The hidden danger that Harley-Davidson (NYSE:HOG) investors were warned was lurking in its financial statements last quarter was on full display this time around, and is what sunk the motorcycle manufacturer in the first quarter.
The 800-pound gorilla in the room
While Wall Street celebrated Harley beating earnings estimates in the fourth quarter, I told investors to be wary of the bike maker's sharply declining sales growth rate. It only managed to sell 3% more bikes in 2014 than it did the year before, when sales were 4%, which was lower than the 6% increase it recorded in 2012.
"In short, the growth rate is coming to a screeching halt," I wrote.
Come the first quarter of 2015, we see that not only did the growth rate stop growing, but it went into decline.
Slamming on the brakes
Harley-Davidson reported that worldwide retail sales fell 1.3%, with dealers selling 56,661 bikes in the quarter compared to the 57,415 motorcycles sold a year ago. It was only slightly better in the U.S., its largest market, where sales were down 0.7% to 35,488 motorcycles.
Yet Harley was also shipping more bikes out to its dealers than they were selling. I had said I wouldn't accuse management of channel stuffing at the time, but the imbalance in shipments compared to sales was curious and seemed to indicate it was important the motorcycle maker surpassed the hurdle it had set for itself because it had already lowered the bar.
Harley-Davidson gave up the pretense this time around and simply shipped fewer bikes to dealers worldwide in the first quarter, some 79,589 motorcycles versus 80,682 in the year-ago period, and more important, announced it would be cutting full-year shipments to 276,000-281,000 motorcycles worldwide. That's just 2%-4% more than it shipped in 2014, but is significantly below the 4%-6% increase it had previously guided toward.
Investors would be wise to expect those numbers to get dialed back again as the year progresses if the sales slide continues. And there's nothing to suggest it won't.
Harley is blaming the competition for discounting their bikes, which it refuses to do in an effort to maintain the premium associated with the nameplate.
Polaris Industries (NYSE:PII) reported its earnings last week, and it recorded a 16% jump in revenues on a whopping 74% increase in motorcycle sales. Polaris' gross margin did slip 70 basis points to 28.4%, suggesting that what Harley-Davidson says is true, but the huge uptake in its bikes by consumers -- particularly of its Indian motorcycles, but also the Victory brand, which bounced back in the quarter -- means it's willing to give up a little bit of profit to gain a lot of share.
And gain it did, as Harley-Davidson's market share tumbled to 51.3% from 56% a year ago. It wasn't just Polaris taking share, though the traction it's gained as new models like the Indian Scout and Dark Horse were introduced helped, but Honda Motors has also been selling more bikes. It sold 10% more motorcycles in North America in 2014 than it did the year before.
Baby, it's cold outside
Harley also wanted to blame the weather for its poor showing, and hardly anyone can argue that February at least was a particularly brutal month, but it's one the big bike maker's competitors had to deal with, too.
Sure, they're starting from a smaller base than Harley-Davidson is, and representing more than half the motorcycle market, Harley remains the straw that stirs the industry's drink. But Polaris is gaining on its bigger rival, and objects in Harley-Davidson's mirrors are definitely getting closer than they appear.
A lot of moving parts
Harley reported generating almost $270 million in profits on $1.51 billion in sales, or earnings of $1.27 per share. That was better than the $266 million it earned in the first quarter of 2014 when it had sales of $1.57 billion, but it's masked by the lower tax rate Harley-Davidson used this quarter (34.4%) versus the year-ago period (35%). That would've markedly reduced the small gains it made this year.
The other area investors need to watch is Harley's financing division. While it gained from better net interest income, the motorcycle maker continues to see higher credit losses and it needed to boost its reserves.
In 2014, Harley-Davidson experienced a nearly 35% hike in credit losses, suggesting riders buying its bikes can't afford them anymore. First-quarter credit losses worsened compared to last year by $5.4 million, so those premiums it's trying to preserve on its bikes may not be doing it any good. It's selling fewer bikes at inflated prices (OK, Harleys have always had a premium price tag), but those buying them are apparently defaulting.
Taking it to the Streets
Certainly there are still some bright spots in Harley-Davidson's reports, including continued uptake of its Street platform, and continuing to attract new riders from different demographics to its brand.
Yet it's clear they're not buying in sufficient numbers to offset the decline in sales to its core customers, and that may be the biggest hidden danger lurking in Harley-Davidson's financials.