Harley-Davidson Pre-Earnings: Sales in Developed Markets Could Remain Strong

Harley-Davidson (NYSE:HOG) is scheduled to announce its Q2 results on July 22. At the end of April, the company’s stock price almost reached the all-time high of $74.93 seen in November 2006, but has since fallen by over 10%. This fall might be partly due to the mass recall of motorcycles issued by the company recently. Harley recalled 66,421 Touring and CVO Touring bikes manufactured between July 1, 2013 and May 7, with anti-lock brakes due to a front-wheel locking problem. Nonetheless, Harley-Davidson boasts a strong global brand appeal and has built a loyal consumer base, owing to its superior quality and services perception. Volumes for the iconic manufacturer of heavyweight motorcycles are expected to remain strong again this quarter, after rising 7.3% year-over-year in Q1. Growth is expected to come from increased sales to outreach customers, launch of the lighter Street motorcycles in the U.S., stabilizing European markets and high demand in emerging countries. Harley expects to ship 279,000-284,000 motorcycles this year, up 7-9% year-over-year, with around 92,000-97,000 units estimated to be shipped in Q2.

We have a $67.49 price estimate for Harley-Davidson, which is around 2.5% higher than the current market price.

See our full analysis for Harley-Davidson

Domestic Sales to Grow Due to Pent-up Demand, Street Launch

The U.S. is the most important market for Harley-Davidson, constituting almost two-thirds of the net shipments last year. While net retail unit sales grew 5.8% in the first quarter for the company, U.S. sales rose moderately by 3%, partly hurt by an unusually cold winter. The country’s economy also witnessed a negative growth of 2.9% in Q1, with declines in consumer spending and investments, somewhat reducing heavyweight motorcycle sales. Volume growth could be higher for Harley in the U.S. this quarter due to pent-up demand, and also due to incremental sales contributed by the recently launched Street motorcycles. The company launched the Street 500 and Street 750, the first Harley-branded lightweight motorcycles in nearly four decades, in the U.S. this quarter. Built on the new “Revolution X” platform, the Street 500 and 750 are the cheapest Harleys on sale, aimed at attracting millennial customers who prefer cheaper and relatively more urban motorcycles. Harley launched the Street 750 in India early this year, and will also start selling the Street 750 and 500 in Italy, Spain and Portugal this year. The company expects to ship 7,000-10,000 Street motorcycles this year, and the domestic market could constitute more than half of the estimated unit sales. This means that even if we assume no year-over-year change in Harley’s U.S. wholesale shipments in 2014, incremental sales of the new Street pair alone could raise the company’s domestic volumes by roughly 3% this year from 2013 levels.

In addition, with a contracting proportion of the core middle-aged Caucasian men demographic, Harley-Davidson is focusing on sales to young adults (ages 18-34), women, African-Americans and Hispanics, also known as its outreach customers, in order to drive volume growth. In 2013, the company’s volume growth rate for outreach customers in the U.S. was more than twice the growth rate for core customers. Sales to outreach customers could continue to boost volumes for Harley this quarter.

Motorcycle Sales Rise in Some Key European Markets

After two years of volume decline amid difficult economic conditions, Harley followed up a 5.5% rise in retail sales in Europe in Q4 2013 with a larger 8.8% growth through March. ^[1] This result was boosted by favorable weather conditions and an uptick in 601+ cc motorcycle registrations in the region, which increased by an impressive 25% in the last quarter. Bike sales in Europe constitute around 10% of Harley’s valuation by our estimates. In an environment of slow economic activity, customers had looked to avoid luxury spending, which also includes large expensive motorcycles. However, motorcycle sales improved in the first five months of this year in some of the key European markets, showing signs of growth going forward. Bike sales in Europe grew 8.1% year-over-year through May, fueled by 22%, 14% and 10% growth in Spain, U.K. and Germany respectively. ^[2] This increase in overall motorcycle sales could also translate into improved volumes for Harley-Davidson in the region this quarter.

What also works for Harley-Davidson is that its market share in Europe has increased in each of the last couple of years, reflecting how the motorcycle giant has fared better than its competitors in the region during tough economic times. The company’s market share has risen 1.7 percentage points since 2011 to 15.1%. The Street 500 and 750 will now be introduced in Italy, Spain and Portugal this year, exported from the assembly plant in India. Rebounding European economies and additional sales contributed by the Street series could further increase Harley’s volumes and market share in Europe going forward.

Margins Expected to Improve Year-Over-Year Following Restructuring

Harley-Davidson had earlier expected start-up costs for the Street motorcycles, being built in Kansas city and in India, to lower profitability in the first two quarters. However, larger volumes and pricing along with a favorable mix, improved the company’s operating margins by 60 basis points from 2013 levels to 22.2% in Q1. Restructuring initiatives which completed in 2013, are expected to boost profitability this quarter. While motorcycle fixed costs were 20%-25% of variable costs at the beginning of restructuring operations in 2009, the figure is expected to decline to 15%-20% this year. This will lower the degree of operating leverage for the company, and mean higher margins on incremental sales. Harley expects gross margins of 47% on additional volumes.

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1. Harley-Davidson 10-q [↩]
2. “Market update“, June 2014, acem.com [↩]