Iconic motorcycle-maker Harley-Davidson’s (NYSE: HOG) stock declined further Tuesday after unveiling hefty losses in worldwide sales.

HOG noted that revenue from its motorcycles segment was down in the first quarter behind lower shipments, and attributed part of the decrease in its operating income to an unfavorable product mix and increased tariffs.

The Milwaukee-based company suffered lower retail revenues across its entire geographical footprint, underscored by a 26.8% year-on-year drop in income in the first quarter of 2019 and a 10.4% fall in consolidated revenue.

The company’s Q1’19 results spurred U.S. President Donald Trump to tweet: “Harley Davidson has struggled with Tariffs with the EU, currently paying 31%. They’ve had to move production overseas to try and offset some of that Tariff they’ve been hit with which will rise to 66% in June 2021.” In the same tweet, directly following this statement, he addressed television journalist Maria Bartiromo, adding: “@MariaBartiromo So unfair to the U.S. We will Reciprocate!”

Shares of HOG had fallen roughly 2% to around US$39.00 intraday Tuesday, contributing to a four-day decline of nearly 4.9%.

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To mitigate the adverse effects of tariffs, HOG said it had started supplying motorcycles to ASEAN (Association of Southeast Asian Nations) emerging markets from its Thailand operations in late 2018. 

It noted that the tax mitigation realized by this strategy enabled more competitive pricing and helped drive a Q1’19 retail sales increase of 126% in these markets.

The popular motorcycle manufacturer had said in late June 2018 that given the tariffs imposed by the U.S. on EU metals, the company stood to incur costs of about US$2,200 per average motorcycle export.

HOG had warned in an SEC filing that “the tremendous cost increase, if passed onto its dealers and retail customers, would have an immediate and lasting detrimental impact to its business in the region, reducing customer access to Harley-Davidson products and negatively impacting the sustainability of its dealers’ businesses.”

HOG added: “To address the substantial cost of this tariff burden long-term, Harley-Davidson will be implementing a plan to shift production of motorcycles for EU destinations from the U.S. to its international facilities to avoid the tariff burden.”

Market participants had generally pointed to HOG as an example of how the escalation of U.S. and global trade-related feuds had brought those tensions closer to home.

The road ahead

Harley-Davidson CEO Matt Levatich said that the firm’s “U.S. market share growth and retail sales performance in the first quarter are further evidence of the effects we are having as we continue to implement and dial-in our More Roads efforts."

As part of its ‘More Roads’ accelerated plan for growth, HOG aims to build two million new riders in the U.S., grow international business to 50% of annual volume and launch 100 new high impact motorcycles through 2027.

The company said it plans to maintain its current investment and return profile and capital allocation strategy, while it funds strategic opportunities expected to drive revenue growth and expand operating margin through 2022.

In Q1’19, while HOG’s U.S. market share was up 0.6 percentage points to 51.1%, its foothold in European markets fell 1.6 percentage points to 8.8%. Its operating margin also contracted 3.6 pts over the prior year to 9.1%.

Pressure gauge

Earlier in April, Fitch Ratings had revised its outlook on HOG to ‘Negative’ from ‘Stable,’ due in large part to the agency’s “increased concern that external pressures on the company,
including declining motorcycle demand, weakening economic conditions in certain end markets, higher raw material prices and increased tariffs on imported motorcycles in particular markets could pressure the company's credit profile over the intermediate term.”

Fitch observed that HOG's motorcycle business has been “under pressure for several years, and so far the company has been able to manage the headwinds without a meaningful deterioration of its credit profile.

“However, the next several years will be more challenging as the company realigns its manufacturing footprint while introducing a number of new products in segments it does not currently serve, increasing the risk of credit profile erosion.”

To grow its product line, HOG said it has expanded its electric portfolio with the purchase of StaCyc, “a maker of electric two-wheelers for kids,” and during the quarter, it continued to partner with its dealers for the launch of LiveWire – the firm’s first electric motorcycle – later this year.

Investment-grade credit

In terms of credit quality, bondholders have been generally benefitting from the company’s high-grade credit profile, underscored by low leverage levels and healthy free cash flow (FCF).

Fitch, which affirmed its ‘A’ investment-grade rating on HOG earlier in April, said it expects the motor company’s EBITDA leverage to remain roughly flat over the intermediate-term, at around 0.7x to 0.8x. HOG's US$750m in senior unsecured notes constitute its only debt, and any additional issuance over this period appears unlikely.

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Against this backdrop, HOG’s 4.625% notes due July 2045 have seen significant price swings over the past year, having hit its most recent 52-week peak at the start of 2019 at around US$94.66 from a low in mid-November 2018 of a little more than US$89.47, according to the IBKR Trader Workstation (TWS).

The notes remain in the discount territory, with recent TWS quotes showing a bid of around US$93.37 intraday Tuesday, while the yield on the 10-year U.S. Treasury note had dipped to about 2.576%.

Meanwhile, HOG held nearly US$760m in cash and marketable securities at the end of Q1’19, up from US$753.5m in the prior year, and while it generated only US$32.7m from operating activities in the latest quarter – almost 83% less than the prior year – it managed to pay a cash dividend of US$0.375 a share – up 1.4% year-on-year.

Fitch added that it anticipates HOG’s FCF to remain “relatively strong” over the intermediate-term, with post-dividend FCF margins running in the 7% to 9% range, “which will provide the company with considerable financial flexibility.”

Fitch also expects capital spending to run at about 4% to 5% of revenue over the intermediate-term, “with heavier spending in the near term as the company consolidates its U.S. operations, expands its Thailand plant and invests in its new product programs.”

2019 Drive

HOG noted in its guidance for the full-year 2019 that it continues to expect capital expenditures of around US$225m to US$245m, including US$20m to support its manufacturing optimization.

The company also eyes motorcycle shipments of around 217,000 to 222,000, with the second quarter to comprise roughly 65,500 to 70,500. It also sees its motorcycles segment operating margin, as a percent of revenue, to come in at around 8.0-9.0%.

The 116-year-old company also believes operating income from its financial services segment will fall year-over-year. In Q1’19, it achieved earnings of US$58.7m, down 7.6% from 2018.

Harley-Davidson was founded in Milwaukee, Wisconsin in 1903. It boasts that its corporate headquarters stand on the site where its first factory was built – in the backyard of the William C. Davidson family home – and touts a current workforce of more than 6,000 employees worldwide.

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