Harley Expands Outreach, Bikes to Attract Customers

Jaime M. Katz: We recently lowered our fair value on wide-moat Harley-Davidson to $34 from $44 per share. We think there are two key factors that are set to impact the company's prospects ahead. First, we expect demographics to remain a significant headwind for the domestic heavyweight business, as outlook for the size of the historic core Harley consumer remains unfavorable over the next 40 years, a key tenet in our updated negative moat trend rating. For perspective, the census forecasts the total white population between 35-64 years of age to decline by 10 million persons, whereas the entire African-American and Asian population of the same age, representing Harley's outreach customers, is set to rise by 6 million new people. In order to cover the gap from those consumers lost from the core cohort, outreach penetration would have to be significantly higher than for the core, something we think is unlikely.

Second, with Harley moving into new categories, we have now explicitly incorporated updated assumptions that include entry into middleweight and small displacement bikes in 2020, efforts we believe the company has undertaken to combat its domestic demographic headwinds. The largest decline in our fair value stems from a lower gross margin and average selling prices associated with new models, partially offset by volume increases and SG&A leverage. For an idea of magnitude, we now have pricing falling by 1% on average, versus a 1% increase prior and gross margins that stabilizes around 29% in 2028 (from 34% prior), as volumes ratchet up with new category bikes ramping to nearly 30% of the shipment mix in 2028 from 6% in 2020, helping offset domestic heavyweight declines. These efforts abroad, however, fail to convince us that the brand intangible asset domestically is not eroding.