Harley On Track for Near-Term Operating Margin Improvement

Business Strategy & Outlook

With a long history of manufacturing experience, Harley-Davidson has brand strength and a dealer network that give the firm a wide economic moat and dominant position in the U.S. motorcycle market. However, there are no switching costs to protect Harley’s brand when consumers replace their bikes, and the premium price Harley commands relative to its peers has proven problematic during cyclical downturns and periods of competitive pricing, hindering Harley’s retail sales and shipments. In 2020, as a result of temporary factory shutdowns and dealer closures (as well as the pushback of product launches until spring 2021), Harley ceded massive market share. While still a significant market player, Harley’s market share fell roughly 800 basis points, to 42.1% in 2020 from above 50% in 2019. Thankfully, it recovered 3% of share in 2021, a gain that it should maintain with the introduction of new products. To monitor Harley’s market share position to help determine whether Harley’s wide moat rating deserves to stay intact. On a positive note, COVID-19 gave Harley the chance to reset its long-term strategy and focus efforts back on its core consumer, one which holds the key to higher profit margins ahead.

With its “The Hardwire” strategy, CEO Jochen Zeitz is set on chasing high ROI opportunities for Harley. The firm is focused on selectively expanding into new channels (for example, with the launch of Pan America), reading consumer preferences (growing into EV), better managing complementary businesses (like high-margin parts and accessories and merchandise), and improving customer experience (to elevate awareness and engagement). Moreover, with the EV line set to be liberated from the business (combining with a SPAC in the back half of 2022), a focus on capitalizing on electric trends should accelerate the production and adoption of such units. In fact, Harley expects to ship more than 100,000 electric units in 2026, representing roughly one third of output. While electric units provide volume growth, the Harley will fall short of its unit target.

Financial Strengths

Harley-Davidson carries more debt on its balance sheet than leverage is required to finance its HDFS arm and offer loans to customers. HDFS generates increased financial risk and weaker profitability when credit standards tighten or credit markets become less liquid. The firm had $2.2 billion in cash and equivalents at the end of June 2022; it has historically strived to hold enough liquid assets to cover its liquidity needs for 12 months. This is a sensible strategy, given the inherent risk in the business model due to HDFS. At the beginning of COVID-19, Harley completed a number of capital market transactions, including asset-backed security issuances, both a euro- and dollar-denominated medium-term note (May and June 2020), and the addition of access to incremental capital via credit facilities (outlined below), indicating the firm can still tap sources of cash. The firm does have a defined-benefit pension program, and weak return performance of its portfolio could become a problem if it needs to make sizable contributions to it. When accounting rules changed, both the assets and liabilities of its formerly unconsolidated qualifying special-purpose entities had to be consolidated. Before 2008, debt/total capital was less than 50%. However, with the consolidation of securitization interests, that ratio jumped to 73% in 2009. The company worked this down to 64% at the end of 2013, but the ratio has risen again above 75% since 2015 with the issuance of incremental debt. The company still has financial flexibility thanks to a $707.5 million revolver (expiring in 2023), and a second $707.5 million revolver (expiring in 2025), which helps address the seasonality of production and shipments. Additionally, Harley maintains flexibility in its capital structure through stock repurchases and dividends (currently at $0.1575 per share per quarter).

Bulls Say

Harley-Davidson’s brand is nearly 120 years old and resonates globally with a wide consumer base, particularly its core market (men over 35). Efforts to reconnect with its core consumer could lead to a unit demand uptick faster than one anticipated.
The firm has historically generated strong free cash flow, and continued doing so after the pandemic, generating a high-single-digit average FCF yield over the next decade.
Harley has high brand awareness and robust market share in custom and touring segments domestically, two of the most profitable motorcycle categories.

Company Description

Harley-Davidson is a global leading manufacturer of heavyweight motorcycles, merchandise, parts, and accessories. It sells custom, cruiser, and touring motorcycles and offers a complete line of Harley-Davidson motorcycle parts, accessories, riding gear, and apparel, as well as merchandise. Harley-Davidson Financial Services provides wholesale financing to dealers and retail financing and insurance brokerage services to customers. Harley has historically captured about half of all heavyweight domestic retail motorcycle registrations, a metric it had ceded in 2020 as it repositioned the business, but a level it is working back toward. In recent years the firm has expanded into the adventure touring market with its Pan America model and into electric with the LiveWire brand.

(Source: Morningstar)

DISCLAIMER for General Advice: (This document is for general advice only).

This document is provided by Laverne Securities Pty Ltd T/as Laverne Investing. Laverne Securities Pty Ltd, CAR 001269781 of Laverne Capital Pty Ltd AFSL No. 482937.

The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This document does not purport to contain all the information that a prospective investor may require. The material contained in this document does not take into consideration an investor’s objectives, financial situation or needs. Before acting on the advice, investors should consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation, and needs. The material contained in this document is for sales purposes. The material contained in this document is for information purposes only and is not an offer, solicitation or recommendation with respect to the subscription for, purchase or sale of securities or financial products and neither or anything in it shall form the basis of any contract or commitment. This document should not be regarded by recipients as a substitute for the exercise of their own judgment and recipients should seek independent advice.

The material in this document has been obtained from sources believed to be true but neither Laverne and Banyan Tree nor its associates make any recommendation or warranty concerning the accuracy or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. Any opinions and or recommendations expressed in this material are subject to change without notice and, Laverne and Banyan Tree are not under any obligation to update or keep current the information contained herein. References made to third parties are based on information believed to be reliable but are not guaranteed as being accurate.

Laverne and Banyan Tree and its respective officers may have an interest in the securities or derivatives of any entities referred to in this material. Laverne and Banyan Tree do and seek to do business with companies that are the subject of its research reports. The analyst(s) hereby certify that all the views expressed in this report accurately reflect their personal views about the subject investment theme and/or company securities.

Although every attempt has been made to verify the accuracy of the information contained in the document, liability for any errors or omissions (except any statutory liability which cannot be excluded) is specifically excluded by Laverne and Banyan Tree, its associates, officers, directors, employees, and agents. Except for any liability which cannot be excluded, Laverne and Banyan Tree, its directors, employees and agents accept no liability or responsibility for any loss or damage of any kind, direct or indirect, arising out of the use of all or any part of this material. Recipients of this document agree in advance that Laverne and Banyan Tree are not liable to recipients in any matters whatsoever otherwise; recipients should disregard, destroy or delete this document. All information is correct at the time of publication. Laverne and Banyan Tree do not guarantee reliability and accuracy of the material contained in this document and are not liable for any unintentional errors in the document.

The securities of any company(ies) mentioned in this document may not be eligible for sale in all jurisdictions or to all categories of investors. This document is provided to the recipient only and is not to be distributed to third parties without the prior consent of Laverne and Banyan Tree.