Fitch Downgrades Harley-Davidson Inc. and HDFS IDRs to 'A'; Outlook Negative

NEW YORK--(BUSINESS WIRE)--Fitch Ratings downgrades Harley-Davidson Inc. (NYSE: HOG) and HOG's 100% owned subsidiary, Harley-Davidson Financial Services, Inc. (HDFS) as follows:

Harley-Davidson Inc

--Issuer Default Rating (IDR) to 'A' from 'A+'.

Harley-Davidson Financial Services

--IDR to 'A' from 'A+';

--Short-term IDR affirmed at 'F1';

--Senior unsecured to 'A' from 'A+'.

Harley-Davidson Funding Corporation

--Short-term IDR affirmed at 'F1';

--Commercial paper affirmed at 'F1';

--Senior unsecured to 'A' from 'A+'.

The Rating Outlook is Negative. Fitch's actions affect $3.2 billion of debt at HDFS and $175 million of debt at HOG. Due to the existence of a support agreement and demonstrated support by the parent, HDFS' ratings are linked to those of HOG.

The rating action is driven by HDFS' declining operating performance, reduced financial flexibility, and deteriorating asset quality combined with declining sales and weaker margins at HOG. The Negative Outlook reflects the current capital market and economic environment which could continue to pressure HDFS' ability to originate and fund as it has historically and Fitch's concern of further weakening asset performance. The Negative Outlook also reflects an expectation of lower sales and operating margins in 2009 for HOG. Minor concerns contributing to the Negative Outlook include the possibility of debt issuance at HOG to support HDFS and the possibility of cash outflows related to share repurchases, increased pension contributions, and additional restructuring actions next year in addition to the material amount of cash used for dividend payments. Fitch continues to view HDFS as an integral part of HOG which provides necessary financing for the purchase of HOG cycles. Improved diversity of funding, stabilization of asset quality metrics or a further change in balance sheet profile at HOG or HDFS could lead to a review of the rating.

The 'A' rating reflects HOG's strong cash generation from its manufacturing operations, strong operating margins, minimal debt, brand strength, and significant distribution network. Excluding HDFS' financial results, Fitch estimates that HOG's manufacturing EBITDA margins are in the high teens and the manufacturing operations have leverage (debt-to-EBITDA) of less than 0.2 times (x). Though the company has an expanding international presence, the U.S. makes up about 75% of its revenue. Most of HOG's competitors are Japanese companies that are more diversified.

Fitch is concerned with HDFS' long-term funding alternatives to fund originations if the capital markets environment remains status quo. Fitch feels that HDFS has sufficient funding alternatives, including financial flexibility at the HOG level to meet near term maturities. Based on HDFS' historical use of the asset backed securities market ($2.5 billion in 2007, $540 million in 2008), and retail origination levels in 2008, Fitch believes HDFS needs approximately $1.0 billion - $1.5 billion in financing in 2009 in addition to its available revolving credit facilities to replace securitization funding used historically. With HOG's reliance on HDFS to fund a large portion of sales, reduced originations at the HDFS level could ultimately impact sales at the HOG level. Fitch will look for HDFS to continue to develop and execute contingency funding plans which may include bank lines and debt issuance at the parent level to meet funding requirements for 2009 on a cost-effective basis. Furthermore, Fitch believes HDFS' operating performance will continue to trend weaker due to the economic and capital markets environment, manifesting itself in higher provision expenses and increased funding costs over the near to intermediate term.

HDFS is currently in compliance with all covenants which include: HDFS leverage covenant of 10:1x debt to equity and a minimum interest coverage ratio at the consolidated HOG level of 2.5:1. The revolver does not contain a material adverse change clause. In addition, HOG must maintain HDFS' fixed-charge coverage at 1.25x and minimum net worth of $40 million.

HOG's sales and operating margins will remain challenged in 2009 as discretionary spending will continue to be pressured by the financial crises and global economic slowdown. Fitch expects that HOG will have to decrease shipments and restructure its operations in 2009 following similar actions this year. For the first nine months of 2008, total Harley-Davidson brand motorcycles shipments decreased 22,515 units or 9.0% to 226,898 bikes, while retail sales decreased 16,948 units or 6.0% to 267,014 units, indicating seasonally adjusted dealer inventories have decreased. The shipment decrease follows HOG's decision in April to reduce shipments of Harley-Davidson brand motorcycles by 23,000 to 27,000 for the year. By matching supply to demand HOG is protecting its brand equity and helping to minimize margin deterioration.

For the first nine months of 2008, HOG repurchased $250 million in shares. The company has announced that it is suspending share purchase activity until it has obtained additional financial flexibility. HOG estimates capital expenditures will be approximately $235 million-$250 million this year, and Fitch projects they will decrease in 2009 to approximately $200 million. At Sept. 28, 2008, HOG's cash balance was $504.9 million. HOG has access to new credit facilities that the company and HDFS entered into in July that total $1.9 billion. These facilities, a $950 million 364-day facility and a $950 million three-year facility are primarily used to support HDFS' commercial paper program and to fund HDFS' lending activities and operations, but unlike the facilities they replaced were structured to also allow HOG to borrow against them. HOG borrowed $175.1 million of short-term revolving debt under the new credit facilities in August to purchase Italian motorcycle maker MV Agusta Group (MVAG). With the exception of the MVAG-related debt, all of HOG's consolidated debt is at HDFS, and HDFS' debt is not an obligation of the parent.

Cash from operations for the first nine months ended Sept. 28, 2008, was negative $221 million versus positive $1.37 billion in the same period last year. The decrease was primarily due to lower securitization proceeds.

The first nine months of 2008 ended Sept. 28, 2008, showed motorcycle and related product segment revenue down only marginally. Sales of $4.3 billion were down $39 million, or less than a percent as a result of Buell motorcycles, parts and accessories, general merchandise and other growth offsetting the $73 million or 2.2% decline of Harley-Davidson branded motorcycle revenue. Gross margin and operating margin over the same period contracted materially. Gross margin declined to 35.4% from 37.3% and operating margin declined to 18.9% from 22.6%. Gross margin and operating margin were both affected by increased raw material costs and the allocation of fixed costs over fewer produced units.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, 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.