WE ARE DOWNGRADING Harley-Davidson shares to Hold from Buy solely due to valuation considerations. We have increased our fair-value estimate to $74 from $73 based on our 2008 estimates after fine-tuning our model.
Based in Milwaukee, Harley is a major U.S. manufacturer of heavyweight motorcycles and a complete line of motorcycle parts, accessories, apparel and general merchandise. The company also owns Buell Motorcycle Co., a manufacturer of high-performance motorcycles. Through its wholly owned Harley-Davidson Financial Services (HDFS) subsidiary, the company provides wholesale and retail financing and insurance to Harley dealers and customers.
Our 12- to 18-month $74 fair-value estimate represents: $62.35 or approximately 14 times our $4.45 2008 earnings-per-share estimate for the core motor-company business; $7.15 or 12 times the 60 cents of estimated EPS from HDFS; and approximately $4.11 (up from $3.40) per share in estimated cash at the end of 2008.
The 14 times multiple for the core motor-company business is a modest premium to the company's likely 10% core operating-earnings growth rate over the next few years, which we believe is appropriate given favorable demographic trends and opportunities for market share gains.
The HDFS 12 multiple is at the higher end of eight times to 12 times range typically applied to financial institutions given the quality of HDFS' loan portfolio.
Limited upside to our fair-value estimate is causing us to go to the sidelines. We continue to believe the company is experiencing strong sell-through based on its 2007 models. We also note early calendar 2007 will face modestly more difficult retail comparisons due to strong calendar 2006 sell-through.
We will look for opportunities to again become more constructive with our rating as we continue to admire Harley's strong management, unlevered balance sheet, and improving returns on equity (30.5% in 2005 to 44.9% in 2008) and capital (21.8% in 2005 to 30.6% in 2008) which supports ongoing accretive share repurchases.
Harley-Davidson (HOG: NYSE) By A.