Harley-Davidson Earnings Review: Retail Sales Rise As Expected To Strengthen Year-End Shipment Estimates

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On October 21st, Harley-Davidson (NYSE:HOG) announced lower revenues in Q3 compared to last year, on lower wholesale motorcycle shipments. This result was in line with analyst expectations as the company looked to hold-off shipping motorcycles, after retail sales remained soft in the second quarter, to avoid inventory build-up. Sales from the motorcycle and related products divisions, which together form around 80% of the net valuation for Harley by our estimates, declined 4.2% year-over-year to $1.13 billion in Q3. [1]

What underscores the motorcycle maker’s strong performance this quarter is a 3.8% jump in worldwide retail sales, despite cycling the strong 15.5% retail sales growth in the third quarter of 2013, following the launch of the Project Rushmore bikes last August. Harley looked to protect its premium brand image and maintain supply in line with demand, and therefore wholesale shipments and consequently financial results this quarter appeared weak. As expected, the re-introduction of the Road Glide, improved availability of the Street 500 and 750 and higher sales of the Sportster lineup accelerated sales to customers during the quarter, laying down a sound foundation for higher wholesale shipments to dealers in the fourth quarter.

Our current price estimate for Harley-Davidson stands at $64.79, which is around 4% higher than the current market price. The stock jumped 8% just after the announcement of quarterly results.

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See our full analysis for Harley-Davidson

Domestic Retail Volumes Rebound In Q3

After retail sales in the U.S. remained essentially flat to slightly positive in the first half of the year, volumes rebounded to a 3.4% growth in Q3 on the back of pent-up demand and new model launches. The domestic market forms around two-thirds of the net shipments for Harley, which is why sales in the country play a crucial role in moulding the overall results for the company. The two main reasons why volumes were weak last quarter were the absence of the touring motorcycle Road Glide from the 2014 model year and low availability of the much anticipated lighterweight Street motorcycles. Potential Sportster buyers also decided to wait for the Street launch to compare the varying features and make an informed buying decision.

Harley managed to overcome these obstacles in Q3, with the launch of the new Road Glide along with other 2015 model year launches in August. In fact, the Road Glide was the highest selling bike from the new model year, but only constituted 4% of the net retail sales this quarter, down from 8% in Q3 2013. [2] This was because the model was only available since the latter part of the quarter, and is now expected to spur domestic sales in the next quarter. Harley also removed the bottlenecks that limited availability of the Street bikes in the U.S. in Q2, thereby witnessing strong growth in Street and Sporter sales in the country through the quarter. Proportionate sales of the Sportster and Street motorcycles increased nearly four percentage points compared to the previous year to 25.8% of the net retail sales this quarter. The 3.4% retail sales growth is in fact a milder reflection of the strong volumes this quarter, as the company was witnessing the 20% growth seen in the U.S. in Q3 2013, following the launch of the iconic Project Rushmore bikes in August last year.

Going forward, Harley expects to ship 46,500-51,500 motorcycles in the last quarter, flat to 10% above the last year’s fourth quarter shipments of 46,618 motorcycles. With anticipated strong demand of the Road Glide and Street bikes in the fourth quarter, motorcycle shipments in the domestic markets could get a boost, consequently pushing overall shipments for the fourth quarter closer to the higher estimated figure. In particular, the Street 500 and 750 are expected to contribute additional sales to the top line. The two models are expanding Harley’s reach to new and outreach customers, which means that the company’s sales in the coming future could remain strong in its biggest sales-base, the U.S.. This is despite the ageing core customer base of baby boomers. Harley continues to expect shipments of the Street bikes to range between 7,000-10,000 units for the full year, buoyed by encouraging initial sales in the U.S., India and Southern Europe. Now the company plans to increase shipments of the Street in Europe in the fourth quarter, and enter other markets by next year, which should see volumes rise significantly by this time next year.

Gross Margins Decline On Lower Revenues

As expected, Lower wholesale shipments dragged down net revenues and consequently gross margins for Harley’s motorcycle business this quarter. Margins fell to 34.9%, down 40 basis points from last year, but this figure was still above the company’s expectations. A higher proportionate mix of the Street and Sportster motorcycles, which carry thinner margins, was expected to lower the margins. However, led by strong Road Glide sales, sales of touring motorcycles also improved simultaneously, somewhat offsetting the impact of the lower range bikes.

Harley expects operating margins for the motorcycle division to range between 17.5% to 18.5% for the full year, up from 16.6% in 2013. Despite operating margins remaining low at 12.9% in Q3, margins through the first nine months stand at 21.3%. This means that the company now expects another quarter of lower margins, due to the unfavorable mix impact and higher start-up costs related to the Street motorcycles. The third quarter figure was also negatively impacted by an additional $14 million, almost 10% of the net operating income, due to the two recalls issued in the quarter. Harley’s operating margins in the fourth quarter might be above the expected levels due to higher shipments, as well as due to the benefits of restructuring that completed last year. 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% for the full year. This will lower the degree of operating leverage for the company, and mean higher margins on incremental sales.

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Notes:
  1. Harley-Davidson earnings release []
  2. Harley-Davidson earnings transcript []