Harley-Davidson: Cruising on Recovery Road?

With help from its loyal customers and even the government, the motorcycle maker may be solving its most vexing problems

Harley-Davidson (HOG) is in a fight not just with the recession and a sharp consumer spending slowdown, but the aging of its customer base, cheap foreign imports, and a credit crisis that has made it difficult for both the motorcycle maker and its loyal riders to get financing.

After a New York Times article cataloged these problems in March, Harley-Davidson responded with typical attitude: "You can file our obituary where the sun don't shine." This message in an ad in the Mar. 29 newspaper ended with Harley's tag line: "Screw It. Let's Ride."

On Apr. 16, Harley-Davidson put some numbers behind its bravado, with a first-quarter earnings report that eased investor worries that it was figuratively skidding off the road. The company said earnings per share dropped 37% from a year earlier, to 50¢, on 12% lower worldwide retail sales and 9.7% lower U.S. retail sales. But the first-quarter sales decline was less than the prior two quarters'. The company also said it still plans to ship 264,000 to 273,000 motorcycles to dealers worldwide in 2009, a 10% to 13% reduction from 2008.

Although Morningstar (MORN) analyst Philip Gorham forecasts a difficult year for Harley, recent sales numbers are "an encouraging sign that the firm could emerge from the recession with its loyal band of followers relatively intact," he wrote.

Finance Arm Suffering

Harley shares, which rose 10% initially on the company's better-than-expected sales and credit situation, ended the day up 5.7%, at 18.11. Just a month earlier, worries about Harley's sales and its credit situation had sent the stock plunging. After trading above 40 last summer and early fall, shares hit a recent low of 8 in early March.

The combination of falling sales and credit problems was a top worry. If Harley didn't have the capital to finance loans to its customers, sales would dry up and it couldn't pay off its debts.

The company's finance arm that funded loans to Harley buyers, Harley-Davidson Financial Services, has suffered from the credit crisis' shuttering of the securitization market. Securitization allowed Harley to bundle together loans to customers—some that arguably fell in the subprime category—and sell them to investors.

Without the credit markets, Harley had to fund loans all by itself. It scrambled to obtain the needed capital. It borrowed $300 million each—at high 15% interest rates—from Warren Buffett's Berkshire Hathaway (BRKA) and Davis Selected Advisors. "Long term, Harley would like to be in the business of making motorcycles, and get out of the business of holding loans," says Robert W. Baird analyst Craig Kennison.

Seeking Help from TALF

Now, with some help from the U.S. government, Harley looks much closer to solving its financial problems—at least this year. This quarter, Harley says it will take advantage of the Federal Reserve's Term Asset-Backed Securities Loan Facility, or TALF. The TALF program is designed to restart the securitization market by giving investors incentives to buy the securities backed by assets like home, car, and student loans. "We do think there is demand out there for a Harley-Davidson asset-backed transaction," Harley Chief Financial Officer Tom Bergmann told analysts on Apr. 16. "We think the best chances of success are making it a TALF-eligible transaction."

Harley also obtained other financing last quarter, and it slashed its quarterly dividend from 33¢ to 10¢ per share, which saved the company $54 million.

Still, significant problems remain for Harley. After all, last month U.S. auto sales plunged 35% from a year ago, even though, for many, cars are a necessity. The famous motorcycles made by Harley-Davidson are discretionary purchases, typically used for weekend joyrides. Harley is slashing production, and on Apr. 16 said it would eliminate 300 to 400 jobs, on top of 800 job cuts announced in January.

But Harley appears to have beaten carmakers and its motorcycle competitors by a mile. While Harley's first-quarter U.S. retail sales fell 9.7%, that's less than the 22% drop in total U.S. sales of heavyweight motorcycles (excluding Harley, sales of competitors plunged 35%, execs said). Harley's share of the U.S. market jumped from 50% to 58%.

Resilient Brand

Why is Harley beating the pack? It stepped up marketing efforts, including offers of free test drives of Harley bikes. But executives attributed Harley's outperformance to loyal customers and the Harley-Davidson name. "It is a unique brand that is built on personal relationship and deep connections with customers, unmatched riding experiences, and proud history," Jim Ziemer, Harley's outgoing president and chief executive, retiring after 40 years at the company, said Apr. 16.

As Scott Murphy, portfolio manager at Hardesty Capital Management (which owns Harley shares), put it: "Harley has been able to maintain a huge following. There are a certain number of Harley riders who would give up virtually everything else in their discretionary budgets to repair a bike or buy a new one."

Much could go wrong for Harley. Sales could deteriorate as unemployment rises. Morningstar's Gorham warns Harley could falter in efforts to cut costs and borrow through the TALF program. But he says its first-quarter results are "a solid initial step on the road to recovery."

"Not only in the media but among investors, people thought Harley was nearing the end," Baird's Kennison says. "This quarter is an example of the resiliency of the brand and the loyalty customers have."

It's also a sign that, though credit markets are still dysfunctional and consumers are wary, the worst fears about the economy and financial system might be left in the dust.

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