Monday, November 11, 2013

Harley-Davidson: A Luxury Company

To assert that Harley-Davidson should be understood as a company that sells luxury items is to make an surprising claim for a company that has always played the populist card. However, as the company’s marketing is primarily based on presenting customers with the opportunity to display ownership of a product with a unique history and mystique the company has met the primary characteristic of a luxury brand. The company is certainly aware of this as can be seen by their exploitation of a product with a long-standing and unchanging sound, design and iconography. In addition, the company is always reinforcing the aspects of the motorcycles that create and preserve an emotional connection to the brand. Notably, Harley-Davidson does not primarily compete in the areas of product quality and technical engineering.

Two definitions of luxury as “something inessential but conducive to pleasure and comfort” and something expensive fit the company’s motorcycles. In fact, although I would argue that the public display is the dominant value that Harley ownership provides; other luxury attributes are also present in Harley products. For example luxury brands (e.g. airplanes, yachts, etc.) may have a group that is exclusive to owners. So we have the Harley Owners Club, similar to the Rolls-Royce Enthusiasts' Club, both sharing a penchant for anniversary celebrations, historical memorabilia and owner and museum collections. Also, Harley-Davidson’s use of limited editions, special series, but especially customization as a way to build a sense of exclusivity is standard fare for luxury products such as watches and sports cars.

Another attribute of luxury brands is a non-utilitarian focus. With the company’s bikes it is sufficient to merely own one and use it occasionally for social events. Whether diamonds or motorcycles, function can take a back seat to mystique.

Where Harley has a problem as a luxury brand is in the creation of scarcity, that distinctive feature of many luxury goods. In the early 2000’s the company could not keep up with demand and the wait for delivery became part of the experience. Now, however, the factory is not running at capacity and the company would love to bring scarcity back as part of the brand. Although this would eventually dilute the brand (imagine Harleys everywhere), unfortunately customers have become as scarce as bikes were ten years ago.

How should investors value such a company that makes luxury goods to a slowly declining customer base? If we factor out any prospects for growth the company’s value is very sensitive to P/E, borrowing costs, discount rate and free cash flow projections but my current estimate is that somewhere in the range of $25-$30 for 2015. After that, we shall see.

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