Harley-Davidson Earnings Preview: Expect Lower Wholesale Shipments In The U.S.

Talking Points:

• Wholesale shipments in developed markets- U.S. forms almost two-thirds of Harley- Davidson’s annual shipments, and Europe another 15-20%, highlighting the company’s dependence on these markets.
• Street motorcycle sales- The new lightweight bikes have been launched in the U.S., India, Spain, Portugal and Italy, and the company expects to ship 7,000-10,000 units this year itself.

The iconic Milwaukee-based maker of heavyweight motorcycles Harley-Davidson (NYSE:HOG) is scheduled to announce its Q3 results on October 21. The company has been in a steady recovery since the collapse of the U.S. heavyweight motorcycle market in the thick of recession between 2008-2010. But Harley’s growth in the domestic market hit a roadblock in the second quarter this year when retail sales remained flat, while shipments to dealers rose 10%. Lower sales to end customers prompted the manufacturer to lower third quarter shipment outlook to 49,000-54,000 units, flat to 9% down from 2013 levels, as the company looked to protect its premium brand image and keep supply in line with demand. In line with the company’s guidance, we expect lower shipments to the dealers in the U.S. in Q3. But at the same time, we expect retail sales in the domestic market to rise this quarter due to pent-up demand and new launches, which could see the fourth quarter shipment outlook pushed higher.

The other crucial market for Harley-Davidson is Europe, and after a couple of years of slowing volume sales, motorcycle demand is picking up in the region. So with shipments expected to remain flat in the U.S., the company’s revenue-growth driver in Q3 could be Europe. In particular, the performance of the lighterweight Street pair, following the launch in five markets, will be in spotlight this quarter.

See our full analysis for Harley-Davidson

Our current price estimate for Harley-Davidson stands at $64.79, which is around 13% higher than the current market price. The company’s stock almost reached the all-time high of $74.93 seen in November 2006 at the end of April this year, but has since fallen nearly 23% on lowered company guidance. To add to the woes, Harley has issued mass recalls twice this year- first recalling 66,421 Touring and CVO Touring bikes in July and then 126,000 2014 Touring motorcycles last month. But we expect retail sales to bounce back in the U.S. and remain strong in Europe this quarter, signalling strong growth prospects for the coming quarters.

Street And Road Glide To Fuel Rise In U.S. Retail Sales

Retail sales remained flat in the U.S. in Q2, but this slowdown was more because of low availability of the much awaited Street motorcycles and absence of the popular Road Glide from the 2014 model year, than lower consumer demand for Harley-Davidson. The latter half of the year should see rejuvenated retail volumes for the company in the U.S., with improved availability of the Street bikes and launch of the Road Glide in the 2015 model year. Built on the new “Revolution X” platform, the highly anticipated Street 500 and 750 went on sale in the U.S. in June, but start-up issues limited product availability, thereby affecting unit sales. Moreover, as consumers decided to wait for the Street motorcycles, volumes for Harley’s Sportster line-up also remained weak. With improved availability of the Street pair, volumes could be higher this quarter.

On the other hand, Road Glide made a return in the 2015 model year lineup, launched in August. This model constituted 10% of the retail mix in Q2 2013 and its absence this year was one of the reasons why retail sales remained subdued last quarter. Road Glide constituted 8% of the retail sales in the U.S. in Q3 last year, and with the new model launched this quarter, sequential U.S. volumes should get a boost. We believe that the new model year launch containing the Road Glide, as well as the anticipated jump in Street/Sportster sales should see retail sales in the U.S. rise. However, Harley is also cycling the introduction of the Project Rushmore bikes, which were launched last August, and pushed the unit sales growth to over 20% in the U.S. in Q3 last year. This could slightly offset year-over-year volume growth in the country this quarter.

Europe Growth Could Boost Overall Shipment Volumes

Harley estimates shipment volumes to remain flat this quarter mainly due to a lower sales outlook for the U.S. business, which typically forms around two-thirds of the company’s shipments. But strong volume growth in Europe this quarter could bolster rise in overall shipments and consequently boost the top line. Europe formed just over 16% of Harley’s net retail sales last year, and dragged down the overall shipments figure for the company, despite positive growths in the U.S. and rest of the world. With shipments expected to be weak in the U.S. this quarter, rebounding European sales could possibly offset this decline and sustain volume growth for the manufacturer. After declining by 14% in the last couple of years, the European heavyweight motorcycle market (601+ cc) grew by 14% in the first six months of this year, signalling strengthening economic conditions and consumer demand. ((Harley-Davidson Q2 results))

What also works for Harley in Europe is that apart from strengthening overall demand for heavyweight motorcycles, the company could also expand its customer base, following the launch of the Street pair in Italy, Spain and Portugal recently. The lighterweight motorcycles could be successful in attracting millennial customers who prefer lighter and cheaper motorcycles carrying the renowned Harley name. The company has reported higher than expected retail sales of the Street 750 in Southern Europe so far, and continues to expect overall Street shipments to range between 7,000-10,000 this year. Harley’s retail sales in Europe increased by 7% in the first half of the year, reflecting strong customer demand, and new launches such as the Street 500 and 750 could see shipments rise again this quarter.

Margins To Contract On Unfavorable Product Mix

While we expect the Street motorcycles to impact the top line and volumes positively, gross margins are expected to decline due to higher sales of these bikes. This is because the lower priced Street 500 and 750, along with the Sportster models, carry relatively lower margins. Lower proportionate sales of these bikes in the last quarter pushed gross margins to 39.5%, a 260 basis points year-over-year rise. But as we expect Sportster and Street volumes to rise this quarter, the product mix will become unfavorable and net margins could decline. In addition, the company is also cycling the strong mix gains delivered by Project Rushmore motorcycles last year, which could drag down gross margins by as much as 2.5%, compared to 2013 levels.

Profitability is also expected to be impacted by start-up costs of around $5 million for the Street motorcycles, which could be offset by the benefits of restructuring, completed last year. We currently estimate Harley’s gross margins to increase by 0.5% this year, but if the figure falls by 1%, our price estimate for the company would decrease by 4%.

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