Harley's Sales Are Born to Be Mild By Doug Kass Special to TheStreet.com 4/16/01 12:49 PM ET

Harley-Davidson's (HDI:NYSE - news - boards) earnings have compounded at an impressive 21%-plus annual rate over the last five years. Wall Street analysts wax enthusiastically about the company's prospects (there are no sell recommendations), expecting profit growth to continue at nearly a 20% rate through 2005.

In part, as a result of those bullish analytical views, Harley-Davidson, the world's largest purveyor of motorcycles, sells at a generous 36 times trailing earnings, 10 times book value per share, and its market capitalization of $13 billion is more than four times its annual revenue. One analyst recently wrote that Harley-Davidson was "the most compelling investment opportunity in our leisure universe."

Harley's common shares peaked at more than $50 last year, and currently sell at about $42. Despite the loss of price momentum, Harley-Davidson is still the leader of the pack in the portfolios of momentum investors such as Putnam Investment Management and the Janus Funds (the wonderful folks who own large positions in Palm, Nokia, Cisco, Palm, Corning, etc.), which each own more than 5 million shares of Harley.

I believe Harley-Davidson faces a number of challenges over the next few years -- the most important of which is the graying of the Baby Boom generation, the same generation that has been the mother lode to Harley's earnings. The Boomers now are trading in those weekends on U.S. Highway 1 for weekends with the grandkids in their new BMW X-5 sport utility vehicles. Another issue is that for several years to come, the faltering economy is unlikely to exhibit the same sort of strength recorded over the last five years. Along with unprecedented economic growth, massive wealth creation, abetted by rising stock prices, provided a strong wind behind the company's growth. No longer.

Besides tepid economic growth, several developing trends indicate an imminent slowdown in sales and profits growth at Harley-Davidson.

1. Harley sales are an international phenomenon. But international sales appear at risk because of the strength of the dollar. Industry and dealer contacts in Europe say that the rising dollar is pricing consumers out of the market -- and sales of BMW and Japanese bikes are gaining market share. Non-Harleys are priced some 40% less than the U.S.-made Harleys. The Japanese knockoffs sound and look very much like Harleys.

2. Since Harley-Davidson recognizes revenue on delivery of bikes, it is paramount to measure inventory and the turn of that inventory. Based on a consultant's survey, Harley dealers have unusually large inventories of bikes. His view is supported not only by the survey of more than 40 dealers, but also by surfing the Internet, where a number of Harley dealers maintain sites and "no-wait-list" advertisements are increasingly common. In the past, dealers have sold hogs at premiums to manufacturers' retail selling prices. I have found that many dealers are no longer selling bikes at premium prices. Used-bike prices are falling, and both new and used are readily available. And the company appears to be offering "special allocations" (read: "more bikes") to selected dealers.

3. Several dealers surveyed have been quick to point out that there are no more waiting lists. That wait -- from three months to two years -- seems to have gone away concurrently with the increase in inventory at the dealers ... strange? And a few dealers even offered up the fact that they were hiring sales managers for their dealerships. Sales managers? Why do you need sales managers for products that, according to Harley-Davidson management, are on allocation and have wait lists?

4. For decades, Harley has been the driving force behind the growth in the heavy (650+ cc engine) motorcycle segment. But in 2000 and in the first quarter of this year, Harley has consistently lost market share in the heavy bike area. Harley lost more than 3 percentage points in market share last year, which, according to the company, was due to its inability to deliver bikes. It is worthy to note that Harleys have been on allocation for the last 15 years and the company has never lost market share to this degree.

Indeed, the beginning of Harley-Davidson's fourth-quarter conference call began with a cry from management that short-sellers were passing on false information! Enough said.

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