the manufacturing and business activities in Asia, namely China and Indian, demand for oil will stay high. This coupled with tight capacities for oil would keep oil prices at a relatively high range. We anticipate a gradual slowdown in the housing market, which would have a steady negative impact on consumer sentiment and spending. Recession risk could become a concern if there are major oil disruptions and further political tensions in the Middle East, causing oil prices to spike up to unprecedented level for a prolonged period. This risk could be exacerbated if the housing market experiences a hard-landing. In our view, recession risk is still remote at this point. Company Specific Risk: In addition to the macro economic forces that pose a threat to the motorcycle industry as a whole, Harley Davidson stands in front of some specific risks: Competition - the industry is very competitive with some of the company's direct competitors possessing deeper financial resources. New competitors in the heavy weight motorcycle market (Polaris' Victory brand) pose some near-term risk to HDI. However, it will take competitors several years to produce sufficient quantities for the market. Brand - The Company must maintain its brand image for continued growth while there is a possibility its marketing strategy of promoting the Harley Davidson life style may not succeed with new customers. Employees - the Company is dependent upon unionized labor and it possesses high health and pension liabilities. Distributors - The Company doesn't have direct access to the final customer and must rely on the network of distributors. Product Liability - there is always the risk of product liability in this industry, and the company is facing several class action and other lawsuits. Regulation - the industry is one of high government regulation that imposes hefty costs on its participants. Market Risk. HDI is exposed to market risk from changes in foreign exchange and interest rates. The company sells products internationally and as a result earnings could be affected by fluctuations in the value of U.S dollar relative to foreign currency. HDI currently uses derivative financial instruments to mitigate such risks. Conclusion: Demand for the Model Year 2007 Harley-Davidson motorcycles remains strong according to the most recent survey done by Baird of the 40 of the largest Harley Davidson dealers. However, the fundamentals of the firm and its strategic positioning in the industry provide for sustainable long term growth. The company is led by a seasoned and experienced management that come from within the company. We expect the market to undergo a sharp correction in the near future. The U.S market is current overvalued and reaching record highs even though the fundamentals do not justify it. Appendix: Profitability chart: Reference: www.harleydavidson.com Read More