Fitch Affirms Harley-Davidson's IDR at 'A'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the Long-term Issuer Default Ratings (IDRs) for Harley-Davidson, Inc. (HOG) and its Harley-Davidson Financial Services, Inc. (HDFS) subsidiary at 'A'. In addition, Fitch has affirmed the senior unsecured ratings of HDFS and Harley-Davidson Funding Corp. (HDFC) at 'A' and HDFS's short-term IDR and commercial paper ratings at 'F1'. The Rating Outlook for HOG and HDFS is Stable. A complete list of ratings follows at the end of this press release.

KEY RATING DRIVERS

The ratings for HOG and HDFS reflect the motorcycle manufacturer's strong credit profile following the completion of its operational restructuring and the repayment of all motor company debt in 2014. The company now only carries debt at the HDFS subsidiary, with the motor company primarily using funds from operations (FFO) to fund its liquidity needs. HOG's ratings are also supported by the company's leading position in the U.S. heavyweight motorcycle segment, strong cash liquidity position, high margins, well-funded pension plans, and conservative financial policies.

HOG's share of the U.S. heavyweight motorcycle market remains above 50% despite some share erosion over the past several quarters following the temporary discontinuation of the Road Glide (which has been reintroduced for the 2015 model year) and production disruptions that slowed the introduction of the new Street line of motorcycles. Outside the U.S., HOG's sales continue to rise, with non-U.S. sales up 5.4% in 2014, driven by a 12% increase in the Asia Pacific region and a 6.4% increase in the Europe, Middle East and Africa region. Over the intermediate term, Fitch expects HOG's non-U.S. sales to continue to growing faster than its U.S. sales and to constitute an increasingly important component of the company's revenue. The fragile European economic recovery and continued weakness in Latin America are concerns, but increasing production of Street motorcycles, which were designed with non-U.S. markets in mind, is likely to support overall sales, particularly in emerging markets.

HDFS' ratings reflect its close operating relationship and support agreement with HOG, under which the parent must maintain HDFS' fixed-charge coverage at 1.25x and its minimum net worth at $40 million. The ratings of HDFS and HOG are linked, as Fitch believes that the finance company is a core subsidiary of the parent as demonstrated by the explicit and implicit level of support between the two entities.

The most significant fundamental risk to HOG's ratings continues to be the cyclicality of the motorcycle industry and the potential for an economic slowdown to reduce motorcycle demand, resulting in lower profitability and potential liquidity pressure. A significant downturn accompanied by tightened credit markets would exacerbate the pressure by potentially limiting HDFS's access to stable sources of capital and forcing HOG to provide financial support to the subsidiary. Despite these risks, HOG is in a significantly stronger position to withstand future downturns than it was prior to the last recession, with a debt-free balance sheet at the motor company, a more flexible cost structure, and a commitment to maintaining a sufficient level of liquidity (including both cash and revolver availability) to meet its consolidated cash needs over a rolling 12-month period.

HOG's product lineup has undergone significant changes and updates over the past 18 months. For the 2014 model year, the company introduced its Project Rushmore Touring motorcycles, which included a number of upgrades and improvements over their predecessor bikes. However, the company temporarily discontinued its popular Road Glide model at the time the other Touring motorcycles received the Rushmore upgrades. Also, in early 2014, HOG introduced its new entry-level Street line of motorcycles, priced below Sportsters and designed for urban riding, particularly in non-U.S. markets. In a break with past practice, Streets manufactured non-U.S. markets are fully assembled in India, while U.S. Streets are built in Kansas City. Startup issues tied to the Street introduction, combined with the absence of Road Glides for the 2014 model year, contributed to some sales pressure in 2014, but Fitch expects sales to improve going forward following the reintroduction of the Road Glide with Rushmore upgrades for the 2015 model year. The company has also resolved the Street-related production issues experienced earlier in 2014.

The motor company's credit profile remains strong, characterized by zero debt, high margins and robust liquidity. Fitch-calculated EBITDA for the motor company in the 12 months ended Sept. 28, 2014, was $1.2 billion, resulting in a strong 22.2% EBITDA margin, up from $1.1 billion and a 20.3% EBITDA margin in the year-earlier period. The motor company's liquidity position remains solid as well, with $0.63 billion in cash, cash equivalents and marketable securities at year end 2014. Liquidity remained relatively strong despite a 27% increase in dividend payments in 2014 to $238 million and $566 million in net share repurchases. With management's ongoing commitment to maintaining sufficient liquidity to meet projected consolidated cash needs on a rolling 12-month basis, Fitch expects liquidity to remain healthy over the intermediate term.

The motor company's free cash flow was very strong in the 12 months ended Sept. 28, 2014, totaling $543 million and equal to a 9.7% free cash flow margin. In addition to the company's high profitability, free cash flow was supported in the most-recent period by a lack of required pension contributions. Capital spending in the 12 months ended Sept. 28, 2014, was $207 million, up slightly from $197 million in the year-earlier period. Over the intermediate term, Fitch expects higher capital spending and dividend payments to put some downward pressure on free cash flow, but Fitch expects it to remain positive and relatively strong. With no obvious acquisition opportunities, Fitch expects HOG to allocate excess liquidity above its rolling 12-month needs to share repurchases and increased dividends. However, the company appears resolute in its strategy to keep the motor company debt free, so Fitch does not expect it to fund any shareholder-friendly activities with incremental motor company borrowing.

At year-end 2013, HOG's pension plans were 12% overfunded on a GAAP projected benefit obligation (PBO) basis, with a PBO of $1.7 billion and total assets of $1.9 billion. Although interest rates declined in 2014, Fitch expects that HOG's pension plans remained close to fully funded at year end 2014. With the plans' strong funded status, the company is not likely to make any contributions to its qualified funded plans in the near term, although it will continue to make relatively minor contributions to its non-qualified plans.

HDFS' operating performance has been relatively stable amid modestly rising credit costs. The company reported operating income of $277.8 million in 2014, modestly lower than $283.1 million reported in 2013, driven primarily by increased loan provisioning and operating expenses, partially offset by higher net interest income from a larger portfolio and increases in other revenue sources. Total retail delinquencies (30+ days past due receivables) as a percentage of total retail receivables stood at 3.61% as of December, 31, 2014, which compared favorably to 3.71% a year earlier. However, managed retail losses as a percentage of average retail receivables were modestly higher, at 1.22% in 2014 compared to 1.09% in 2013 and 0.79% in 2012. Fitch expects operating performance for 2015 to be modestly lower relative to 2014 due to margin compression driven by increased lending competition in the prime segment, rising interest rates and a normalizing credit environment.

As of year-end 2014, HDFS had $1.55 billion of liquidity, which included approximately $330 million of cash and marketable securities and $1.22 billion of availability under its global credit and asset-backed conduit facilities. HDFS' debt maturities are well laddered, with manageable maturities between September 2015 and 2019. Overall, Fitch believes HDFS' funding profile has improved markedly since the financial crisis, evidenced by the lengthening of debt maturities, reduced reliance on commercial paper and increased amount of unsecured funding. Although a breakout is not yet available for year-end 2014, as of Sept. 28, 2014, unsecured debt represented approximately 72% of total debt, which is viewed favorably by Fitch. Fitch believes HDFS has sufficient liquidity to meet upcoming debt maturities and fund new motorcycle receivables.

Leverage, defined as total debt divided by tangible equity was 6.2x at 3Q'14 compared to 5.8x at YE13. Leverage increased modestly, as the company increased debt to fund growth in its receivables portfolio, which grew approximately 11% in the first nine months of 2014. HDFS' historical leverage has ranged been between 5x - 7x debt/tangible equity, which is moderately lower than captive finance company peers, but higher than many stand-alone finance companies.

RATING SENSITIVITIES

Positive: Due to the inherent cyclicality and risk of the motorcycle industry, 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-friendly activities;

--A shift in business strategy away from a focus on the namesake brand;

--A need for HOG to provide material support to HDFS.

Negative rating actions for HDFS could also be driven by the following:

--A change in the perceived core relationship between HOG and HDFS;

--A change in profitability leading to material and sustained operating losses;

--A meaningful deterioration in HDFS's asset quality;

-- A material increase in leverage at HDFS;

--Difficulty in HDFS accessing long-term funding for new originations and/or a significant reliance on secured or short-term debt.

Fitch has affirmed the following ratings:

HOG

--Long-term IDR at 'A';

The Rating Outlook is Stable.

HDFS

--Long-term IDR at 'A';

--Senior unsecured rating at 'A';

--Short-term IDR at 'F1';

--Commercial paper rating at 'F1';

The Rating Outlook is Stable

HDFC

--Senior unsecured rating at 'A'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);

--'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=749393

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=978977

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Contacts

Fitch Ratings
Primary Analyst (HOG)
Stephen Brown
Senior Director
+1-312-368-3139
Fitch Ratings
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst (HOG)
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Primary Analyst (HDFS and HDFC)
Johann Juan
Director
+1-312-368-3339
or
Secondary Analyst (HDFS and HDFC)
Richard Wilusz
Associate Director
+1-312-368-5459
or
Committee Chairperson (HOG)
Michael L. Weaver
Managing Director
+1-312-368-3156
or
Committee Chairperson (HDFS and HDFC)
Nathan Flanders
Managing Director
+1-212-908-0827
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst (HOG)
Stephen Brown
Senior Director
+1-312-368-3139
Fitch Ratings
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst (HOG)
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Primary Analyst (HDFS and HDFC)
Johann Juan
Director
+1-312-368-3339
or
Secondary Analyst (HDFS and HDFC)
Richard Wilusz
Associate Director
+1-312-368-5459
or
Committee Chairperson (HOG)
Michael L. Weaver
Managing Director
+1-312-368-3156
or
Committee Chairperson (HDFS and HDFC)
Nathan Flanders
Managing Director
+1-212-908-0827
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com