Will inflation crush Harley-Davidson’s chances of living high on the hog?

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The share price of Harley davidson (NYSE: HOG) slipped last Wednesday after its second quarter 2021 earnings report and conference call, plunging 7.19% at market close. Despite many bright spots in the motorcycle maker’s measures, investors have focused on rising raw material and supply chain costs, driving down its stock value over fears of further inflation. The stock continued to decline for several days but more slowly.

With Harley-Davidson’s Hardwire strategy to transform itself into a more modern, profitable business, the alarm about a possible stall may seem justified at first glance. But there are also enough signs of a reversal to potentially support a more bullish point of view.

The situation Harley faces

Rising steel and aluminum commodity prices, chip shortages and supply chain issues all have an effect on Harley-Davidson’s operations, with the ongoing European tariff battle piling on these. other factors. On the second quarter earnings conference call, CFO Gina Goetter said the supply chain was “very fragile” while noting that the company “continued to see inflation in all modes. freight as well as in commodities, “a situation that Harley analysts expect to continue and worsen. until 2021.

Image source: Getty Images.

Economists are sharply divided over how long the inflation lasts, with some arguing that the price spike is temporary after the brake on COVID-19 lockdowns has been lifted and the economy has started to reopen. Others say the inflationary trend will continue well beyond 2021 and longer term, citing the effects of large government spending bills.

Steel and aluminum are also trading higher. The chip shortage, although it has eased somewhat as some semiconductor companies begin to bring increased production capacity online, could be part of a trend in which prices remain high as the demand for chips increases in the long run. Vehicle manufacturers, including Harley-Davidson, are also under pressure from strained global and national supply chains, as fallout from lockdowns and COVID-19, along with the explosive growth of e-commerce, puts pressure on the area.

Harley is also currently in the middle of a tariff battle, with a European tariff on the import of its two-wheelers currently at 31%. The company says this factor could lower its operating margins by as much as 6% over the next few quarters, although it believes margins as high as 9% are likely if trade negotiations soften the effects of the tariff, with an “average single digit” margin impacting the likely of all factors combined.

In addition to squeezing operating margins, another tangible effect of tariff and input price inflation is a 2% surtax on all U.S. sales of Harley-Davidson motorcycles, which the company says is currently supposed to be in place between July 1 and December 31. , 2021. Nonetheless, Goetter added that the company “maintains our forecast for Motorcycle segment revenue growth of 30% to 35%” for the third and fourth quarters of 2021. Despite all the converging pressures, the company appears to believe that it can maintain its positive momentum – a belief based on its new leadership, new strategy and the recent gains these factors have created.

Harley-Davidson successes

Currently led by a new CEO with a record of success in business turnarounds, Harley-Davidson has launched its five-year Hardwire strategic plan to reconfigure itself for success in the modern motorcycle market. The plan involves marketing to younger generations, designing and selling more affordable vehicles, and continuing the popular angle of electric vehicles (EVs) with electric motorcycles. Harley is kicking off these new initiatives at a time when motorcycle ownership and use appears to be on the rise, giving it a more solid foundation for its efforts to start growing again.

The ‘pigs’ maker just released exceptional second quarter 2021 results, including a 77% year-on-year jump in revenue to $ 1.53 billion and adjusted earnings per share (EPS) of $ 1.41 , compared to a loss of $ 0.38 per share in the second quarter of 2020. Compared to 2019, revenue declined slightly from $ 1.63 billion in the second quarter of that year, although the recovery continues. Harley-Davidson after the dire economy of 2020 may explain the difference. Notably, EPS is up 14.6% from the $ 1.23 per share in Q2 2019. The business appears to be operating more efficiently.

In terms of debt, both short-term and long-term debt types are higher than they were in 2019, but have deleveraged significantly from 2020 highs:

Type of debt

Q2 2019

Q2 2020

Q2 2021

Short term

$ 405 million

$ 1.55 billion

$ 749 million

Long term (net)

$ 4.65 billion

$ 6.49 billion

$ 4.75 billion

SOURCE: HARLEY-DAVIDSON PROFIT REPORTS.

While Harley-Davidson’s current indebtedness is potentially troubling, its halving of short-term debt from its 2020 peak, as well as the reduction in long-term net debt to very close to the 2019 figure, reducing it by nearly $ 2 billion, are positive developments and could see further deleveraging if the trend continues.

Beyond immediate action, Harley appears to be performing strongly on several important facets of its turnaround strategy. Its LiveWire electric motorcycle is one of these strengths. The new line of motorcycles has its own “independent” brand, giving it potential marketing leeway, without the shadow of Harley-Davidson style, culture and nameplates. The price is also positive, with the LiveWire One posting a Manufacturer’s Suggested Retail Price (MSRP) of around $ 22,000. While it’s not the cheapest e-bike, it’s reasonable enough to make it competitive against competing models.

Likewise, the company’s Pan America Adventure Motorcycle costs just under $ 20,000, which puts it in the middle of the pack for 2021 Adventure Bike Ride awards and extends Harley’s foray to a affordable price. The potential to appeal to younger generations, who are looking for more thrifty options that offer fun rather than massive ‘pigs’ and the culture associated with them, may also help drive sales growth in the coming quarters.

In another attempt to monetize the company’s budget, Harley-Davidson opened its “H-D1 Marketplace” on July 21, offering certified pre-owned Harleys at dealerships, with digital purchases and customization available to them. potential buyers to streamline the buying process. The company has also created a new feature to allow current Harley-Davidson owners to resell their motorcycles on the H-D1 Marketplace network. Although brand new and therefore untested, the program at least shows that the motorcycle manufacturer is aggressively seeking new approaches to selling.

The new initiatives could also be timely to take advantage of current trends, with the Motorcycle Industry Council and other organizations showing a sharp double-digit increase in first-time motorcycle purchases, along with metrics (such as increase in replacement tire sales), motorcycles are actually used rather than sitting idle.

Parent and offspring with a big Harley-type motorcycle, representing the continuation of the motorcycle trend through the generations.

Image source: Getty Images.

While not new, its financial services segment is booming, its operating profit for fiscal 2021 is expected to grow 75-85% year-over-year. This is a significant upgrade from the 50% to 60% gains it predicted earlier in 2021. With financial services integrated into the H-D1 market according to the company’s press releases, the Used Hog program, if successful, could be another driver for this service.

Verdict: HOG – yes or no?

Alongside European tariffs, the shortages of 2021, their effects already felt on the entire automotive sector, are starting to affect Harley-Davidson. The material impact on the company will be a “single digit” drop in operating margins. With a second quarter operating margin of 14%, a hypothetical 5% drop, exactly in the middle of the range, would potentially lower the third and fourth quarter operating margins to around 9%. How important is that, however, in the bigger picture, using the context of Harley’s operational history?

Clarity can come from a look at previous operating margins. In the third quarter of 2020, the operating margin was 4.5%, but Harley-Davidson still generated the largest quarterly net profit in this quarter since 2015. Prior to the pandemic, the operating margin of the third quarter of 2019 amounted to 4.4%. When it comes to annual results, the metric was 5.7% negative in 2020 overall and 6.3% positive for full year 2019.

It seems that even with commodity inflation and other factors driving up spending, Harley-Davidson will generate profits more efficiently not only compared to last year with its COVID-19 lockdown burden, but also better. than in 2019. Assuming its estimates of single-digit margin impacts are correct, it will still perform better in this regard than it has in years, an indicator that the Hardwire strategy is already triggering a long-term recovery. Tariffs are already in place, and while reducing profits in the European market, have not reversed Harley-Davidson’s strong revenue and profit gains.

Unless inflation, shortages and tariffs persist over the long term, and many companies already expect inflation and shortages to ease in 2022, Harley-Davidson’s new strategy seems succeed, giving it a bullish future for fools investing in consumer durables.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.


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