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Morningstar | Heavyweight Demand Continues to Languish, Leading to Further Shipment Declines at Harley in 2019

About to embark on its fifth year of shipment declines, wide-moat Harley-Davidson continues to attempt to pivot to changing consumer preferences. Most importantly, this includes a shift in demand to smaller bikes, out of Harley’s traditional high-margin touring and cruising product wheelhouse, but to which it has been attempting to cater with its Street and Sportster models. However, it appears traction has not yet taken hold, with Harley ceding further market share in the fourth quarter domestically (a market that takes about 60% of annual units), as retail sales of Harley bikes declined 10% while the heavyweight market contracted just 8%. The forecast for 2019 fails to hold promise of an imminent resurrection for the brand and market share gains. Anticipated global shipments of 217,000-222,000 are below our 232,000 prior estimate and represent a 4% decline from 2018’s 228,665 units shipped at the midpoint.

As we lower our shipment expectation for 2019, we expect to lower our $45 fair value estimate by around $3. We view shares as attractive for those with longer time horizons given that many midsize bikes are set to come out in 2020 and beyond, indicating stabilization in shipments could still take some time. Unfortunately, we don’t think Harley’s More Roads initiative launched in mid-2018 will result in swift enough adoption of bikes abroad to offset languishing shipment results at home, as Harley fights to steal share from existing market incumbents in many overseas markets and does so at potentially lower profit margin levels than it has captured with its touring and cruising models. With our forecast calling for volume accretion at the cost of margin dilution, our motorcycle operating margin is still able to climb back to a low-teens rate by 2027, from 8.5% in 2018 (as-reported), thanks to fixed cost leverage and the eventual reduction in tariffs.

Fourth-quarter sales declined 9%, hindered by 8% shipment declines and double-digit downticks in both general merchandise and parts and accessories that were impacted by a calendar shift that was one week short of last year. The as-reported gross margin contracted about 300 basis points, to 27.6%, with lower volumes, restructuring expenses, and tariffs packing the biggest punch to the metric. The SG&A ratio also rose to nearly 32% of sales, impacted by two recalls. Harley continues to trim inventory at dealers to better match supply with demand, which has ultimately resulted in the lower shipment outlook ahead.

We don’t believe Harley expects an easy road ahead for the resumption of demand, which underlies its efforts to introduce new products, facilitate broader access to its brand, and form a stronger dealer base to ensure the health of its brand and the consumption of its innovation. However, given what appears to be an ongoing secular shift to a different type of product than Harley has traditionally focused on, we plan to watch the More Roads plan unfold to determine whether the firm is able to compete as well in the new demand environment, maintaining its stable moat trend rating, or whether it struggles to meet new consumer demands, potentially putting the company on the path of a negative moat trend rating ahead.