Strategic Pricing By Competitors And Unfavorable Currency Impact Hurt Harley-Davidson’s Q1 Results

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Contrary to prior expectations, Harley-Davidson (NYSE:HOG) carried its weak form from the last three quarters into Q1 this year. Revenues from sales of motorcycles and related products were down 3.9% year-over-year to $1.51 billion this quarter, due to a fall in wholesale shipments and the impact of negative currency translations. [1] After lower sales in the U.S. in Q2 last year prompted Harley to lower its full-year guidance, the company has again lowered its shipment outlook for 2015, on the back of less than expected retail sales in the country this quarter. Overall shipments were down 1.4% year-over-year to 79,589 units, near the lower end of the estimated 79,000-84,000 unit shipments for this quarter. While shipments in the U.S. rose by over 4% this quarter, retail sales were down 0.7%. As the domestic market forms approximately two-thirds of the net shipments for Harley, sales in the country have a major impact on the company’s overall results. Lower retail sales and high shipments in the U.S. this quarter has prompted Harley to lower its shipments to dealers in the near term, in order to keep supply in line with demand, avoid inventory pile-up, and protect its premium brand image. [2]

Our current price estimate for Harley-Davidson stands at $67 which is above the current market price. However, we are in the process of incorporating the recent quarterly results into our forecasts.

See our full analysis for Harley-Davidson

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Harley now expects to ship 276,000-281,000 motorcycles globally this year, up approximately 2-4% year-over-year, or around 6,000 fewer motorcycles than the prior guidance. Although the company remains optimistic about reaching its revised targets, the new shipment guidance has yet again given rise to the question of slowing growth at Harley. The company’s shipment volume growth sequentially declined from 2011 to 2014, and is expected to decline again this year, compared to the volume growth of 4% last year.

Harley has remained committed to evolving with shifting market trends, launching its lighter-weight Street 500 and 750, and also touring its plug-in electric concept motorcycle in the U.S. and Europe, to gauge the initial response before manufacturing it commercially. This phase of weak shipment growth might be a calm before the Street pair, which has reported encouraging sales in its initial roll-out, becomes more widely available, and sales then begin to take off. However, this could also be a sign of how the aging population of Harley’s core customer base, and stiffer competition, are catching up to the Milwaukee-based iconic motorcycle manufacturer.

Competitors Trump Harley On Strategic Pricing In The U.S.

Harley’s new guidance reflects a more modest shipment outlook in the U.S. for the rest of the year, as demand in the country for the company’s luxury heavyweight motorcycles remained lower than expected in Q1. Retail sales were down 0.7%, even as registrations in the country’s 601+cc motorcycle market rose an impressive 9% during the quarter. A rise in net motorcycle sales was boosted by an improving economic environment in the country, with lower energy prices and historically-low unemployment rates. However, Harley was not able to benefit from this growth. This is mainly due to increased competitive price discounting by the competition, especially international manufacturers who scaled down their product prices in the U.S., as the dollar continued to strengthen against other currencies. Harley protected its premium brand image, and going forward, hopes to leverage its strong brand appeal and loyal customer following to grow sales, once its competitors raise their product prices once again.

Harley’s market share is down 4.7 percentage points from a year ago to 51.3% in the U.S., mainly as its Japanese and European competitors took advantage of the strengthening U.S. dollar and manufacturing in low-cost countries, and subsequently adopted aggressive product pricing. This trend could continue in the near term and as Harley is not looking to discount its bikes, this will mean slower volume growth for the company in the next few quarters.

Demand In International Markets Remains Weak

With an aging core customer base comprising Caucasian males in the U.S., much of Harley’s growth was expected to come from international markets. However, the fall in retail sales outside the U.S. was even more than that in the domestic market this quarter. Net international retail sales fell 2.4% year-over-year in international markets, with a disappointing decline in demand in Asia-Pacific as well, despite strong growth in India and China. The company was cycling the strong growth in Japan in Q1 2014, due to the pull-forward of sales in advance of the April 2014 consumption tax increase, which had a major bearing on Asia-Pacific results as Japan is the largest market in this region.

On the other hand, after returning to growth last year, Harley’s sales in the Europe, Middle East and Africa (EMEA) region declined again this quarter. The EMEA region forms approximately 10% of the company’s valuation, by our estimates, and continued weak economic conditions in the region, and fears of deflation could result in slower demand for heavyweight motorcycles and Harley going forward. Another downer for Harley could be its high model prices in the region. During Q1, the company took an off-model year price rise of 1.2% in Europe to mitigate the impact of unfavorable currency translations. Price rise, and further increases in model prices will hurt Harley’s price competitiveness in the region. The company could relinquish more market share to its competitors, after the company’s share in Q1 was down 1.5 percentage points to 9.8% in Europe, mainly impacted by the introduction of several low-priced models by the competition.

And now for the positives for Harley. Despite a decline in net revenues, the company was able to achieve gross margins of 39.1%, its highest in at least 15 years. Harley is expected to continue to reap the benefits of its restructuring operations which ended in 2013. While motorcycle fixed costs were 20%-25% of variable costs at the beginning of restructuring operations, the figure declined to 15%-20% at the end of last year. This lowered the degree of operating leverage for the company, and meant higher margins on incremental sales.

Sales for the Street 500 and 750 remained strong in Q1, and with increased availability of this lineup in most markets going forward, volume sales could get a boost. On the back of higher Street sales, the shipment mix of Harley’s Street and Sportster category was up 2.8 percentage points in Q1.

Harley-Davidson’s Q1 results tell a story of lost sales on strategic pricing by the competition in the U.S. and negative currency translations, which were a 3.5% headwind on the top line this quarter. Going forward, continual discounting by other motorcycle manufacturers could further eat into Harley’s market share in the U.S., and drag down the top line.

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Notes:
  1. Harley-Davidson 8-k []
  2. Harley-Davidson earnings transcript []