Harley Meets Expectations on Higher Profit

| About: Harley-Davidson, Inc. (HOG)

Harley-Davidson Inc. (HOG) posted a 66% rise in profit to $93.7 million or 40 cents per share in the third quarter of the year from $56.4 million or 24 cents per share in the same quarter a year ago. The profit was in line with the Zacks Consensus Estimate.

The increase in profit was attributable to the company’s aggressive restructuring actions, incorporated in its go-forward business strategy, as well as improvement in profit in Harley-Davidson Financial Services.

Operating income rose by 54% to $152.4 million from $99.1 million in the third quarter of 2009, driven by higher revenues in Harley-Davidson Financial Services.

Motorcycles and Related Products
Revenues from Motorcycles and Related Products declined a tad 2% to $1.09 billion due to poor retail sales of heavyweight motorcycles. Revenues from Harley-Davidson motorcycles fell marginally by 0.6% to $798.8 million as shipments of motorcycles declined to 53,293 units from 54,236 units in the third quarter of 2009.

Harley’s worldwide dealer retail sales of new motorcycles ebbed 7.7% to 58,849 units during the quarter. In the U.S., retail unit sales fell 9.4% to 40,459 units while international retail sales decreased 3.6% to 18,390 units.

Retail sales were up 5% in the European region (including Europe, Middle East and Africa) and 5% in Latin America. Meanwhile, it went down 27% in Canada and 12% in Asia-Pacific. Heavyweight motorcycle (651cc-plus) retail unit sales in the U.S. industry declined 14.4% during the quarter.

Revenues from Parts and Accessories slid 1.2% to $219 million and revenues from General Merchandise – which includes MotorClothes apparel – dipped 9.4% to $64.1 million.

Gross margin improved to 34.9% from 33.4% in the year-ago period. However, operating margin decreased to 9.3% from 11.8% percent in the third quarter of 2009, due to a rise in restructuring and selling, general and administrative expenditures. Harley continues to expect gross margin in the range of 32.5%–34% for the full year 2010.

Harley has revised its guidance for full year 2010 shipments to 207,000–212,000 motorcycles compared to the prior forecast of 201,000–212,000 motorcycles. The guidance reflected a decline of 5%–7% from 2009 shipments.

Harley-Davidson Financial Services (HDFS)
Revenues in the Financial Services segment rose 26% to $172.8 million. The segment reported an operating income of $50.9 million in sharp contrast to an operating loss of $31.5 million in the year-ago quarter. This was attributable to lower cost of funds and improvement in credit losses.

Restructuring Activities
Harley’s restructuring expenditures and other impairments increased 33% to $67.5 million. The company has lowered its forecast to incur one-time charges, related to restructuring activities that began in 2009, to $505 million–$535 million in 2012 (including charges of $190 million to $210 million in 2010), from the prior estimate of $515 million–$545 million.

Consequently, the company anticipates savings in 2010 to rise to $150 million–$165 million from restructuring activities from the previous estimate of $135 million to $155 million. It continues to expect annual ongoing savings of $290 million to $310 million, beginning in 2013, upon completion of the restructuring activities.

Last month, Harley announced that its Wisconsin labor unions had ratified new labor agreements that will take effect in April 2012. Costs and savings related to these labor agreements are included in the above projections.

Financial Position
Harley’s cash and cash equivalents totaled $1.49 billion as of September 26, 2010 compared to $1.52 billion as of September 27, 2009. Long-term debt decreased to $3.02 billion as of September 26, 2010 from $3.84 billion a year ago. Consequently, long-term debt to capitalization ratio reduced to 58% from 63% a year ago.

In the first nine months of 2010, Harley had an operating cash flow of $1.17 billion, a significant improvement from $561.3 million in the prior year period. This can be mainly attributable to an improvement in profit.

Meanwhile, capital expenditures were flat at $77.6 million in the period under review compared to $76.6 million in the same period last year. For the full year, the company has lowered its guidance for capital expenditures to $190 million–$210 million from the earlier projection of $235 million–$255 million. The guidance included $75 million to $90 million to support restructuring activities, down from the prior guidance of $95 million to $110 million.

Our Take
Harley-Davidson commands roughly 50% of the U.S. market, providing scale advantages over most competitors. Furthermore, the company maintains an extremely strong franchise. It has a network of over 680 independent U.S. dealers (over 1,300 worldwide), 55% of which exclusively market Harley-Davidson branded motorcycles.

However, we believe the company’s aging customer base and slow recovery in the markets, reflecting its sluggish worldwide retail sales, will continue to negatively affect the company’s results. As a result, the company retained a Zacks #3 Rank on its stock, which translated to a ‘Hold’ recommendation for the short term (1–3 months).