Fitch Ratings has taken the following rating actions on Harley-Davidson, Inc. (HOG) and its Harley-Davidson Financial Services, Inc. (HDFS) and Harley-Davidson Funding Corp. (HDFC) subsidiaries as follows:
HOG
--Long-term Issuer Default Rating (IDR) affirmed at 'BBB+';
--Senior unsecured rating affirmed at 'BBB+';
--Rating Outlook revised to Stable from Negative.
HDFS
--Long-term IDR affirmed at 'BBB+';
--Short-term IDR affirmed at 'F2';
--Rating Outlook revised to Stable from Negative.
HDFC
--Long-term IDR rated 'BBB+'; Outlook Stable;
--Short-term IDR affirmed at 'F2';
--Senior unsecured rating affirmed at 'BBB+';
--Short-term debt rating affirmed at 'F2'.
HOG's ratings apply to $600 million in senior unsecured debt. HDFC's ratings apply to approximately $2.1 billion of senior unsecured debt.
HOG's ratings reflect the company's leading position in the U.S. heavyweight motorcycle segment, robust cash liquidity position and relatively low leverage in the motorcycle operations segment. Although motorcycle market conditions in the U.S. remain weak, with industry sales projected to be down for the full year in 2010, the market appears to be stabilizing and Fitch expects the industry could return to growth in 2011. HOG's continued progress on restructuring activities, begun in 2009, are expected to provide much needed manufacturing flexibility and lower costs over the next several years, while the discontinuation of the Buell motorcycle line and the eventual sale of MV Agusta will increase the company's focus on the core Harley-Davidson brand. HDFS' performance also has improved materially over the past 12 months, as funding costs have declined and both delinquency rates and loss expectations have improved. The aforementioned items also support the revision of the Rating Outlook to Stable from Negative. The primary near-term risk to HOG's credit profile is the potential for a negative turn in the global economy that would result in further depressed motorcycle demand.
In 2009, HOG experienced a nearly 27% decline in motorcycle shipments to dealers, as the global recession drove a 23% decline in worldwide retail sales of Harley-Davidson motorcycles. Although HOG was able to mitigate the effect of the downturn somewhat by growing its share to 53% of the U.S. heavyweight motorcycle market (from 46% in 2008), total motorcycle and related products revenue declined by a steep 23% for the full year. Since the demand trough in the second quarter of 2009, when HOG's retail sales were down 30% year-over-year, the rate of decline has improved, with sales in the first quarter of this year down about 18% and down only 5.5% in the second quarter, albeit against a very weak comparison period. Although Fitch does not expect positive full-year sales growth in 2010, the deceleration in the rate of decline is encouraging, and Fitch expects that sales could begin to grow in 2011. This market stabilization, along with positive mix effects, should help to support revenue this year, with sales of higher priced Touring and Custom motorcycles projected to comprise a relatively higher share of HOG's overall motorcycle revenue than lower-priced Sportster models. As such, although Fitch expects HOG's full-year revenue to be lower than 2009, the decline in revenue likely will be less than the decline in units shipped.
In reaction to the challenges posed by the recession-driven decline in motorcycle demand, in 2009 HOG began work on a comprehensive restructuring program, with the primary objectives of reducing costs and increasing the flexibility and responsiveness of the company's manufacturing operations. The various initiatives included in the program include a number of facility consolidations, the restructuring of the company's York, Pa., manufacturing facility to focus on certain core operations, cessation of the Buell motorcycle brand and the sale of MV Agusta, the Italian motorcycle manufacturer acquired by HOG in 2008. The multiyear restructuring program is slated to be complete in 2012 and ultimately will result in headcount declines of up to 3,600 employees in the company's motorcycle operations and 100 at HDFS. Although HOG estimates the total cost of the restructuring will be between $430 million and $460 million once it is complete, the company expects that it will result in annual benefits of $240 million to $260 million. In 2010, HOG expects to realize $135 million to $155 million in annualized benefits, with all but a small portion of the program's full benefits in place by year-end 2011. In addition to the program's direct cost savings, Fitch expects the increased manufacturing flexibility, which will allow all of the company's manufacturing facilities to produce all of the company's motorcycle products, to aid in HOG's ability to react quickly to changing market dynamics, further strengthening the company's operating margins. Fitch expects the motorcycle operations unit could produce EBITDA margins of 19% to 20% or more over the medium term as benefits from the restructuring take hold.
The credit profile of HOG's motorcycle operations weakened in 2009, as earnings and free cash flow declined and the company issued $600 million in privately placed senior unsecured notes at a very high 15% coupon. Proceeds from the notes, which mature in 2014, were temporarily used to bolster HDFS' liquidity position during a period when the credit markets were largely frozen. With HDFS' ability to access more typical sources of funding restored, the proceeds were returned to HOG late last year. The weaker operating performance and the addition of the notes to its capital structure drove leverage (debt/EBITDA) up at the motorcycle operations unit to 1.0 times (x) at year-end 2009 from 0.2x at year-end 2008, when the motorcycle operations unit only had $182 million of credit facility debt associated with the MV Agusta acquisition outstanding. Fitch expects leverage to improve to below 1.0x by year-end 2010, however, as EBITDA rises with improvements in the company's margins and the outstanding MV Agusta-related debt is paid down. The motorcycle operation's cash liquidity, which stood at $1.3 billion at the end of the 2010 second quarter, is expected to remain very strong over at least the medium term and puts the unit in a negative net debt position. Free cash flow for the full year 2010 could be very low, or potentially negative, however, as consolidated capital expenditures rise to an estimated $235 million and $255 million (including $95 million to $110 million of restructuring expenses), up from actual consolidated capital spending of only $117 million in 2009. Beyond 2010, Fitch expects free cash flow to be stronger, which will further bolster the company's liquidity position.
HDFS' financial performance for the six months ended June 27, 2010, improved as operating income was $88 million versus an operating loss of $79 million (including $28 million of goodwill impairment) in the first half of 2009. The improvement in operating income was due to higher interest income which benefited substantially from higher average retail finance receivables, driven by the consolidation of formerly off-balance sheet receivables. In addition, HDFS' asset quality performance is showing evidence of stabilization, which may reduce the need to increase provisioning; however, it is too early to tell if the positive trends will continue. Although the company's decision to maintain HDFS as it is currently structured means that it will not have the more stable funding source that a sale or partnership could have provided, it does allow HOG to maintain full control over this key component of its overall business and ensures that the objectives of the operating and financing arms remain aligned.
Asset quality performance has shown stabilization and, recently, improvement. Annualized losses on HDFS' managed retail motorcycle loans were 2.04% during the first half of 2010 compared to 2.69% during the first half of last year. The 30-day delinquency rate for managed retail motorcycle loans at June 27, 2010 decreased to 4.5% from 4.97% at June 28, 2009. The decrease in credit losses from the first half of 2009 was due to a lower frequency of loss and improvement in the recovery values of repossessed motorcycles. With the improvement in delinquencies and recovery values, asset quality performance has been better than expected. Improving inventory levels at dealers will improve the supply/demand dynamic, stabilizing recovery rates. Also, higher underwriting standards at HDFS have resulted in an increase in the percentage of prime customers in the retail portfolio, which has helped to improve asset quality performance.
HDFS' access to the capital markets has improved in conjunction with the overall markets. With the completion of the securitizations in 2009 and the change in accounting bringing all off-balance sheet receivables on balance sheet, the amount of unencumbered collateral available for the unsecured debt holders is a concern. Although the level of secured debt to total debt has shown improvement from 72% in 2006 to its current level of 58%, the level remains high. Fitch will look for HDFS to continue to develop and execute contingency funding plans to meet funding requirements and diversity for the future.
Offsetting near-term liquidity concerns at HDFS, HOG has taken steps to improve its liquidity position, which could be used at the HDFS level in a stress scenario. HDFS' funding needs for the remainder of 2010 and 2011 have largely been satisfied by the renewal of expiring facilities, the execution of securitizations, and the issuance of a $500 million medium-term note. Fitch expects that HDFS will have available funding to meet needs through next year.
The primary near-term risk to HOG's credit profile is the potential for another economic downturn to further pressure motorcycle demand and delay a return to growth in unit sales. This could result in another weakening of the company's credit metrics and put some pressure on the company's liquidity, especially if the downturn is accompanied by another tightening of the credit markets. In particular, to the extent that HDFS is unable to obtain a stable source of ongoing funding under such a scenario, HOG could be required to provide financial support to HDFS, weakening the operating unit's liquidity position. This being said, HOG currently is in a much stronger position to withstand another downturn than it was in late 2008. Along with changes in key management personnel over the past 15 months has been a shift toward a more conservative stance on financial policies, which can be seen in the company's liquidity strategy, as well as its strategic decision to focus solely on the Harley-Davidson brand.
Although the aforementioned changes have positioned the company to better withstand another downturn, they cannot insulate it completely, and a negative rating action could follow another downturn if the company's credit profile is materially weakened. A positive rating action could follow a return to growth in the motorcycle market, a decline in leverage at the manufacturing operations and/or continued improvement in the performance of HDFS.
HOG's ratings reflect the application of Fitch's current criteria, which are available at 'www.fitchratings.com' and specifically include the following reports:
--'Corporate Rating Methodology' (Nov. 24, 2009);
--'Liquidity Considerations for Corporate Issuers' (June 27, 2007);
--'Cash Flow Measures in Corporate Analysis' (Oct. 12, 2005);
--'Global Financial Institutions Rating Criteria' (Dec. 29, 2009);
--'Finance and Leasing Companies Criteria' (Dec. 30, 2009);
--'Rating Linkages in Parent and Nonbank Financial Subsidiary Relationships' (Dec. 30, 2009).
Additional information is available at www.fitchratings.com.
Related Research:
Liquidity Considerations for Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=328666
Cash Flow Measures in Corporate Analysis
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=243758
Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493146
Finance and Leasing Companies Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493344
Rating Linkages in Parent and Nonbank Financial Subsidiary Relationships
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493334
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=489018
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.
Contacts:
Fitch Ratings
Stephen Brown, 312-368-3139, Chicago
Craig
Fraser, 212-908-0310, New York, (HOG)
Peter Shimkus, 312-368-2063,
Chicago
Bill Artz, 312-368-3178, Chicago, (HDFS and HDFC)
or
Media
Relations:
Cindy Stoller, 212-908-0526, New York
Email: cindy.stoller@fitchratings.com
