Harley-davidson (hog): Buy, Sell, Or Hold?

Portfolio Holding Re-Evaluation: Harley-Davidson (HOG) October 27th James Cullen Portfolio Manager Boston College Investment Club

Portfolio Management Perspective • We Still Own About 35 Stocks – Too Diversified (i.e. Closet Index Fund)

• Re-Evaluate Positions • Balance Sheet Strength is Crucial • What Are You, Harley? Via Malkiel’s “Random Walk”

What is Harley-Davidson? • Iconic Motorcycle Brand – 100+ Years of Operations

• Manufactures Variety of Bikes – Models Range from $9,900 to $19,000+

• But is H-D Really a Manufacturer? – Growth of Finance Arm (HDFS)

• Club Owns 150 Shares = About $3,000

The Balance Sheet • Harley Uses HDFS to Finance Bike Buyers – Aggressively Expanded Market Share from 38% in 2003 to >50% Now – How? Zero Down, Teaser Rates, Subprime Borrowers, and LTV of >100%

• Finance Receivables Are 56% of Assets – Up from 35% in 2003

• $400mm in HDFS Debt Due at Year-End – Refinance? At What Rate?

Asset Breakdown

Harley-Davidson: The Good • Unparalleled Brand Loyalty – Limited Substitution

• Core Motorcycle Sales Highly Profitable – Very High Average ROE (29% 10 yr. Avg.) – But Leveraged Up to Increase ROE in ’05-’07

• Valuations Lowest in History • Backward-Looking Valuation a Positive, But Not Yet Reflective of Future Realities

The Earnings Impact • Loose HDFS Financing Allowed Harley to Grow Sales to Marginal Buyers – Dealer Network Overstocked

• 100%+ LTV Let Buyers Add High-Margin Accessories – 100%+ LTV Discontinued

• Goodbye, Securitization Income • Rest-of-World Sales Slowing “More Than Anticipated”

Let’s Take Action on Harley-Davidson (HOG) • Motorcycle Manufacturer, or Auto Lender? – Delinquencies +25%, Credit Losses +20%, Year-over-Year

• “Pooring of America” – And Rest of World Following, But Consensus EPS Only Revised -10%

• Boom Time Expansion Does Not Go Unpunished

But Not Without Considering Valuation • Long-Term Profit Averages – 29% ROE – Only 1.83x Avg. Leverage (vs. 2.68x Now) – 21.8% Operating Margins

• Long-Term Valuation Averages – Selling for 6.8x 10-Yr. Avg. Net Income – Book Value 6.6x 10-Yr. Avg. (vs. 1.85x Now) – Price-to-Sales 2.9x 5 yr. Avg. (vs. 0.8x Now)