Fitch Upgrades Harley-Davidson's IDR to 'A-'; Outlook Stable

CHICAGO, IL – July 20, 2012 – (Motor Sports Newswire) – Fitch Ratings has upgraded the Issuer Default Ratings (IDRs) of Harley-Davidson, Inc. (HOG) and its Harley-Davidson Financial Services, Inc. (HDFS) and Harley-Davidson Funding Corp. (HDFC) subsidiaries to ‘A-‘. The Rating Outlooks for HOG, HDFS and HDFC are Stable. See below for a complete list of ratings.

The upgrades reflect the motorcycle manufacturer’s leading position in the U.S. heavyweight motorcycle segment, its robust cash liquidity position, high EBITDA margins and low operating company (OC) leverage. Demand for Harley-Davidson motorcycles remains strong in the U.S., with dealer sales growing consistently since early 2011, while outside the U.S. the company continues to see positive growth trends in emerging markets. Demand in Europe is likely to weaken, however, as a result of the region’s challenging economic conditions. Nonetheless, HOG’s cost structure continues to improve as a result of its significant restructuring actions, which are nearing completion, while HDFS continues to experience good asset performance and funding access. Although the OC’s restructuring program will result in somewhat higher expenses through the remainder of 2012, over the long term the changes will provide it with significantly greater manufacturing flexibility and lower operating costs.

HDFS’s ratings reflect its close operating relationship with HOG, which is governed by a support agreement under which HOG must maintain HDFS’s fixed-charge coverage at 1.25x and minimum net worth of $40 million. HDFS’s ratings are linked to HOG, as Fitch believes that the company is strategically important to its parent and there is an implicit level of support between the two entities.

The main risk to HOG’s ratings is the potential for a global economic slowdown to pressure heavyweight motorcycle demand and reverse the positive growth trends that have taken hold since early last year. This could weaken the company’s credit metrics and pressure the company’s liquidity. A downturn that is accompanied by tightening credit markets could also challenge HDFS’s ability to access stable sources of capital, and under a particularly stressed scenario, HOG might need to provide financial support to HDFS under the support agreement. Despite these potential risks, however, the company is in a much better position today to withstand a downturn than it was several years ago. The operational restructuring has produced a more flexible cost structure, and, by discontinuing Buell and selling MV Agusta, the company is now focused solely on its namesake brand. In addition, management’s commitment to holding a sufficient level of liquidity (including both cash and revolver availability) to cover the company’s projected liquidity needs for a rolling 12-month period adds to its financial flexibility. Low operating company debt and well-funded pension plans further strengthen the company’s ability to manage a decline in demand.

The Stable Outlook on HOG’s ratings suggests that a further upgrade is unlikely prior to the repayment of the remaining OC debt. Longer term, Fitch could potentially upgrade HOG’s ratings if global heavyweight motorcycle demand continues to grow and the company increases its market share, particularly outside the U.S. Other factors that could influence a positive rating action would be further margin expansion at the OC and/or further improvement in the performance of HDFS. In particular, continued diversity of HDFS’s funding and long-term stabilization of asset quality metrics are factors that Fitch would consider for an upgrade.

On the other hand, Fitch could consider taking a negative rating action on HOG in the event that there is a severe downturn in global heavyweight motorcycle demand that leads to a fundamental weakening of the company’s credit profile. A change in financial policy toward increasing debt or reducing liquidity at the OC would also be viewed negatively, as would a change in business strategy that diverts management’s focus from the core Harley-Davidson brand. A negative rating action also could be considered if HDFS experiences difficulties in obtaining long-term funding for new originations in a tight capital market environment, if it significantly increases its reliance on secured debt or commercial paper, or if it sees a substantial deterioration in asset quality.

HOG is nearing completion of the operational restructuring that it began in 2009. Through year-end 2011, the company had spent about $292 million in cash related to the restructuring, and estimates that it will spend another $40 million to $50 million in cash before the plan is completed in 2013. HOG estimates annualized expense savings associated with the restructuring (compared with 2008 levels) will run between $275 million and $295 million in 2012 and between $315 million and $335 million when the program is complete. Fitch views the restructuring plan, which has grown in scope since it was begun three years ago, as an important driver of HOG’s credit profile improvement. Once completed, Fitch expects that the company will not only have a lower cost base leading to generally higher margins, but that it will also provide HOG with the ability to flex its operations up and down to better match production to actual demand.

The credit profile of HOG’s operating company has strengthened over the past year as its operating performance improved, while debt has remained flat. At the end of the first quarter of 2012, Fitch-calculated leverage (debt/EBITDA) stood at 0.3x, with the operating company carrying only $303 million in debt on its balance sheet. Fitch-calculated EBITDA in the 12 months ended April 1, 2012 was $923 million, resulting in a relatively high EBITDA margin of 18.9%. Fitch does not expect HOG to incur any additional debt at the OC for the foreseeable future, which will keep leverage very low. The remaining OC debt matures in February 2014, and Fitch expects HOG to repay these notes with cash on hand when due, allowing the OC to be debt free in less than two years. Fitch notes that HOG carried no debt at its OC prior to its acquisition of MV Agusta in 2008.

HOG’s liquidity remains strong, with the OC holding $1.1 billion of cash, cash equivalents and marketable securities as of April 1, 2012, and after backing out its debt, the OC was in a $761 million net cash position. This was despite the company making another $200 million voluntary contribution to its pension plans in this year’s first quarter, just as it did in the same period last year. Even with the discretionary pension contribution, OC free cash flow was a relatively robust $497 million in the 12 months ended April 1, 2012. For the full year, increased capital spending and higher dividends are likely to put some downward pressure on free cash flow, although Fitch expects it to remain positive and relatively strong. The company has indicated that capital spending in 2012 will total between $190 million and $210 million versus actual capital spending of $180 million in 2011. Pro forma for the first quarter discretionary contribution, Fitch calculates that the company’s pensions would be about 93% funded on a projected benefit obligation basis.

HDFS’s operating performance over the last two years has benefitted from decreased loan loss provisioning due to improved asset quality performance. Total delinquencies (30+ day past due receivables) and net losses as a percentage of total receivables were 2.6% and 1.0%, respectively as of April 1, 2012 compared to 1.6% and 3.7%, respectively, one-year prior. However, operating income was relatively flat for the quarter ended April 1, 2012 compared to the same period one-year prior. HDFS reported operating income of $67.8 million for first-quarter 2012 compared to $68 million for the first-quarter 2011. Fitch expects operating performance for full-year 2012 to be slightly lower than 2011 as a result of decreased net interest income as the retail receivables portfolio continues to contract and increased competition in the prime retail lending environment.

As of the quarter ended April 1, 2012, HDFS had access to $2.6 billion of liquidity, which included $1.4 billion of consolidated balance sheet cash and marketable securities (including the $1.1 billion at the OC) and $1.1 billion of availability under its credit facilities. Fitch believes HDFS has sufficient liquidity to meet upcoming maturities in the near term. In addition, the company’s funding profile has improved substantially over the last several years with the lengthening of its credit facilities and increased unsecured funding.

Leverage, as measured by total debt divided by tangible equity was 6.4x at April 1, 2012 compared to 6.2x the same period, one-year prior. The company’s equity base is of high quality with no material goodwill or intangibles. Fitch believes HDFS’s leverage is consistent with similarly rated captive finance peers and within the historical range of between 5.0x and 7.0x.

WHAT COULD TRIGGER A RATING ACTION

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

  • Repayment of the remaining operating company debt;
  • Continued growth in global heavyweight motorcycle demand;
  • HOG maintaining or growing its share of the global heavyweight market, particularly outside the U.S.;
  • Further margin expansion at the operating company;
  • Continued diversity of HDFS’s funding mix;
  • Additional stabilization of HDFS’s asset quality.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

  • A severe downturn in global heavyweight motorcycle demand that erodes HOG’s credit metrics;
  • A change in financial policy that leads to higher debt or lower liquidity at the operating company;
  • A shift in business strategy away from a focus on the ‘Harley-Davidson’ brand;
  • Any difficulty in HDFS’s access to long-term funding for new originations;
  • A significant increase in HDFS’s reliance on secured debt or commercial paper;
  • A significant deterioration in HDFS’s asset quality.

Fitch has taken the following rating actions on HOG, HDFS and HDFC:

HOG

  • Long-term IDR upgraded to ‘A-‘ from ‘BBB+’;
  • Senior unsecured rating upgraded to ‘A-‘ from ‘BBB+’.

Rating Outlook Stable

HDFS

  • Long-term IDR upgraded to ‘A-‘ from ‘BBB+’;
  • Senior unsecured rating upgraded to ‘A-‘ from ‘BBB+’;
  • Short-term IDR affirmed at ‘F2’.

Rating Outlook Stable

HDFC

  • Long-term IDR upgraded to ‘A-‘ from ‘BBB+’;
  • Short-term IDR affirmed at ‘F2’;
  • Senior unsecured rating upgraded to ‘A-‘ from ‘BBB+’;
  • Short-term debt rating affirmed at ‘F2’.

Rating Outlook Stable

Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

  • Corporate Rating Methodology (Aug. 12, 2011);
  • Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (May 4, 2012);
  • Global Financial Institutions Rating Criteria (Aug. 16, 2011);
  • Finance and Leasing Companies Criteria (Dec. 12, 2011);
  • Rating Linkages in Parent and Nonbank Financial Subsidiary Relationships (Nov. 29, 2011).

Applicable Criteria and Related Research:
Rating Linkages in Nonbank Financial Subsidiary Relationships
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=656583
Finance and Leasing Companies Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=659834
Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=649171
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=677740

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.

 

####