How healthy is Harley-Davidson as the end of the 3rd quarter approaches?

Many stock market analysts believe motorcycles are a sign of consumer confidence. If that belief is true, then the economy is slightly improving:

Harley’s second quarter shipments were slightly up from first quarter 2010, and, as Harley announced in its 2Q earning report, at the end of the 2Q income was 71.2 million compared to 19.8 million at the same point last year. It seems things are looking up in the Beer and Bike city and thus for the nation.

And, despite all this, more analysts say hold—even sell—than buy. So why aren’t they all woo, woo, go Harley? Let’s look deeper at Harley’s self-proclaimed road to renewing health:

Shipments up but not over 2009

Harley counts a shipment as a sale—that means the motorcycle is sold to the dealer. It doesn’t mean it’s sold to the consumer. It also cut shipments back severely over 2009 and lowered inventory.

Harley’s Stock Price and Shipments at the end of the 2 quarter for each year:

In its second quarter report, Harley announced shipments were down 8.4% from the same quarter in 2009. Of course, that was in the throes of the Great Recession and an abysmal year for the Motor Company. If shipments are still down from that, it’s not

H-D would have to meet their goal of selling 53,000-58,000 motorcycles in the 3Q in order to hit their goal of shipping 201,000–212,000 motorcycles by the end of 2010. That’s still 5%–10% down from 2009, which was significantly lower than 2008.

The growth in shipments over 1Q is good—but distracts from the real picture: shipments are worse than at the height of the Great Recession.

Dealer sales are down A report commissioned by analysts show that 66% of the dealers surveyed at the end of the second quarter said their sales fell by 20% in the 2Q.

If product is choking showroom floors and dealers are choking on the interest payments from that unsold stock, third quarter orders are likely to be lower especially since there’s nothing particularly new or exciting in the 2011 models to driver consumers to buy. This makes it harder for Harley to make their shipment goal.

According to Matt Andrejczak in a July 30, 2010 MarketWatch article, “How short-selling sleuths spot accounting gimmicks on financial reports”,“Typically, inventories should rise at about the same pace as sales. If a company’s inventories are growing faster than sales or expected sales growth, it’s a clue that products aren’t moving. In that case, gross margins could get squeezed.”

Harley is aware of that—and set what TPTB thought were modest shipment goals. Dealers, clearly, thought they could sell what they bought but were wrong and inventories have grown, in many cases faster than sales.

Needless to say, paring shipments further is likely to end in more layoffs, which doesn’t help the nation’s recovery (or the workers, obviously).

But high unemployment is a major reason why dealer sales are down—H-D’s core demographic has been hit hard by both job loss and uncertainty that their savings and investments are secure. And Harleys are high-end discretionary products.

Until Harley’s base is securely employed, sales will continue to lag. But the slower the recovery goes, the slower sales and the slower Harley recovers. Hello, vicious circle. And this is true of a great many companies and entities in the USA that are busy cutting benefits and wages: they feed into the very process that undermines their future profitability.

Dealers have unhappy choices to deal with their inventory: They can—and would—cut orders for new product, which exacerbates the problems H-D already faces. They can cut prices, which also cuts into gross margin profits. It could also damage the brand—it’s no longer a prestige product if it’s on the sale rack.

Market saturation Harley’s problems are exacerbated by market saturation (both here and in Canada). More and more analysts are realizing the Motor Company’s inability to attract women, minorities and younger men and caution that it will affect the corporation’s recovery. Nor is Harley making significant inroads in other countries.

These domestic and international failures are the result of the same branding that made the company such a success. It’s an image that’s dated, narrow and even a joke among the very people the company needs to attract. Moreso, the essential elements of motorcycling—individuality, daring, independence—have been successfully incorporated by Harley’s competitors in their sport, tourer, adventure models in ways that appeal to the very groups Harley has been unable to attract.

Bottom line: when times were good, the leadership failed to find a creative way to translate the brand for a new generation and new concerns. It dwelt in the past even as it aggressively pursued questionable business practices (such as the subprime loan fiasco). Unless a marketing miracle occurs, Harley’s market share will continue to shrink.

This suggests that, unless something dramatically positive happens in the economy in the next few weeks, both sales to consumers and shipments to dealers will be down in the 3Q. And that would mean that Harley may not make its already depressed and modest shipment goal this year. And that does not bode well for the Motor Company.

Both sluggish sales and market saturation affects the other two main streams of revenues: Motorclothes/accessories and Harley-Davidson Financial Services. How it affects the first, the Motorclothes division, is obvious—the second deserves a bit of explanation.

Harley-Davidson Financial Services At the height of the recession almost 30% of Harley’s Financial Services loans were subprime and the Financial Services subsidiary lost about 60 million. This is where the 600 million dollar loan from Buffet and Davis Selected Advisers, L.P. went. A change in the subprime loan policy, the restructuring and infusion of cash has made the subsidiary profitable in the 2Q. For now. And, of course, since Harley loans the dealers money to buy its motorcycles Harley makes money from the interest on shipments dealers paid for but can’t sell.

The bottom line is: Demand for loans is contingent on demand for bikes and it’s going to be years before Harley gets back to even 2007 shipments.  HDFS’ recovery looks good on paper but under the surface lurks the hefty 15% interest on that 600 million loan that and the debt itself that is due in just three years.

Ultimately though, a motorcycle manufacturer has to sell motorcycles to be successful or even to stay in business. It’s still behind

As “Harley-Davidson: Easy Riding on Less Bad Results” published on July 20, 2010, stated,  “At Ockham, we would not recommend buying Harley’s stock following today’s earnings report because “less bad” just is not good enough.”

In the next entry we’ll look at some troubling signs some analysts have found when they looked behind the numbers of the 2Q report. And what they worried about in July is likely to be even more true as the end of the 3Q approaches.

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6 Comments on “How healthy is Harley-Davidson as the end of the 3rd quarter approaches?”

  1. Jim Says:

    HD has unique problems, but it also shares problems with the greater MC industry. The largest of these is demographics, if the baby boomers were responsible for the two great MC post WWII sales booms, then it’s 1982 again and there are simply fewer buyers. Then to make matters worse younger consumers, teens and twenties have less interest in MC’s and for that matter automobiles than their predecessors.

    In 10 years the MC marketplace will look very different, HD will either be a subsidiary or private; with owners who will settle for a steady revenue stream rather than looking for growth. One or more of the Japanese brands will be gone and the marginal Italian brands will be history.

  2. wmoon Says:

    Actually, Jim, you’ve just described the big shake-up that happened in the late 1960s and through the middle of the 1970s. The British motorcycle manufacturers failed to react to the threat posed by the Japanese bike makers and American (Harley, Indian and Excelsior) also failed to respond in a dynamic way. Harley made it through (barely and with the help of the federal government) then.

    I’ve written extensively on the issue of the boomers, Gen X and Y and the effect it will have on the industry. You may be interested in reading about it–just go back a few months.

  3. Jim Says:

    I’m familiar with those posts and as I recall they summarized the issue well.

    History is repeating itself. My picks of the survivors and dyers

    Survive
    HD as a subsidiary of an investment trust that is satisfied with a profit margin target.
    Honda & Yamaha- well diversified parent corporations, brand equity
    Triumph – private
    Ducati – too much brand equity.
    Vespa – brand equity

    Die
    Kawasaki, Suzuki poor brand equity
    MV, Moto Guzzi, Cavagia – marginal in the best of times
    KTM – Too small to survive

    On the cusp
    BMW- Future tied directly to the prospects of the auto division. If motorrad remains profitable and AG remains independent, it will survive. All bets are off if AG is forced to merge or sell.
    Aprila – will probably die but there’s a chance.

  4. wmoon Says:

    I might agree with you about H-D though I would be sad if that happened. I tend to agree that some of the smaller European brands might go down and Aprila would be the most likely. I think BMW will make it through.

    I’m wondering why you think Kawasaki and Suzuki will go down since motorcycles aren’t the only tool in their tool box–they have other lines that are well diversified, I think (unlike H-D that was never able to diversify successfully).
    W.

  5. Jim Says:

    Regarding Kawasaki and Suzuki, among the Japanese brands they have the weakest brand image and within in their respective corporate portfolios they are a weak product lines in a stagnating market.

    Japan’s manufacturing conglomerates are on the cusp of a product rationalization similar to the one that US companies went through in the 70’s and 80’s, they need to pick and support their winners in order to strengthen the core as they face competition from China and India.

    Rather than on the cusp, I should have said on the bubble with regard to BMW and Aprila,

    BMW AG has nearly killed motorrad a few times, even as recently as the late 90’s when it seemed the brand was missing the boom, there were rumblings out of AG’s boardroom that motorcycles were put on notice. Happily compelling product came to market and sales grew.

    If BMW AG still viewed themselves as purveyors of the ultimate driving machine, I’d feel motorrad would be secure. But the new focus on being the ultimate yuppy vehicle producer, regardless of segment, who knows.

  6. Gunslinger Says:

    Two very important points seem to be missing from this conversation. The first is the used motorcycle market. The 30% sub prime loans that were charged off were secured by motorcycles. Once repossessed they went to auction. Bottom feeders attend aouctions and values have been depressed. Think about it? A 2008 883 Sportster is selling for $4,200.00 and a 2007 Ultra Classic is selling for under $10,000.00. The once ‘investment’ value of a HD sunk like a stone. 30% of a portfolio of whatever dollars represents quite a few bikes. Who would buy a new one for full value when a decent low mileage spiffy used one can be had for 50% less?

    The second item that has to be examined is the enrollment of students in the various state motorcycle training programs. I worked in two different state programs and enrollment is down. It is so depressed where classes have been cancelled and the ones that were conducted were not full. The last two classes I taugh consisted of ten and seven.

    If one wants to consider training to be the pipe line for new bike sales then one has to believe the pipeline is quite empty. I truly believe the days of owning a motorcycle as a fashion accessory are long gone.

    One last thought before you say I am full of ‘prunes’ is many years ago when I first started my 35 year career in the financial services industry a wise old sage counseled me ‘…never finance a fad…’ His words seem to be as true now as hey were all those years ago.


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