Margin Of Safety Saves The Day In A DCF Valuation Of Harley-Davidson

I recently stumbled across an old discounted cash flow (DCF) model from mid-2006 that I built for Harley-Davidson (HOG, formerly HDI) as I was weighing whether to invest. I thought it would be fun to assess my process from the vantage point of 2019.

In June 2006, HOG’s stock chart looked like this compared to the S&P 500 over the previous 5 years:

(Click on image to enlarge)

Source: Yahoo Finance

It was up almost 13% vs. SPY, but in the year prior it had had a pretty big mid-year tumble, from $62 to $45, reaching around $54 by the end of June ’06. This brought it to a relative value that made it worth taking a look at.

The main reason HOG had come across my radar, however, was its dividend. It had steadily grown its dividend to the point where its dividend yield (as of mid-June 2006) was about 1.28%. My minimum screener threshold is usually around 1.0%. Here’s HOG’s recent dividend history at the time:

That’s a strong, consistent dividend growth rate!

With a company like Harley-Davidson, I already knew quite a bit about their products, so there was less digging necessary. Here are some highlights from my research (mostly quantitative, since anything qualitative is gone):

  • Overall sales growth had been solid, especially during the economic weakness from 2001-2003, but it had slowed of late — which is was concerning given the strength of the worldwide economy by that point.

  • US sales were up slightly, while international sales were more robust but were still only 20% of the total. It seemed like there was room to run internationally, but US and European heavyweight motorcycle markets would probably not grow much, so the main opportunity in those two largest markets was to take share (a difficult proposition).

  • Harley’s financing division was also growing, and at a slightly faster rate than sales. This was under 6% of sales, though, so I didn’t consider it hugely material.
  • EV/EBITDA was around 8.2, so didn’t look expensive.
  • FCF/Sales was around 12%, so it’s obviously not a massive FCF generator, but it was OK, and the dividends were decent and growing. The actual dividend payout was around $174M, so it was covered by FCF 3.5x. The dividend seemed pretty safe.
  • As brands and products go, I rated HOG as very strongly differentiated.
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