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Investment Overview for Harley-Davidson (NYSE:HOG)
Harley-Davidson gains market share in a shrinking U.S. heavyweight motorcycle market
Through the first three quarters of 2016, although Harley has reported a decline in retail sales in the U.S., which prompted the company to lower its year-end shipment guidance, the company has grown market share in the country.
Harley has been losing out to competition in the last year or two due to the aggressive discounting by its competitors on account of the stronger U.S. dollar. Harley has looked to keep supply in line with demand to protect its premium brand image, and chosen not to lower its model prices to an extent that rivals its competition. This has definitely cost the company sales, but the strategy for Harley has always been to first maintain its iconic brand and develop the sport of motorcycling.
The U.S. heavyweight motorcycle market (601+ cc) was expected to shrink in the first half of this year, as it was lapping the positive growth of 7.6% in the year-ago period, driven by the onset of aggressive competitive discounting, and due to weak anticipated sales in oil-dependent areas. However, the market was down by more than expected, especially in Q2. The U.S. heavyweight motorcycle market hasn't filled up to the peak levels of 2005-2006, and it might not in the near future as well. This is primarily as the millennials are typically more price-conscious, especially after the recession, and are looking to hold off on making discretionary expenditures, which includes the luxury heavyweight motorcycles.
The good news for Harley is that it has been able to increase its market share, as its retail sales in the U.S. declined by a smaller percentage than the overall market through the first nine months of the year. The incremental growth in the U.S. last year was due to the aggressive discounting by competitors, and the de-growth this year has also been due to lower sales for the competition.
Harley-Davidson looking to reorganize to improve margins
Harley is looking to reorganize and reduce its workforce to streamline functions, for which it will incur expenses of approximately $20 million to $25 million in Q4 2016. The company previously announced that it was laying off casual workers in its U.S. plants. This step now is in accordance with the trend of softer customer demand, which is expected to lower production levels at the iconic motorcycle maker's facilities. A trimmer business might help the company boost its profitability moving into the new year.
Harley-Davidson stepping-up investment to boost sales
The company is hoping to stir customer demand for its lineup by pumping more money into product development and marketing, and banking on models such as the Street 500, which are relatively cheaper, to draw-in new customers. Harley planned to increase investment in customer-facing marketing in 2016 by approximately 65% above 2015 levels, and increase investment in new product development by approximately 35% from 2015 levels. In dollar terms, this represents a $70 million increase from 2015 levels in investment by Harley, in a bid to raise brand awareness, grow ridership in the domestic market, and increase reach, and availability. Harley has consistently emphasized increasing its customer base, seeing how its core base is thinning.
Softer demand in the U.S. has prompted the company to lower its full-year guidance on motorcycle shipments to 264,000-269,000 units, down 1% to up 1% from 2015 levels, from the earlier estimate of 269,000-274,000 shipments. Harley will now hope for demand to rise, and for this to happen, the company is doing its part.
Delay in launching Project LiveWire could impact future volumes
It might be two to three years before Harley-Davidson launches its own plug-in motorcycle, code-named Project LiveWire, which was previously expected to be launched by 2016. There are two ways in which this could play out -- it could either give Harley enough time to upgrade its technology, and come out with a more solid, and potentially winning product, or it could give the company's competition a head-start in the electric motorcycle space.
U.S. Heavyweight Motorcycle Market Size and Harley-Davidson U.S. Market Share:
Heavyweight motorcycle sales in the U.S. have been hit severely since 2006, with 2010 sales (~360,000 units) falling at over 50% below 2006 sales. However, the market did show signs of recovery and the total U.S. shipments grew by ~4% in 2011 as well as in 2012. The overall market grew by 2.2% and 2.5% in 2013 and 2014, respectively. In 2015, the market grew by 4.8%. We believe the market has already bottomed out in 2010 and it will recover along with the economy. Meanwhile, Harley-Davidson's market share is dependent on consumer preferences for touring and cruiser motorcycles (that the company produces) vs. sports and dual-purpose motorcycles. Younger generations have shown a preference for sports and dual-purpose motorcycles, a trend that could affect Harley-Davidson's market share. If the U.S. market does not recover as we anticipate, and rises to just 380,000 units by the end of the forecast period instead of the currently projected 440,000, and Harley-Davidson's market share drops to 45%, from 48% that we expect, there could be a 6% downside to the Trefis price estimate. On the other hand, if the market size grows to ~480,000 units by 2022, and Harley-Davidson's market share rises to 53%, there could be a 7% upside to our price estimate. We believe the upside scenario is probable, since Harley-Davidson's core base is the baby boomer generation who have at least a decade of riding years ahead of them.
- SG&A as % of Gross Profits:Harley-Davidson's SG&A expenses as a percent of Gross Profits increased from 15% in 2006 to 38% in 2011. This jump was due to lower motorcycle sales resulting in lower gross profits, without a corresponding decrease in SG&A expenses. In 2013 and 2014, the figure stayed relatively stable, but rose to 36% in 2015. We forecast the figure to remain relatively stable through the end of the forecast period. However, if the SG&A as a percent of Gross Profits falls to 31% in the long run, there could be a 10% upside to the Trefis price estimate.
Harley-Davidson is a manufacturer of heavyweight (601cc+) cruiser and touring motorcycles. Harley-Davidson is an iconic brand that commands a ~50% share in heavyweight motorcycle sales in the U.S. After the U.S., the most significant markets are Europe and Japan. Harley-Davidson is known to engage its customers in motorcycling related community activities. The company sponsored the Harley Owners Group (HOG) which is the largest riding club in the world, with over 1 million members. Such initiatives boost sales of motorcycle accessories and merchandise, which contribute a significant amount to the overall revenue. Like most automobile manufacturers, the company has a financial services division called Harley-Davidson Financial Services (HDFS) that provides retail loans to customers to buy new and used motorcycles, provides wholesale loans to dealers to help them finance their operations, and also acts as an agent to provide motorcycle related insurance to customers. In 2009, the company embarked on a significant restructuring plan to streamline its operations. This plan completed in 2013.
Despite a shrinking market over the past few years, U.S. motorcycle sales are still the largest source of value for Harley-Davidson
U.S. Heavyweight Motorcycle sales account for almost two-thirds of the company’s overall motorcycle sales, making it the largest single geographic market for Harley-Davidson. Over the past few years, overall heavyweight motorcycle sales have declined significantly in the U.S. while international sales have increased slightly. Revenues from international markets (excluding U.S. and Europe) have consistently risen, while U.S. revenues still haven't reverted to pre-recession days. The market did show signs of recovery and the total U.S. sales grew by ~32% between 2010-2014. However, a tough pricing environment and stiff competition, due to the stronger U.S. dollar, dragged down revenues in 2015. Despite already forming two-thirds of Harley's net shipments, U.S. motorcycle sales still haven't reached the highs seen in pre-recession times. We believe U.S. motorcycle sales will recover over the next few years making this region a strong source of overall motorcycle sales growth.
Increased push in wholesale and retail lending by Harley-Davidson Financial Services (HDFS)
Harley-Davidson has significant lending operations, financing 100% of its dealers in North America through its subsidiary HDFS. It also finances a significant portion of new motorcycle retail sales. Harley-Davidson has recently increased lending for used motorcycles via its dealer network. As of December 31, 2015, unused lines of credit extended to HDFS' wholesale finance customers totaled $1.27 billion. Approved but unfunded retail finance loans totaled $169.6 million, up from 149.8 million at December 31, 2013, up more than 70% from the levels seen in 2010. As HDFS continues to finance used motorcycles, its overall loan portfolio will grow at a faster pace than company sales. Furthermore, Harley-Davidson management has said it would like its dealers to increase their inventory. A large part of this inventory is financed via HDFS, thereby further increasing its loan portfolio.
Stabilizing European markets to fuel growth going forward
As the economy recovers, Trefis believes the motorcycle market size will trend back towards its prior highs. The overall heavyweight motorcycle market (601+ cc) in Europe suffered a declining number of registrations between 2011-2013, down to 281,000 units in 2013 from 328,500 units in 2011. Sales were hurt by weak economic conditions and negative consumer sentiment, which also caused retail sales for Harley-Davidson to contract 1% in 2013 and 3% in 2012.
However, motorcycle sales rebounded in Europe in 2014 and 2015, rising by 13.5% and 10% respectively. Going forward, heavyweight motorcycle sales are expected to continue to rise in Europe, bolstered by the recovery of sales lost in the last few years. The double digit growth of the European heavyweight motorcycle market (601+ cc) in the last two years reflects better economic conditions and strengthening consumer demand, albeit still not as strong as pre-recession years. Continually low oil prices and continual reforms are expected to boost consumer purchasing power, which could in turn bolster chances of spending on luxury, high-priced, heavyweight motorcycles. The Euro area economy grew by 1.5% in 2015, and is expected to grow by 1.7% in both 2016 and 2017.
Harley-Davidson enters the lightweight segment with the Street motorcycles
The Street 500 and Street 750, built on the new "Revolution X" platform, are the first lightweight motorcycles for Harley-Davidson since the 350 cc Sprint, which was discontinued in 1974. The highly anticipated bikes went on sale in the U.S. in June 2014, and before that, the Street 750 was launched in India at the beginning of that year. The company also launched the Street pair in Italy, Portugal, and Spain in 2014. The company sold 9,900 units of these bikes in 2014, and subsequently launched these bikes in Canada and other parts of Europe.
The two models are expanding Harley's reach to new and outreach customers in the U.S., which means that the company's sales in the future could remain strong in its single largest market, despite the aging core customer base of baby boomers. The Street pair is expected to attract customers who would prefer a Harley-branded cheaper and lighter motorcycle. 7 out of 10 Harley-Davidson Street Riders were new to the brand in the duo's first full year in 2015, with the number rising to 9 out of 10 in EMEA, and nearly 10 out of 10 in India. Incremental sales from new models, which don't cannibalize sales of sister models, are also expected to bode well for Harley.
Increase in non-traditional riders taking up motorcycling
The core customer base for heavyweight motorcycles in the U.S. consists of middle-aged Caucasian males. But with an aging population of baby boomers in the domestic market, and rising popularity of affordable lighter motorcycles among millennial customers, the heavyweight motorcycle market might see negligible growth in the coming years. Harley-Davidson hopes to meet the deficit created by its declining core customer base with sales to its outreach customers. According to Harley, sales to the outreach customer base comprising young adults, women, African-Americans, and Hispanics have increased at a CAGR of 7% in the last five years.
Strict riding laws in China resist growth for Harley
Many local governments in China have imposed laws against bike-riding in order to curb traffic and drive-by thefts associated with motorcycle riders. Low safety performance has also been cited for the restriction of bikes in some cities. Motorcycles have been banned in close to 200 cities, including the highly populated Beijing and Guangzhou. China also limits distribution of number plates to control traffic on roads. In addition, motorcycles have to be scrapped after eleven years of registration, as per law in China. This law encompasses not only the cheaper mopeds and scooters, but also high-end premium motorcycles. Strict laws laid down by the Chinese government clearly point to the absence of a leisure biking culture in the country. If no amendments are made to these regulations in the future, growth of the heavyweight motorcycle in China could continue to face headwinds.
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How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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