Fat Boys on Great Wall Help Harley Cut Yields: Corporate Finance
Rising profits at Harley-Davidson Inc. (HOG) are encouraging bond investors to lend to the biggest U.S. motorcycle maker at the lowest interest rates on record, further expanding the Milwaukee-based company’s margins.
The 105-year-old company, whose Chief Executive Officer Keith Wandell rode a motorcycle on the Great Wall of China as part of an enthusiasts’ rally in April, is paying a 2.7 percent rate on $400 million of five-year notes sold last week. The issue follows an upgrade by Standard & Poor’s to BBB+ from BBB on Jan. 25, the first increase since 2004, as the maker of Fat Boy bikes reversed a four-year decline in sales.
Investors approve of Wandell’s plans to improve profits by lowering labor costs, pruning dealerships, expanding international sales and restoring the brand’s high-end cachet. The extra yield investors demand to hold Harley-Davidson bonds instead of Treasuries has been little changed over the past year at about 278 basis points, while spreads on all U.S. automotive industry bonds widened 67 basis points over the period.
“Harley is a great turnaround story from a credit perspective,” said Hitin Anand, an analyst at bond researcher CreditSights Inc. “They took the downtime in their volume to restructure the operations and that’s paying off,” Anand said in a telephone interview from New York.
The motorcycle maker previously sold debt in March, when it issued $450 million of 3.875 percent, five-year notes, according to data compiled by Bloomberg. The lowest prior coupon was 3.625 percent on five-year debt sold in November 2003.
Demand for the latest issue was so strong that the company was able to narrow the spread to 195 basis points from initial guidance of about 210, while boosting the size of the offering from $300 million, Bloomberg data show. Bob Klein, a Harley spokesman, said he couldn’t comment on the bond sale.
Harley had $2.8 billion of long-term debt on Sept. 25, according to its latest quarterly filing. Three bond issues totaling $1.65 billion will mature by 2017 and the lowest coupon is 3.875 percent, Bloomberg data show.
The highest coupon is 15 percent, on $303 million of bonds that remain from a $600 million issue sold in February 2009 amid the height of the worst financial crisis since the Great Depression to Warren Buffett’s Berkshire Hathaway Inc. and Harley’s then-largest shareholder, Davis Selected Advisers Inc.
Harley said in a statement at the time it would use the money to give customers loans to buy its motorcycles. The company bought back $297 million of the notes in 2010, paying about 128 cents on the dollar, it said in the latest quarterly filing.
‘It Was Armageddon’
“It was Armageddon out there,” said Christopher Brown, who helps manage $2.5 billion as chief investment officer at Pax World Management Corp. Harley had to pay more to borrow money than it could earn on the loans, he said in a telephone interview from Portsmouth, New Hampshire.
Brown said he bought $2 million of Harley’s $400 million of 5.25 percent bonds due December 2012 for about 78 cents on the dollar in January 2009. The debt now trades for about 103 cents, according to Bloomberg Valuation data.
If Harley uses the new bonds to refinance debt due in December, it will save about $10 million a year in interest, Brown said. “They should be able to put that money back out there and earn a pretty decent spread,” he said.
Wandell, who joined Harley two months after it sold the 15 percent bonds, has “definitely done a good job of turning things around,” Brown said. The CEO, who previously worked for auto-parts maker Johnson Controls Inc., is altering labor contracts, allowing the company to hire at lower wages and get greater operational flexibility.
The process started with agreements with unionized employees in Harley’s York, Pennsylvania, facility followed by similar deals in Wisconsin and Missouri. “All the credit goes to Wandell because he was completely involved in the negotiations,” said Anand at CreditSights.
The company has surpassed analysts’ earnings estimates for seven of the past eight quarters, Bloomberg data show. Worldwide sales increased 11 percent in the fourth quarter, according to a Jan. 24 statement. The company had raised prices on its bikes for the first time in four years in July, while introducing models to attract women and other new riders.
“We have been devoting considerable attention and resources to markets like India and China,” Klein, the Harley spokesman said in a telephone interview. “We see those as having strong long-term potential even if volumes are not high in the short term.”
The company added 35 new dealers internationally in 2011 including places like China and India, part of a plan to increase the number by as much as 150 from the 2009 level.
“The opportunity is tremendous for them overseas,” said Pax World Management’s Brown. “It’s going to be a big driver of their growth going forward. People that want the American experience would certainly look at these motorcycles.”
William Harley and Arthur Davidson sold their first bike in 1903, and the company was incorporated four years later, according to its website.
To fuel its international expansion the company also supports riding groups to promote the brand. The CEO’s rally to the Great Wall last year was one such effort as Harley plans to drive international motorcycle unit sales to more than 40 percent of its total.
Harley has also reduced its dealerships by 10 percent, dropping underperforming outlets, mostly in urban areas. Wandell is encouraging dealers to improve stores and customer service to a level befitting premium bikes that can sell for more than $35,000.
“They have realized they are not going to have the same demand they once had,” said Michael Millman at Millman Research Associates. “It is the brand that matters and they will get benefits from the high-end placement.”
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