CHICAGO--(BUSINESS WIRE)--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 HOG, 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 - HOG
HOG's ratings continue to reflect its strong credit profile, including low motor company leverage and relatively strong free cash flow (FCF), despite some erosion in sales and market share over the past year and the initiation of debt-funded share repurchases in mid-2015. The company's ratings are also supported by the company's strong brand recognition, solid liquidity position, high margins and well-funded pension plans.
Despite a decline in U.S. retail sales in 2015 and the first quarter of 2016, HOG continues to command about half of the U.S. heavyweight motorcycle market, well above its key competitors. Outside the U.S., retail sales also declined in 2015, but the situation improved in the latter part of the year, and international retail sales grew overall in the first quarter of 2016 (1Q16). Over the intermediate term, Fitch expects HOG's non-U.S. sales to grow faster than its U.S. sales as it increases its penetration in key developing markets. As a result, sales outside the U.S. will constitute an increasingly important component of the company's revenue going forward. The fragile European economic recovery and continued weakness in Latin America are concerns, but increasing production of Street motorcycles, which were designed with outreach and international markets in mind, is likely to support longer-term sales, particularly in key markets such as India.
The most significant 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 a future downturn than it was prior to the last recession, with low motor company leverage, a more flexible cost structure, and a commitment to maintaining a sufficient level of liquidity (including both cash, revolver and U.S. conduit availability) to meet its consolidated cash needs over a rolling 12-month period.
The motor company's credit profile remains strong, with low financial leverage, high margins and strong cash liquidity. Fitch expects motor company EBITDA leverage to remain flat at around 0.7x over the intermediate term following the issuance of $750 million in senior unsecured 10-year and 30-year notes in mid-2015. Those notes constitute the motor company's only debt, and Fitch does not expect it to issue any additional debt over the intermediate term. Fitch expects the motor company to produce EBITDA margins in the 20% range for the next several years, which is in-line with the 20.7% actual Fitch-calculated EBITDA margin recorded in 2015.
Fitch expects motor company FCF to remain relatively strong over the intermediate term, with FCF margins in the 4% to 6% range, which will continue to provide the company with substantial financial flexibility. Fitch's calculation of FCF includes motor company capital spending and common dividends but excludes dividends paid by HDFS to the motor company, which Fitch classifies as investing cash flows. Fitch expects FCF to remain solid despite potential increases in dividends and capital spending as the company balances cash deployment between investments and shareholder returns. The motor company's actual FCF in 2015 was $301 million, leading to a FCF margin of 5.7%.
Although not included in Fitch's calculation of FCF, dividends from HDFS are an additional material source of cash for the motor company. HDFS dividends to the motor company totaled $100 million in 2015, and in the first quarter of 2016, HDFS paid an additional $140 million in dividends to the motor company. Going forward, Fitch expects HDFS dividends could provide an additional $100 million or more in cash to the motor company in excess of FCF on an annual basis.
Fitch expects consolidated liquidity to remain strong, as management remains focused on keeping a sufficient amount of consolidated cash and credit facility availability to cover a rolling 12 months of liquidity needs at HOG and HDFS. The motor company ended 2015 with $446 million in cash and marketable securities. Cash liquidity declined from $631 million at year-end 2014, due in part to substantial share repurchase activity in 2015. Actual share repurchases for the year were $1.5 billion, funded primarily via a combination of cash on hand, FCF and proceeds from the debt issuance. With no plans to issue additional debt, Fitch expects the rate of share repurchases going forward will be substantially lower than the 2015 level.
HOG's pension plans are well funded and do not pose a risk to HOG's credit profile. At year-end 2015, the company's pension plans were underfunded by $167 million on a GAAP projected benefit obligation (PBO) basis, leading to a funded status of 92%. HOG contributed $25 million to its qualified plans in January 2016, which will likely be the only contribution to those plans this year, although the company will continue to make relatively minor contributions to its non-qualified plans. Going forward, Fitch expects contributions to both the qualified and non-qualified plans to be relatively modest compared to the company's cash generating capability.
KEY RATING DRIVERS - HDFS
HDFS's ratings reflect its close operating relationship and support agreement with HOG, under which the parent must maintain HDFS's 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.
HDFS's operating performance slightly declined in 1Q16 compared to 1Q15. The company reported 1Q16 operating income of $56.4 million, a modest decline (12.8%) compared to $64.7 million reported in 1Q15. A continuation in adverse credit trends from the latter half in 2015 drove this trend, leading to higher credit losses and provisioning. A decline in the overall portfolio yield, partially offset by a larger average portfolio fueled by an increase in originations, also impacted operating income results.
Total retail delinquencies (30+ days past due receivables) as a percentage of total retail receivables increased 24 basis points (bps) to 2.88% at the end of 1Q16 compared to 2.64% a year earlier. Managed retail losses as a percentage of average retail receivables were also modestly higher at 1.98% in 1Q16 compared to 1.56% in 1Q16. Credit performance in 1Q16 was impacted by continued normalization in the subprime portfolio, a decline in the performance of loans from U.S. states with more oil dependent economies and lower recovery values on repossessed motorcycles.
Operating performance for 2016 is expected to be modestly lower than 2015 driven by continued margin erosion. This is due to an expected continuation of recent credit trends over the last several quarters, including the normalization of subprime performance. Net interest margin erosion, due to lower yields driven by increased competition in the prime segment, and rising borrowing costs should also impact 2016 performance.
Overall, Fitch believes HDFS's funding profile has improved markedly since the financial crisis as evidenced by the lengthening of debt maturities, reduced reliance on commercial paper and increased amount of unsecured funding. As of the quarter ended 1Q16, HDFS had $1.42 billion of liquidity, which included approximately $344.7 million of cash and cash equivalents and $1.08 billion of availability under its global credit and asset-backed conduit facilities.
At year-end 2015, HDFS's debt maturities were well laddered, with manageable maturities between March 2016 and 2020. As of year-end 2015, unsecured debt represented approximately 73.7% of total term 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 5.89x at year-end 2015 compared to 5.64x at year-end 2014. Leverage increased as debt grew approximately 11.6% in 2015 to fund growth in HDFS's receivables portfolio. HDFS's 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. Fitch expects HDFS's leverage to remain within its historical range.
KEY ASSUMPTIONS
--Heavyweight motorcycle demand grows modestly in the U.S. and Western Europe over the next several years, while it grows at a faster rate in certain developing markets like China and India;
--Demand conditions remain depressed in Brazil;
--Revenue rises modestly over each of the next several years on overall shipment growth and positive pricing;
--Margins decline slightly in 2016 on continued foreign exchange pressure and costs related to the rollout of an enterprise resource planning system at the Kansas City plant, then grow modestly in future years as pricing and production increase;
--Capital spending runs near 5% of revenue over the next several years to support new product programs;
--HDFS pays about $140 million in dividends to the parent company in 2016 and about $100 million annually in follow-on years;
--Motor company FCF margins run in the 4% to 6% range over the intermediate term.
RATING SENSITIVITIES - HOG
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 need for HOG to provide material support to HDFS;
--A shift in business strategy away from a focus on the namesake brand.
RATING SENSITIVITIES - HDFS
HDFS's 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:
HOG
--Long-term IDR at 'A';
--Senior unsecured notes at 'A';
The Rating Outlook is Stable.
HDFS
--Long-term IDR at 'A';
--Senior unsecured debt at 'A';
--Short-term IDR at 'F1';
--Commercial paper rating at 'F1';
The Rating Outlook is Stable.
HDFC
--Senior unsecured rating at 'A'.
Additional information is available at 'www.fitchratings.com'.
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--Fitch has moved the historical and projected dividends paid by HDFS to the motor company to net cash used in investing activities from net cash provided by operating activities on the motor company's cash flow statement.
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=865351
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1002985
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1002985
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.