It's been quite a ride for Harley-Davidson, Inc. (NYSE:HOG) investors this year. The stock?has?been?up?and down this year, but it has soared 240% since the March 6, 2009 bottom of slightly over $8 per share. Margin pressures are now?putting the brakes on the stock. Has the recent?slowdown finally broken Harley's?momentum, or is this just?a bump in the road? (For more, read Earnings: Quality Means Everything.)
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Smooth Ride
As the market leader in heavyweight motorcycles, Harley-Davidson is in good financial condition thanks?in large part to its?significant brand power. Third quarter earnings surged from $88.8 million in the third quarter of 2010 to $183.6 million last quarter. Solid revenues and?a very favorable temporary tax rate of 30.4% padded earnings. Global motorcycle?and parts sales?increased 13% to $1.23 billion.?Harley's debt-to-asset ratio has steadily improved sequentially and operating cash flows remain strong.
The company has made significant?inroads into global markets. Retail sales climbed 1.8% in the Asia Pacific region last quarter. It is?concerning that demand?in Japan still has not recovered following the tsunami earlier this year, and a large percentage of?international sales derive from troubled Europe.
Margin?Miss
Global growth fears and Harley's transformation into a smaller manufacturer have?pushed the stock into the red; since July 15, HOG is down 17%. Inventories are?near multi-year lows as a result of supply constraints. The restructuring underway?at Harley's York manufacturing facility?has caused?tangible disruptions and margin pressures, particularly for higher-priced Touring and Softail lines. Harley?fell short?on both margins and margin guidance during the third quarter,?as?lower productivity and?inefficiencies were induced by the?restructuring.?Manufacturing?constraints?will continue to be felt during the fourth quarter, and inefficiencies are expected to persist?through 2013.?
Currency impacts squeezed margins as well last quarter. Harley revalues foreign assets?at end of quarter currency exchange rates. If exchange rates are lower at?the end of the?reporting period?(as the euro, Australian dollar and Brazilian real were last quarter), the impact is negative. Instability in?Europe, and for the euro,?adds a?big currency risk premium to Harley's significant?European operations. (To learn more about the effect currency can have on a corporation, see Corporate Currency Risks Explained.)
Higher prices for?steel, rubber and other?materials?that go into the production process are another major concern. Will?Harley be able to?pass along those costs to buyers? 2012 models are expected to be priced 1% higher on average. If gas prices remain very high, will the allure of the Harley brand prevent consumers from trading down to lower cost,?more fuel efficient, lighter bikes made by Honda Motor Co., LTD. (NYSE:HMC), Suzuki or Yamaha? Higher gas prices could?push more?buyers toward the growing?electric bike market. On October 26, diversified vehicle producer Polaris Industries Inc. (NYSE:PII) announced a minority investment in electric motorcycle?maker Brammo Inc.?Polaris says the electric motorcycle market is "rapidly growing."
The Bottom Line
There are a lot of near-term obstacles that may dent Harley's stock, yet?there's still a lot to like. The company is very profitable and is growing its international footprint in emerging markets. Synergies and?assembly proficiencies from the York restructuring will provide long-term benefits. The 1.4% dividend yield is a nice feature as well.?
And, the?Harley brand remains a status symbol that buyers want. But there are?long-term risks to the brand. The company's?demographic continues to get older. Younger buyers, that may not appreciate the nostalgia of owning a Harley as much as the older generation,?are increasingly demanding more fuel efficient, cost effective vehicles. Harley-Davidson could be beat?off the line?by lower cost, more manageable Japanese vehicles, just as muscle cars made by General Motors Company (NYSE:GM) and Ford Motor Company (NYSE:F)?were. Near-term margin pressures, capacity constraints and rising?input costs?weigh heavily on?the stock. Now might not be the time to ride high on HOG. (For more on the effect rising fuel cost have had on the market, read 4 Ways Rising Fuel Costs Influence The Auto Industry.)
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At the time of writing, Matt Cavallaro did not own shares in any of the companies mentioned in this article.
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