KEY RATING DRIVERS
The upgrade of the IDRs of HOG and HDFS reflects the motorcycle manufacturer’s strengthened credit profile now that its restructuring is complete. Also, on Feb. 3, 2014, HOG repaid the remaining $303 million in senior unsecured notes outstanding at the motor company, leaving the motor company debt free. All remaining debt is at the HDFS subsidiary, and Fitch expects all debt issuance going forward will be at HDFS. In addition to its relatively strong credit profile, HOG’s ratings are also supported by the company’s leading position in the U.S. heavyweight motorcycle segment, strong cash liquidity position, relatively high margins, well-funded pension plans, and conservative financial policies.
HOG commands more than 50% of the U.S. heavyweight motorcycle market, and sales outside the U.S. continue to grow, particularly in emerging markets such as India and Latin America. Over the past several years, demand in Europe has been pressured by the region’s challenging economic conditions, but over the intermediate term, Fitch expects HOG to further grow the percentage of its sales generated outside the U.S. Helping in this regard will be the new Street motorcycles, whose lighter weight and lower price should appeal to non-U.S. customers, especially in emerging markets.
Fitch also expects HOG’s cost structure to improve now that its restructuring program has been largely completed and its Kansas City plant has been shifted to a flexible production system. HDFS’ asset performance and funding access remain strong and the subsidiary continues to increase the proportion of unsecured debt in its funding profile. Fitch notes, however, that loss rates could rise modestly over the intermediate term as HDFS has increased the number of subprime originations in its asset base.
HDFS’ ratings reflect its close operating relationship with HOG, which is governed by a support agreement under which HOG must maintain HDFS’ fixed-charge coverage at 1.25 times (x) and minimum net worth of $40 million. HDFS’ ratings are linked to HOG, as Fitch believes that the company is a core subsidiary of HOG and there is an implicit level of support between the two entities.
The primary risk to HOG’s ratings is the potential for an economic slowdown to result in lower motorcycle demand and reverse the positive growth trends that have taken hold over the past several years. This could weaken HOG’s profitability and pressure the company’s liquidity. A downturn that is accompanied by tightened credit markets would exacerbate the pressure by potentially limiting HDFS’ access to stable sources of capital and forcing HOG to provide financial support to the subsidiary.
Despite these risks, HOG is now in a significantly better position to withstand a future downturn than is was prior to the last recession, with a more flexible cost structure and a commitment to maintaining liquidity (including both cash and revolver availability) sufficient to meet its consolidated cash needs over a rolling 12-month period. The motor company’s debt-free balance sheet and well-funded pension plans also enhance its financial flexibility.
The operational restructuring that HOG began in 2009 is complete. In January 2014, the company transitioned its Kansas City plant to the same flexible manufacturing process that it implemented at its York plant in 2012. With surge capability in place at its primary manufacturing facilities, HOG is now able to flex all of its production in line with the significant seasonality in its business, which will help to reduce costs and better align dealer inventories with seasonal demand patterns.
Through Dec. 31, 2013, the company had spent about $302 million in cash related to the restructuring since the program began. HOG estimates annualized expense savings associated with the restructuring (compared with 2008 levels) were about $310 million for the full year 2013 and will be $320 million going forward. Fitch views the restructuring as an important driver of HOG’s financial flexibility and credit profile improvement, and it has already had a meaningful effect on HOG’s financial and operational performance.
For the 2014 model year, HOG has introduced its heavily updated line of Touring motorcycles known as ‘Project Rushmore’. These are the first motorcycles designed under the accelerated product development process that HOG implemented several years ago. The Rushmore motorcycles feature a number of new design elements, upgraded technology and updated motors. HOG has raised prices on the Rushmore bikes, but the company has noted that their higher level of equipment actually results in slightly lower margins. In addition to the Rushmore motorcycles, in the spring of 2014, HOG will introduce the entirely new Street line of motorcycles.
The Street motorcycles are lighter weight and will have a lower base price than HOG’s existing motorcycles, and they are powered by new, smaller engines. The Street motorcycles have been designed with non-U.S. markets in mind, but they will be sold as entry-level motorcycles in the U.S. as well. Although the lower price of the Street motorcycles risks some cannibalization with lower-end Sportsters, Fitch views the introduction of both the Rushmore and Street motorcycles positively, as their updated technology and design will help to further diversify HOG’s customer base without diluting its strong brand image.
The motor company’s credit profile remains strong and, following the debt repayment, is characterized by zero debt, high margins and robust liquidity. Fitch-calculated EBITDA for the motor company in the 12 months ended Sept. 29, 2013, was $1.1 billion, resulting in an EBITDA margin of 20.3%, up from $962 million and a 19.4% EBITDA margin in the year-earlier period. The motor company’s liquidity position remains solid as well, with about $820 million in cash, cash equivalents and marketable securities at Dec. 31, 2013.
Year-end liquidity remained robust despite the company voluntarily contributing $175 million to its pension plans in early 2013. Dividend payments in 2013 were $188 million, up from $142 million in the year-earlier period, while net share repurchases increased to $479 million in 2013, up from $312 million in 2012.
The motor company’s free cash flow remained robust in the 12 months ended Sept. 29, 2013, totaling $440 million. This was $100 million higher than the corresponding year-earlier period despite increases in both capital spending and dividends. As a result, the motor company’s free cash flow margin grew to 8.4% from 6.8% in the year-earlier period. Going forward, increased capital spending and higher dividends will put some downward pressure on free cash flow, but Fitch expects it to remain positive and relatively strong.
Consolidated capital spending in 2013, most of which was at the motor company, was $208 million, up from $189 million in 2012. With no obvious acquisition opportunities, Fitch expects HOG to allocate excess future cash flows to share repurchases. However, the company appears resolute in its strategy to keep all debt at the HDFS level, so Fitch does not expect it to fund any share repurchases with incremental motor company borrowing.
At year-end 2012 (the most recent detailed information available), HOG’s pension plans were 82% funded on a projected benefit obligation (PBO) basis, with a PBO of $1.9 billion and total assets of $1.5 billion. As noted above, in the first quarter of 2013, the company voluntarily contributed $175 million to its plans, and no further contributions were required in 2013.
HOG noted on it recent earnings call that a combination of strong asset returns and a higher discount rate improved the funded status of its pension and post-retirement plans by about $600 million at year end 2013, suggesting that the pension plan may have been fully funded at the end of 2013. As such, the company does not expect to make any contributions to its funded plans in 2014.
HDFS’ operating performance has been stable. In 2013, its operating income of $283.1 million was relatively flat year-over-year compared to $284.7 million in 2012. Total delinquencies (30-plus days past due) as a percentage of retail receivables were 3.71%, compared to 3.94% one year prior. Annualized net losses, as percentage of retail receivables, were 1.09% as of Dec. 31, 2013 compared to 0.79% one year prior. Fitch expects operating performance for 2014 to continue to be flat to modestly lower, as lower cost of funds will be offset by higher credit loss provisioning for the year.
As of year-end Dec. 31, 2013, HDFS had $2.45 billion of liquidity, which was comprised of $1.17 billion of balance sheet cash (including $820 million at the motor company) and $1.28 billion of availability under its credit facilities. HDFS’ debt maturities are well laddered, with no significant long-term debt maturing within the next year. Fitch believes HDFS has sufficient liquidity to meet upcoming debt maturities and fund new motorcycle receivables.
Leverage, as measured by total debt divided by tangible equity, was 6.0x at Dec. 31, 2013, compared to 5.5x the same period, one year prior. The company’s equity base is of high quality with no material goodwill or intangibles. Fitch believes HDFS’ leverage is consistent with similarly rated peers and within the historical range of between 5.0x and 7.0x.
RATING SENSITIVITIES
Positive: Fitch does not anticipate upgrading the ratings of HOG or HDFS in the intermediate term.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
–A severe downturn in global heavyweight motorcycle demand;
–A change in financial policy that leads to the motor company once again carrying debt, particularly to fund shareholder activities;
–A shift in business strategy away from a focus on the namesake brand;
–Difficulty in HDFS accessing long-term funding for new originations;
–A significant increase in HDFS’ reliance on secured debt or commercial paper;
–A meaningful deterioration in HDFS’ asset quality;
–A change in the perceived core relationship between HOG and HDFS.
Fitch has taken the following rating actions on HOG and HDFS:
HOG
–Long-term IDR upgraded to ‘A’ from ‘A-’;
–Senior unsecured rating withdrawn.
HDFS
–Long-term IDR upgraded to ‘A’ from ‘A-’;
–Senior unsecured rating upgraded to ‘A’ from ‘A-’;
–Short-term IDR upgraded to ‘F1′ from ‘F2′;
–Commercial paper rating upgraded to ‘F1′ from ‘F2′.
Harley-Davidson Funding Corp. (HDFC)
–Senior unsecured rating upgraded to ‘A’ from ‘A-’.
The Rating Outlook is Stable.
Additional information is available at ‘www.fitchratings.com‘.
Applicable Criteria and Related Research:
–Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage (Aug. 5, 2013);
–Global Financial Institutions Rating Criteria (Jan. 31, 2014);
–Finance and Leasing Companies Criteria (Dec. 11, 2012);
–Rating FI Subsidiaries and Holding Companies (Aug. 10, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139
Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397
Finance and Leasing Companies Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696720
Rating FI Subsidiaries and Holding Companies
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=679209
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=819231
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Contacts
Fitch Ratings / Primary Analyst (HOG) / Stephen Brown / Senior Director
+1-312-368-3139 / Fitch Ratings, Inc. / 70 West Madison Street / Chicago, IL 60602
or
Media Relations:
Brian Bertsch, New York, +1 212-908-0549 / Email: brian.bertsch@fitchratings.com
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