Harley Davidson Q3 Margins Squeezed by Plant Restructuring

Harley Davidson (NYSE:HOG), the biggest U.S. motorcycle maker, saw its stock drop by more than 7% on the day it reported its third quarter results before recovering over the course of last week. The stock dipped despite motorcycle revenues increased by 13 percentage points year-over-year (yoy) as Harley reported that the restructuring of one of its major facilities was more complex than previously communicated. This restructuring resulted in decreased production capacity for some of the company’s more expensive and most profitable models, leading to overall margin decline. Harley Davidson’s market share in U.S. in third quarter stood at 58% with Polaris Industries (NYSE:PII),  Honda (NYSE:HMC), Yamaha, Suzuki, Kawasaki and BMW controlling a major chunk of the remaining market.

We currently have a price estimate of $40 for Harley Davison’s stock, which is more than 15% above current market price.

See our full analysis for Harley

Skewed sales hurt margins

Even though in third quarter, Harley Davidson sales picked up, its margins suffered due to increased proportion of sales of its cheaper motorcycles – Sportsters, which increased to 22.3% of total motorcycle shipments. This unfavorable mix was largely driven by the temporary disruptions at York, which hurt production of its priciest motorcycle models – Touring and custom bikes, as Harley Davidson shifts to a more flexible work-force. ^[1]

The company has indicated that it expects changes at York to be completed by the end of next year. This will alleviate the temporary capacity constraints of pricier models in the U.S., leading to recovery of Harley’s margins from 2013.

U.S. sales remained strong in the quarter but threats of slowdown grow on the horizon

Harley Davidson sales in third quarter increased in U.S. in spite of economic concerns and stubbornly high unemployment rates. U.S. sales in the quarter was helped by introduction of 2012 model year motorcycles.

Demand for Harley Davidson’s high-end products is largely dependent upon discretionary spending ability among its customer base and thus is closely linked to consumer confidence. In 2008, demand for Harley’s bikes dipped as consumers cut on spending due to the credit crisis. Now as the sales have been recovering from that slowdown, consumer confidence are again at the risk of dropping as threats of another slowdown grow due to deteriorating economic environment in U.S. and Europe. In early October, U.S. consumer sentiment dropped to its lowest levels in 30 years on worries about declining income. ^[2] Thus, we expect that Harley Davidson sales can suffer over the medium-term if consumer sentiments continue to stay depressed as threats of slowdown grow.

Stock hurt by price estimate downgrades

Following the earnings, several investment banks such as UBS, RBC Capital, JPMorgan Chase & Co. and Goldman Sachs cut their price targets on shares of Harley Davidson. ^[3] This also contributed to the plunge witnessed by the stock on Tuesday.

See our full analysis for Harley Davidson stock here

1. Harley-Davidson’s Q3 2011 Results – Earnings Call Transcript [↩]
2. US consumer sentiment sags in Oct, expectations dip [↩]
3. UBS Analysts Cut Harley-Davidson EPS Estimates [↩]