Wednesday, March 01, 2006

Is Harley Still On Top of the World?

Bike king Harley Davidson (HDI) could be headed down some bumpy roads. We are initiating coverage on the 100+ year old icon today with a marketperform rating.

For as long as one can remember, Harley has held the motorcycle category in a headlock. Selling an image that chimed well with machismo Americana, Harley posted increasing revenue growth for 10 straight years.

While we think Harley's #1 competitive advantage -- its brand -- faces litte risk, we are concerned with two factors.

One, Harley's core market seems to have hit a saturation point. Bikes in general have a long life cycle, and the average Harley customer is between 35 and 55 years old. Studies show that these people are unlikely to buy a new bike anytime soon. They are part of the Baby Boomer generation. Frankly, we don't see these guys jumping out of their rocking chairs at the age of 62 for a ride around the block. Meanwhile, the next generation -- us youngsters -- suffers from an abysmal savings rate. We can't afford a Harley. We suspect top line growth will inevitably hit a rough patch, even as operating margins remain robust.

Our second concern is tied to monetary policy. Harley has a financing arm that services Harley customers. That division could suffer with climbing interest rates. Analysts on the Street feel that this arm is worth $7-$8 dollars to Harley, but increasing interest rate exposure could force analysts to reconsider their models. Lastly, the international expansion could fail. There is no guarantee that the Harley product image will carry the same weight overseas as it does here in the US. If demand abroad is weak, Harley's streak could fade.

To console patient investors, Harley remains a highly profitable business with an all-star management team. Most importantly, Harley's brand equity faces little erosion risk. But we remind investors that an impenetrable brand in and of itself can not prop up up a stock forever.

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