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Fitch Affirms Harley-Davidson's IDR at 'A'; Outlook Stable
April 14, 2017 / 4:10 PM / 8 months ago

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

(The following statement was released by the rating agency) CHICAGO, April 14 (Fitch) 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 over the past two years and relatively high share-repurchase activity. The company's ratings are also supported by its strong brand recognition, solid liquidity position, high margins and well-funded pension plans. Despite declines in U.S. retail sales in 2015 and 2016, HOG continues to command over half of the U.S. heavyweight motorcycle market, with a market share of 51.2% in 2016, well above its key competitors. Outside the U.S., retail sales grew in 2016 on improving conditions in its largest non-U.S. markets. Over the intermediate term, Fitch expects HOG's non-U.S. sales will increase faster than its U.S. sales as it grows its non-U.S. dealer base and 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 base over time, helping to offset the aging of its core customer base in the U.S. The potential effect of Brexit on the broader European economy and ongoing weakness in the Latin American market are concerns, but the company's continued focus on outreach customer demographics in the U.S. and sales growth in international markets are likely to support longer-term sales strength, particularly in key emerging markets such as China and 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 possible liquidity pressure. A significant downturn accompanied by tightened credit markets could exacerbate the pressure by limiting HDFS's access to stable sources of capital and forcing HOG to provide financial support to its finance 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 sufficient liquidity (including cash, revolver and 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 roughly flat over the intermediate term, at around 0.6x to 0.7x, due to 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 19% to 20% range over the next several years, which is in-line with the 19.2% actual Fitch-calculated EBITDA margin recorded in 2016. Fitch expects motor company FCF to remain relatively strong over the intermediate term, with FCF margins after dividends of around 8% (including dividends received from HDFS), which will provide it with substantial financial flexibility. Fitch expects annual capital expenditures to run in the $200 million to $250 million range over the intermediate term, while share repurchases will offset much of the impact of any increases in per share dividends. HDFS dividends could provide $100 million or more in cash annually to the motor company over the intermediate term. According to Fitch's calculations, the motor company's actual FCF in 2015 was $440 million, including $183 million in dividends received from HDFS, leading to a FCF margin of 8.3%. Fitch expects HOG's 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 2016 with $431 million in cash and marketable securities, down from $446 million at year-end 2015, due in part to substantial share repurchase activity in 2016. Share repurchases totaled $465 million and were funded via a combination of cash on hand and FCF, and we expect the company will target most of its excess FCF toward share repurchases going forward. According to Fitch's Criteria for Rating Non-Financial Corporates, when analyzing a corporate issuer with a captive finance subsidiary, Fitch calculates an appropriate target debt-to-equity ratio for the finance subsidiary based on its asset quality, funding and liquidity. If the finance subsidiary's target debt-to-equity ratio is lower than the actual ratio, Fitch assumes that the parent injects additional equity into the finance subsidiary to bring the debt-to-equity ratio down to the appropriate target level. Fitch then considers the effect of this equity injection in its analysis of the parent's credit profile. For HDFS, Fitch calculated an appropriate target debt-to-equity ratio of 6.0x at year-end 2016, slightly below the Fitch-calculated actual ratio of 6.1x. For purposes of this analysis, when calculating the actual debt-to-equity ratio, Fitch adjusted HDFS's debt and equity to record the debt at principal value and to treat off-balance-sheet securitizations as on-balance-sheet debt. This differs from the total debt-to-tangible equity leverage figure noted below. As a result of its analysis, Fitch has assumed that the motor company makes an $18 million equity injection into HDFS, funded with cash on hand, to bring HDFS's debt-to-equity ratio down to 6.0x. The resulting adjustment has no meaningful impact on the motor company's credit profile. HOG's pension plans are well funded and do not pose a risk to HOG's credit profile. At year-end 2016, the company's pension plans were underfunded by only $87 million on a GAAP projected benefit obligation (PBO) basis, leading to a funded status of 96%. HOG voluntarily contributed $25 million to its qualified plans in January 2017, although the company is not required to make any contributions in 2017. Going forward, Fitch expects the company to continue making voluntary contributions to its pension plans from time-to-time, but the contributions are likely to be relatively modest compared to the company's cash generating capability. KEY RATING DRIVERS - HDFS IDR AND SENIOR DEBT The ratings of HDFS and HOG are linked, as we believe 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 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. HDFS's operating performance declined slightly in 2016 year over year, with operating income down 1.6%, to $267.2 million. The decline was primarily driven by an increase in interest expense and provision for credit losses, partially offset by a 5.6% increase in revenues. The increase in revenue was partially driven by a $9.3 million gain on sale of finance receivables which were sold through an off-balance-sheet asset-backed securitization in 2Q16. Total retail delinquencies (30+ days past due) as a percentage of retail receivables increased to 4.25% in 2016 from 3.78% in 2015. Net charge-offs on retail motorcycle loans also increased in 2016, to 1.83% from 1.42% in the prior year. Fitch expects credit performance to deteriorate modestly in 2017 as credit normalization continues, driven by industry trends, economic conditions in oil dependent areas and lower used bike values at auction. Leverage, defined as total debt divided by tangible equity, was 5.88x in 2016; flat with 2015, given commensurate declines in debt and equity. HDFS's historical leverage has ranged between 5.0x and 7.0x, which is moderately lower than captive finance company peers. At year-end 2016, HDFS had nearly $1.7 billion of liquidity, which included approximately $334 million of cash and cash equivalents and $1.34 billion available under its global credit and asset-backed conduit facilities. HDFS's debt maturities are well-laddered, with manageable maturities between November 2017 and January 2021. 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 an increased amount of unsecured funding. As of Dec. 31, 2016, unsecured debt represented approximately 84% of total debt, which is viewed favorably by Fitch. In our view, HDFS has sufficient liquidity to meet upcoming debt maturities and fund new motorcycle receivables. 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 such as China and India; --Revenue rises modestly over each of the next several years on overall shipment growth and positive pricing; --Margins grow modestly as pricing and production increase; --Capital spending runs near 4% of revenue over the next several years to support new product programs; --HDFS pays a dividend to HOG of about $100 million annually, including $106 million in 2017; --Motor company FCF margins, including dividends from HDFS, run at about 8% over the intermediate term; --Excess cash is used for share repurchases, while motor company debt remains flat at $750 million 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. HDFS IDR AND SENIOR DEBT 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; for example, if Fitch believes that HDFS was no longer core to HOG's operations and/or adequate financial support was not provided to the captive finance subsidiary in a time of need. Negative rating actions could also result from a change in HDFS's profitability leading to operating losses, meaningful deterioration in asset quality, a material change in leverage, difficulty accessing long-term funding, and/or a significant increase in reliance on secured debt or commercial paper. Positive rating momentum for HDFS would be limited by Fitch's view of HOG's credit profile. However, Fitch cannot envision a scenario where the captive would be rated higher than its parent. Fitch has affirmed the following ratings with a Stable Outlook: HOG --Long-Term IDR at 'A'; --Senior unsecured notes at 'A'. HDFS -- Long-Term IDR at 'A'; -- Senior Unsecured at 'A'; -- Short-Term IDR at 'F1'; -- Commercial Paper at 'F1'. HDFC -- Senior unsecured at 'A'. Contact: Primary Analyst (HOG) Stephen Brown Senior Director +1-312-368-3139 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst (HOG) Craig D. Fraser Managing Director +1-212-908-0310 Primary Analyst (HDFS and HDFC) Jared Kirsch, CFA Associate Director +1-212-908-0332 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst (HDFS and HDFC) Michael Taiano, CPA Director +1-646-582-4956 Committee Chairperson (HOG) Peter Molica Senior Director +1-212-908-0288 Committee Chairperson (HDFS and HDFC) Sean Pattap Senior Director +1-212-908-0642 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Summary of Financial Statement Adjustments: In calculating HDFS's actual debt/equity ratio for purposes of comparing it to the appropriate target ratio discussed above, Fitch has treated HDFS's off-balance-sheet securitizations as on-balance-sheet debt. 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