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

CHICAGO--()--Fitch Ratings affirmed the long-term Issuer Default Ratings (IDRs) of 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 Fitch has affirmed HDFS' short-term IDR and commercial paper ratings at 'F1'. The Rating Outlook for HOG and HDFS is Stable. See the full list of rating actions at the end of this press release.

KEY RATING DRIVERS - HOG

The affirmation of the ratings of HOG and HDFS follows the motorcycle manufacturer's announced plan to issue $750 million in debt at the motor company in the third quarter of 2015 (3Q15) to fund share buybacks. Although the recapitalization plan represents a significant change from Fitch's prior expectation that the motor company would remain debt free over the long term, the motor company's leverage will be low following the issuance and Fitch expects it to remain consistent with the 'A' IDR. However, headroom within the rating will be diminished, increasing the potential for a downgrade in a severe market downturn.

Aside from the recapitalization plan, Fitch expects many of the company's fundamental credit qualities to remain intact, despite foreign exchange-related pressures that have recently affected the company's sales. HOG continues to lead the U.S. heavyweight motorcycle segment, with a substantial lead over its nearest competitors, and its credit profile is still supported by strong liquidity, high margins and well-funded pension plans. Fitch views the planned third-quarter issuance as a one-time event, as the company is not likely to issue any further motor company debt over the long term.

The substantial strengthening of the U.S. dollar over the past several quarters has negatively affected HOG's business. The vast majority of the company's motorcycles are built in the U.S., but with more than one-third of its sales generated outside the U.S., there has been an increasing mismatch between the company's U.S. dollar-based cost structure and the revenue derived from its foreign currency-denominated non-U.S. sales. Adding to the pressure, many of HOG's competitors in the U.S., mostly Japanese and European manufacturers who export motorcycles to the U.S. from overseas factories, have taken advantage of the strong U.S. dollar by drastically cutting prices, some by as much as $3,000 off the manufacturer's suggested retail price.

HOG has responded to the heightened competition in the U.S. with an increase in subvented financing offers, increased advertising and stepped-up customer outreach activities. Outside the U.S., the company has instituted modest price increases in certain markets to offset a portion of the foreign exchange effect. The company also has some natural hedges related to foreign-sourced components, and it has hedged a substantial portion of its currency exposure. With lower sales projected, HOG has reduced its planned motorcycle production in 2015 by 6,000 units or roughly 2% from its previous guidance. The company noted in April 2015 that if foreign exchange rates stayed at the levels seen at that time, its full-year 2015 revenue would be negatively affected by 4.25%, with about half of that flowing through to the company's gross profit.

Despite the recent pressures, HOG's fundamental business position and credit profile remain relatively strong. The company's share of the U.S. heavyweight motorcycle market remains above 50% despite some share erosion due to the heightened price competition, and it continues to have the top market share in each of its targeted outreach customer demographic segments. In addition, the company's flexible manufacturing process, the result of its multiyear restructuring program that was largely completed in 2014, has helped to support HOG's profitability in the face of lower sales and foreign exchange pressure. Based on Fitch's calculations, HOG's EBITDA margin in the 12 months ended March 29, 2015, was 22.1%, and although it is likely to decline for the full-year 2015, Fitch expects it to remain at least in the high teens, which is still strong for the sector. Fitch also expects free cash flow (FCF) to remain relatively strong, with FCF margins in the high-single-digit range.

Fitch expects other elements of the motor company's credit profile to remain solid despite the expected increase in debt and heavy share repurchase activity. Fitch estimates EBITDA (debt/Fitch-calculated EBITDA) leverage will rise to about 0.7x following the issuance, up from zero currently but still relatively low by industry standards. Fitch expects funds from operations (FFO) adjusted leverage to rise to about 0.9x from 0.1x today. Based on the motor company's performance in the last downturn, Fitch expects leverage would remain at or below 1.0x at the cyclical trough, assuming no further debt issuance.

Fitch expects liquidity to remain strong, as the company has not wavered from its strategy of maintaining a sufficient amount of liquidity (cash and revolver capacity) to meet its consolidated liquidity needs on a rolling 12-month basis (including HDFS). As noted above, Fitch expects FCF to remain relatively strong despite an increase in capital spending and common dividends (although the latter will decline as a result of the increased share repurchases.) The midpoint of the company's 2015 capital spending guidance is $250 million, up from actual capital spending of $224 million in 2014, and in February 2015, HOG raised its dividend per share by about 13%.

KEY RATING DRIVERS - HDFS

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. Further, despite the increase in leverage at HOG, Fitch believes the parent still has sufficient liquidity and financial flexibility to support HDFS if required under the terms of the support agreement. Nonetheless, Fitch will continue to monitor for future events which could adversely impact HOG's liquidity and/or financial flexibility and thereby constrain its ability to support HDFS.

HDFS' operating performance has been relatively stable amid modestly rising credit costs. The company reported operating income of $64.7 million in 1Q15, relatively consistent compared to $63.2 million reported in 1Q14, driven primarily by portfolio growth, partially offset by lower yields due to increased competition. Total retail delinquencies (30+ days past due receivables) as a percentage of total retail receivables stood at 2.64% as of March 31, 2015, compared to 2.66% a year earlier. However, managed retail losses as a percentage of average retail receivables were modestly higher, at 1.56% in 1Q15 compared to 1.33% in 1Q14. Fitch expects operating performance for 2015 to be modestly lower relative to 2014 due to lower yields driven by increased lending competition in the prime segment, rising interest rates and a normalizing credit environment.

As of year-end 2014, HDFS had $1.23 billion of liquidity, which included approximately $405 million of cash and marketable securities and $1.88 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. As of March 31, 2015, unsecured debt represented approximately 68% 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 6.5x at 1Q15 compared to 5.9x at YE14. Leverage increased modestly, as the company increased debt to fund growth in its receivables portfolio, which grew approximately 6.5% in the first three months of 2015. 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.

KEY ASSUMPTIONS

--Heavyweight motorcycle demand grows modestly in the U.S. and Western Europe over the next several years, with faster growth in developing markets like China and India.

--HOG's U.S. market share remains at or above 50% over the intermediate term.

--Margins grow modestly over the forecast period as motorcycle as production increases, but in the near term, margins are pressured by negative foreign exchange.

--Capital spending rises through the intermediate term to support new product development.

--The motor company issues $750 million in debt in 2015, but it issues no further debt after that.

--HDFS repays loans made to it by the motor company over the next several years.

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;

--An inability to maintain motor company leverage below 1.2x through the cycle;

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

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

HDFS' ratings and Rating Outlook are linked to those of its parent. However, negative rating action could also be driven by a change in the perceived relationship between HOG and HDFS. Additionally, a change in profitability leading to operating losses, meaningful deterioration in asset quality, material change in leverage, difficulty in accessing long-term funding for new originations and/or a significant increase in reliance on secured debt or commercial paper could also yield negative rating action. Positive rating momentum for HDFS would be limited by Fitch's view of HOG's credit profile.

Fitch cannot envision a scenario where the captive would be rated higher than its parent.

Fitch has affirmed the following ratings of HOG, HDFS and HDFC with a Stable Outlook:

HOG

--Long-term IDR at 'A'.

HDFS

--Long-term IDR at 'A';

--Senior unsecured debt at 'A';

--Short-term IDR at 'F1';

--Commercial paper rating at 'F1'.

HDFC

--Senior unsecured rating at 'A'.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=865351

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=986700

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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)
Johann Juan
Director
+1-312-368-3339
or
Secondary Analyst (HDFS)
Richard Wilusz
Associate Director
+1-312-368-5459
or
Committee Chairperson (HOG)
Peter Molica
Senior Director
+1-212-908-0288
or
Committee Chairperson (HDFS)
Nathan Flanders
Managing Director
+1-212-908-0827
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@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)
Johann Juan
Director
+1-312-368-3339
or
Secondary Analyst (HDFS)
Richard Wilusz
Associate Director
+1-312-368-5459
or
Committee Chairperson (HOG)
Peter Molica
Senior Director
+1-212-908-0288
or
Committee Chairperson (HDFS)
Nathan Flanders
Managing Director
+1-212-908-0827
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com