Not As Bad As It Seems For Harley-Davidson

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Harley-Davidson‘s stock (NYSE:HOG) recently traded with a large increase in volume. In the last 52 weeks, the stock reached close to $72 a share, but that was in June last year. Since then, Harley’s lowered annual outlook for motorcycle shipments, and weaker-than-expected showing in the U.S., has impacted investor sentiment negatively, pushing the stock down 20% in the past year. After touching a 52-week low of $53.04, the stock is up approximately 4% in the last month, with Fitch Ratings affirming the long-term Issuer Default Ratings (IDRs) of Harley-Davidson and its Harley-Davidson Financial Services (HDFS) subsidiary at ‘A’, and Goldman Sachs maintaining its current rating of buy on Harley shares.

Our current price estimate for Harley-Davidson stands at $60, which is above the current market price.

See our full analysis for Harley-Davidson

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 Despite recent headwinds, the heavyweight motorcycle manufacturer’s credit profile and business position remain strong compared to the rest of the industry. Here are some of the bright spots for Harley-Davidson, which could propel sales growth for the company going forward:

Strong U.S. Dollar weighing down growth, but for how long?

The Milwaukee manufacturer ships approximately two-thirds of its motorcycles in the U.S. itself, and controls more than 50% of the country’s heavyweight motorcycle market (601+cc). Harley’s market share stumbled a bit to 51.3% in the U.S. in Q1, down 4.7 percentage points from a year ago, mainly as its main competitors are Japanese and European, which took advantage of the strengthening U.S. dollar and manufacturing in low-cost countries, and subsequently adopted aggressive product pricing. The U.S. dollar rose approximately 10% against most foreign currencies in the last quarter alone, allowing Harley’s foreign manufacturers to cut their model prices, in some cases, by as much as $3,000 off the manufacturer’s suggested retail price.

Harley Davidson revenue growth

Moving away from the U.S., seeing how one-third of Harley’s net shipments are in foreign markets, and local currencies are declining against the dollar, the company has had to push-up pricing to cover the translation losses. This, again, has given its foreign counterparts pricing advantage in key market such as Europe, where Harley’s market share in Q1 was 9.8%, down 1.5 percentage points, hurt by the introduction of several low-priced models by the competition.

However, Harley hasn’t looked to lower its model prices, in a bid to protect its premium brand image. The company still commands a solid lead in the U.S., and has increased its presence in the outreach (young adults, women, Hispanics, and African-Americans) segment too in the last few years, suggesting there is still potential growth for the manufacturer in the U.S.  Harley might be geared for further growth once foreign currencies rebound, and its competition is forced to raise model prices again.

— European heavyweight motorcycle market has returned to growth, as of last year:

Low fuel prices, higher customer purchasing power, tax breaks, and incentives, helped Harley improve its Europe retail sales by 6.7% year-over-year in 2014, after volumes declined in the region for two consecutive years. Retail sales in the region fell 3% year-over-year in Q1 for Harley, but this was mainly on the back of model price hikes by the company, and competitive product pricing by its competition, as aforementioned. The European heavyweight motorcycle market continued its solid recovery in Q1 this year, with registrations rising 9.7% over a year ago period. With key markets such as the U.K., Germany, and Spain showing strong growth, motorcycle sales could continue to rise going forward.

Harley-Davidson revenue forecast

Last month, the European Commission revised its forecast for eurozone economic growth to 1.5% for 2015, up from the previously estimated 1.3%, and 0.9% growth posted last year. The eurozone economy could grow by 1.9% next year. Europe accounts for slightly over 14% of Harley’s net retail sales, and approximately 8% of the company’s valuation, as per our estimates. After an 8% rise in Europe shipments last year, we currently estimate shipments to rise by less than 4% this year, and grow at a CAGR of ~2.3% through 2021. However, these numbers could improve once Harley’s competition starts raising its product prices again.

Margins have remained strong, reflecting sound operational efficiency:

Harley’s margins are expected to be hurt by negative currency translations in the near term, but higher production should boost profitability going forward. Despite a decline in net revenues in Q1, 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 (which sold 9,900 units in their debut year in 2014) remained strong in Q1, and with increased availability of this lineup in most markets going forward, volume sales, and, in turn, margins, could get a boost.

According to Fitch Ratings, Harley’s adjusted EBITDA margin in the 52 weeks to March 29, 2015, was 22.1%, and although this figure might slightly decline this year, it is expected to remain at least in the high teens, which is still strong for the sector. [1]

The lowered shipment outlook for Harley has been impacted by growing competition from foreign companies, in both the domestic and international markets, on the back of a strengthening U.S. dollar. However, this might be a short-term headwind. Europe’s heavyweight motorcycle market has returned to growth in the last year, and Harley is also looking to increase production of its new and popular Street duo, which could boost sales. And, despite the smaller volume and sales growth, the fact that Harley’s margins remain solid reflects how the company might not take much time to bounce back.

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Notes:
  1. Fitch Affirms Harley-Davidson’s IDR at ‘A’; Outlook Stable []