HOG Presentation Best Ideas 2016

PO Box 5071 West Chester, PA 19380

[email protected]

www.gdsinvestments.com

Best Ideas Conference 2016

January 12-13, 2016

About GDS Investments

PO Box 5071 West Chester, PA 19380610-436-1120 (direct)


• Long only / no leverage

• Concentrated portfolios(15-20 positions)

• Separately managed accounts with third-party custody(Schwab and TD Ameritrade)

• Ability to customize individual client services(tax considerations, investment horizon, risk tolerance)

• 13.3%/year since inception (12/2008) through 12/31/2015

• All-cap value with emphasis on companies undergoing significant change(management, business composition, balance sheet, cyclical pressure)

• “Success carries within itself the seeds of failure, and failure the seeds ofsuccess.” The Most Important Thing by Howard Marks

Framework for Success



• Delayed gratification. The stock market isn’t designed to reward yourparticular strategy year-in, year-out.

• Don’t let volatility guide your decision-making; let the facts.

• Establish a 24-30 month holding period before determining success or failure.

• Become a better stock “owner.”

• Avoid Internet “addiction” (e.g. watching daily price changes).

• Get out of your own way and don’t create false expectations around short-term results.

• Understand and embrace 2015: momentum was rewarded, value waspenalized.• 50 best stocks from 2014 went up 1.4% in 2015 (as of 12.28.15)• 50 worst stocks from 2014 went down 25.9% (as of 12.28.15)

• Source: Bespoke Investment Group

Harley-Davidson, Inc. (NYSE: HOG)



• Price: $45.39 (as of 1.1.2016)

• Shares Outstanding: 206M

• Market Cap: $9.2B

• 52-week Range: $45.14 - $67.55

• Revenues: $6.2B YE 2014

• Cash & Marketable Securities at 9/27/15 - $1.42B

• Operating Cash Flow YTD - $1.02B

• Capital Spending YTD - $139.1M

Company History



• 1903: Arthur and Walter Davidson found Harley-Davidson.

• 1918: Becomes the world’s largest motorcycle company by producing 28,000 units.

• 1950’s: Fends off European competition in the post-WWII decade by introducing larger,more power motorcycles to the market; sees market share increase to 60% by the middleof the decade.

• 1960’s-1970’s: U.S. market goes through dramatic change as Japanese manufacturers(Honda, Yamaha, Suzuki and Kawasaki) enter the market with a focus on smaller, less-expensive alternatives.

• 1965: Harley-Davidson sells shares to the public after 60 years of private ownership.Shortly thereafter (1969), company is acquired by AMF, an industrial conglomeratelooking to diversify into leisure products.

• 1965-1981: AMF presides over several decades of mismanagement as product reliabilityand brand reputation declined considerably over this period. Market share declines to23% by 1980.

Company History (continued)



• 1981: CEO Vaughn Beals leads a leveraged management buyout of Harley-Davidson.

• Harley-Davidson Owners Group (HOG) established in 1983. Worldwide membershipnow over 1 million. HOG organizes rides, training courses, social events, etc.

• 1986: Harley Davidson, Inc. once-again becomes publicly-held.

Harley-Davidson, Inc.



1. Motorcycles & Related Products ($5.5B in revenues / 80% of total HOG, Inc. operatingincome). Pages 3 – 9, 28 of 10-K

• Motorcycles (79% of segment revenues)• Parts & Accessories (16% of segment revenues)• Other (Licensing, General Merchandise, Harley-Davidson Museum, etc.)• International (32% of overall segment sales)• Other Assets:

• 3.6 million square feet of owned properties (Corporate Office, Manufacturing,etc.). Page 19 (Item 2) of 10-K

• Harley Owners Group (HOG): organizes rides, events, etc. for motorcycleenthusiasts. It has over 1 million members worldwide.

• Harley-Davidson Riding Academy: trained over 400k riders since inception.• Distribution: sells products to over 1,600 independently-owned dealerships

worldwide (790 in U.S.), of which the majority sell Harley-Davidsonmotorcycles exclusively.

2. Financial Services (HDFS) Page 10, 30 and 66-68 (note 5) of 10-K

• Wholesale: financing for dealerships and distributors (inventory, parts, accessories,floor plan); 100% dealer participation.

• Retail: consumer financing for motorcycle purchases; 57% consumer participation.• Other (Insurance, Licensing)

Competitive Strengths



• Iconic / Lifestyle brand

• Stable and dominant market share

• Brand reinforced pre- and post-ownership:• Harley-Davidson Owners Group (HOG)• Riding Academy

• Fully integrated offering (financing, parts & accessories, merchandise)

• Consistently high ROE/ROIC metrics

• Pricing power

• Distribution

• 100+ year operating history with core product consistency







Long-Term Operating Metrics



U.S. and Canada 2014 2009 2004 1999 1994

HOG Market Share 53.3% 49.8% 49.2% 49.0% 46.4%

Europe Region

HOG Market Share 12.0% 10.3% 7.3% 6.5% 7.1%

Motorcycle Shipments (Units)

Domestic 173,994 144,464 260,607 135,614 66,498

International 96,732 78,559 56,682 41,573 29,313

270,726 223,023 317,289 177,187 95,811

Revenue (In Thousands)

Motorcycle & Related Products 5,567,681 4,287,130 5,015,190 2,452,939 1,158,887

Operating Income (In Thousands)

Motorcycle & Related Products 1,003,147 314,055 1,189,519 415,859 153,562

HD Financial Services 277,836 (117,969) 188,600 27,685 -

1,280,983 196,086 1,378,119 443,544 153,562

Shareholder's Equity (In Thousands)

Treasury Stock (6,303,510) (4,672,720) (1,150,372) (187,992) (1,581)

Total Book Value 2,909,286 2,108,118 3,218,471 1,161,080 433,232

U.S. Market SharePO Box 5071 West Chester, PA 19380

610-436-1120 (direct)www.gdsinvestments.com

U.S. Market Share



Recent Problems



• U.S. Harley-Davidson: retail sales down 1.3% YTD.• Competition (April 27, 2015 NYSE Analyst Meeting, Slide 9)

• Limited availability of certain Cruiser, Touring and Street models

• International Harley-Davidson: retail sales down 1.5% YTD.• Asia-Pacific and Mexico strong / Brazil and Europe weak• Expect to grow international at a faster rate than U.S. over time

• Stiff competition from European and Japanese competitors. Strong dollar hurtingdomestically produced goods relative to imports, and exports become more expensivein local (foreign) currencies. WSJ Dollar Index up 25% over the last 18 months.

• Polaris (Indian and Victory motorcycles) and other manufactures engaged in heavingdiscounting at expense of gross margins.

Gross Margin Analysis (Motorcycle Segment)



YTD

2014 Gross Margin $ 1,710.90 % of revenue 37.70%

- Volume $ (46.80)- Pricing $ 61.60 - Mix $ (8.80)- Currency $ (105.40)- Raw Materials $ 12.60 - Manufacturing $ 7.40

2015 Gross Margin $ 1,631.50 % of revenue 37.90%

Recent Actions (Operational)



• Spend an incremental $70M on customer-facing marketing (increase of 65%y/y) and new product development (increase of 35% y/y) in 2016. Money tocome from SG&A expense savings.

• Increase product and brand awareness.

• Grow new ridership in the U.S.• Riding Academy: 220k riders trained worldwide since 2010. Goal is to double number of

riders trained annually to 100k by 2020.

• Increase and enhance brand access.• Grow international dealer network, expand e-commerce and new retail formats for urban

formats. HOG intends to open 150 to 200 new dealerships internationally over the next fiveyears (20% to 25% increase).

• Accelerate the cadence and impact of new products.

• Refrain from “Race to the Bottom” and continue to think long-term.

Recent Actions (Financial)



• June 2015 Recapitalization Plan:• Incurred $750M of long-term debt in Q3

• $450M / 10-year notes @ 3.5%• $300M / 30-year notes @ 4.625%

• Debt proceeds to be used to repurchase shares during 2H 2015: “This decision wasdriven by what we believe to be a favorable credit environment and our current shareprice, which we believe is inordinately influenced by near-term headwinds, includingcurrency exchange rates.” Q2 2015 Conference Call, July 2015

• Share repurchase history:• 2010: $0 (stock price high / low)• 2011: $218M• 2012: $300M• 2013: $456M• 2014: $604M• 2015(E): $1.5B

• Dividends Per Share - $.31/quarter. 29% CAGR over the last five years.

Long-Term Strategy



• Lead in every market.

• Grow U.S. retail sales and international retail sales at a faster rate.• Grow international dealer network by 150 to 200 new dealerships by 2020.

• Grow the sport of motorcycling in the U.S.• Grow number of U.S. core customers and grow U.S. outreach customers at a faster rate.

• Grow revenue and grow earnings faster than revenue through 2020.

• Outperform the S&P 500.

Oct. 20, 2015 Conference Call Slide Presentation

Valuation Considerations



• More art than science.• HOG expected to earn $4-$4.50/share in 2016. Could earn > $6/share within

3 years.• Current PE too low considering the following:

• ROE history• ROE improvement through combination of higher earnings,

dividends and share repurchases.• Quality of brand• Dividends/share up 12-fold since 2000• Earnings/share up 3.5-fold since 2000• Very little non-financial debt• Free cash flow positive throughout economic cycle.• Ability to raise prices• Single industry + long operating history• Other “lifestyle” brands trading at much higher multiples.

Investment Return Drivers



• Execute on near-term investments, create greater value in the future.• International expansion• New products with better cadence

• Grow future per-share earnings through combination of expandingnumerator and shrinking the denominator.

• Multiple expansion. Cycle of declining earnings estimates and multiplecontraction coming to an end.

• “Limited visibility” with “plenty of uncertainty” and “dead money in thenear term” generally rewards investors with a longer-term horizon.

• Dividends.

Market Observations



• Possible bubble in longer-dated Treasuries.

• New opportunities in high yield market related to distressed industries.

• Broadly speaking, equity markets are fairly valued.

• Lots to do in energy, industrials, materials and “broken” growthcompanies (e.g. WFM).

• Bubble in indexing? Value in value?

Books



1. The Outsiders, by William N. Thorndike, Jr.2. Investing and the Irrational Mind, by Robert Koppel3. The Most Important Thing, by Howard Marks4. The Education of a Value Investor, by Guy Spier5. The Ultimate Question, by Fred Reichheld6. The Manual of Ideas, by John Mihaljevic7. Capital Account: A Money Manager’s Reports on a Turbulent

Decade 1993-2002, by Marathon Asset Management8. You Can Be a Stock Market Genius, by Joel Greenblatt9. The Dhandho Investor, by Mohnish Pabrai10.All Warren Buffett books by Cunningham, Lowenstein, etc.

Books (continued)



11. Charlie Munger: The Complete Investor, by Tren Griffin12. The Investor’s Anthology, by Charles Ellis13. One Up On Wall Street, by Peter Lynch14. The Tao Jones Averages, by Bennett Goodspeed15. Value Investing: From Graham to Buffett and Beyond, byGreenwald, Kahn, Sonkin and van Biema.16. Zen and the Art of Poker, by Larry Phillips17. “The Little Book” series18. All books by Michael Lewis

Questions?



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HOG Presentation Best Ideas 2016

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