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Morningstar | Weak Industry Demand Halts Harley's Ability to Raise Shipment Outlook; Shares Modestly Undervalued

There remains little to get excited about regarding top-line potential for wide-moat Harley-Davidson in 2019 as the heavyweight motorcycle market continues to struggle, with worldwide and U.S. retail sales both tumbling around 4% in the first quarter. The firm took 60 basis points of share (to 51.1%) in the United States, which made up 58% of global shipments in 2018, while ceding 160 basis points of share (to 8.8%) in Europe. International retail sales fell 3.3%, with declines across all regions. Harley’s gross margin remains under pressure as mix headwinds, lower cost absorption, and restructuring and tariff expenses persist. Given that performance was in line with prior expectations, the company maintained its shipment guidance of 217,000-222,000 units for 2019 (a decrease of about 4% at the midpoint), matching our 219,000-unit forecast. Overall, we didn’t perceive anything in the first-quarter results to put our already tepid 2019 and modestly improving long-term outlook at risk. We don’t plan any material change to our $44 fair value estimate and view the shares as modestly undervalued, trading at a 10% discount to our valuation.

We don’t think many factors currently weighing on performance will persist perpetually, leading to our more sanguine outlook for Harley over time. While secular headwinds could prevail across the industry, tariff and restructuring costs should abate, offering a lift to Harley's motorcycle operating margin performance. Furthermore, the launch of new products across underpenetrated categories as the company utilizes its More Roads program to pivot and attract new global audiences should be able to stimulate demand, increasing unit sales growth to a sustainable low-single-digit clip. While some operating margin expansion should ensue with higher volume, we anticipate the motorcycle operating margin will only rise back to 14%, well below the 18% earned in 2014, bound by the lower-margin mix we believe Harley is pursuing.

Total revenue fell 12% to $1.195 billion. Motorcycles acted as the biggest drag on performance, down 14%, with shipments contracting nearly 8% and average selling prices declining almost 7%. Parts and accessories fell 5.5% and 2.1%, respectively, more closely in line with retail sales. The gross margin (GAAP) contracted 560 basis points to 29.1%, affected by volume, mix, restructuring costs, and tariffs. With tariffs removed, we estimate this metric was closer to 31%, which still represents a nearly 400-basis-point decline.

Financial services income continued to decline, falling 8%, as higher operating expenses and provisions for loan losses weren’t offset by a higher percentage of sales financed (64.5% of new U.S. Harley bikes, up nearly 6% from the first quarter last year). Delinquencies and losses have ticked up over the last year, with 30-day-plus delinquencies at the highest first-quarter level since 2010, exiting the recession.

Commentary surrounding efforts to stimulate demand concerns us the most over the near term, as financial incentives could be shifting demand from one period to another and could imply that the brand may not be considered to be as premium or aspirational as in the past (additionally, if financing tactics are driving demand, it could be that Harley is tapping into a less affluent demographic than in the past). We plan to continue to watch the motivation behind the purchase decision to ascertain whether brand equity could improve or falter from current levels.