Harley Davidson: A Case Study in Trade War

On March 1st, President Donald Trump announced that the United States would impose a 25% tariff on steel and a 10% on aluminum. The economic impact of that, in isolation, would be widely felt, as we covered last week. Just as the world was learning there would be no exemptions to the new import tax, Trump took to twitter to claim trade wars are “good and easy to win.” Within hours, European Commission President Jean-Claude Juncker promised to impose retaliatory tariffs on Harley Davidson products, among other products such as “whiskey and blue jeans.”

Harley Davidson (NYSE:HOG) fell in response- down 5.9% on the week. The stock market often responds reflexively to news of any kind in a given Security when it pops up in the financial press. We wanted to take a deep look into Harley Davidson’s exposure to tariffs. We do this not to attempt to find an ideal price for the stock or capitalize on the market reaction, but as a case study in retaliatory tariffs and the “ease” of waging trade wars. What we found surprised us.

Full disclosure: neither our firm (Victor Schramm LLC) nor the Investment Advisor, Victor Schramm, CFS®, have financial interests in Harley Davidson (neither Long nor Short). This is merely an exemplary topic in economics and geopolitics.

We’ll be referencing Harley Davidson’s most recent Annual Report- an important document filed with the SEC and known officially as a “Form 10-K”- for the rest of this article. It can be found here. In this most recent annual report, Harley Davidson lumps Europe and America together in reporting regional sales, reporting “In 2017, the U.S. and European markets accounted for approximately 77% of the total annual independent dealer retail sales of new Harley-Davidson motorcycles.” They do this because Europe is by far Harley’s largest overseas market.

Harley has a large share of the American motorcycle market. In 2017, they earned just over half of the total new motorcycle registrations in the country- up 0.5% from 2015.

As the Annual Report notes, the European market for motorcycles is broader, with many market options. It’s also a larger market than America. Preferences there for motorcycles differ from American markets. European infrastructure is significantly different from America, with more consumers living in cities with smaller streets. In the U.S., parts of the rural West and Midwest are large motorcycle markets that feature large swaths of non-urban roadways. This should be familiar to anyone who’s taken a road trip across Montana or Nevada, for example.

These facts bare out in the sales data for motorcycle preferences. By the numbers, Harley notes that the big bikes accounted for a much smaller share of the European market: “The touring and cruiser categories represented approximately 52% of the European market in 2017 compared to approximately 73% of the market in the U.S.”

Despite the strong competition and smaller share of preference for Harley’s signature style of motorcycle in Europe, the company still commands a surprising share of the market- 9.8% in 2017, down from 10.8% in 2016.

Sales of motorcycles is obviously Harley Davidson’s core business. Bike sales accounted for between 77 and 78% of total revenue over the past few years for Harley Davidson. That still leaves a substantial slice of total income to other revenue sources, the largest of which is parts and accessories (16%).

Though Harley Davidson has struggled to dominate the large European market for motorcycles in recent years, their total sales to the continent in the past decade leaves a large trailing market for that 22-23% of the rest of their revenue. Any tariff on Harley Davidson could potentially affect not only the market share of Europe’s sales they compete for, it could also affect the parts and accessories revenues collected.

In the worst case, if tariffs did impact parts sales and ultimate consumer costs of ownership, owners of Harleys could end up purchasing cheaper bikes with cheaper servicing on the already vast European motorcycle market. A trend like that could leave a lasting impact on Harley Davidson’s international sales.

While the majority of Harley Davidson’s sales come from the U.S. domestic market, the size of that market has declined substantially in recent years. In 2015, there were 328,800 new motorcycle registrations in the United States. In 2017, there were only 288,800. This despite the fact that average wages have increased and unemployment rates collapsed to historical lows. There’s also the issue of Harley owning a stable share of the domestic motorcycle market- around 50%. How much more of America’s motorcycle market can we expect Harley to grab, especially when there are already a whopping 698 independent Harley dealerships in the U.S.?

Against this backdrop, long-term investors should be looking at Europe and Asia as the future of Harley Davidson’s growth profile. Europe’s market for motorcycles has actually grown over past years, up to 390,000 new registrations in 2017 from 350,000 in 2015. Though Asia’s market has immense growth potential, the total sales from all Asian countries accounted for nearly 25% less than Europe’s sales last year. As mentioned above, Harley takes in less than 10% of Europe’s current new bike registrations- that’s a lot of room to grab market share.

This is the context in which investors are considering the potential impact of European tariffs on Harley Davidson motorcycles. There’s not only a substantial share of current sales done in Europe in recent years. Investors can’t help but look to Europe and Asia for growth prospects, given how mature the motorcycle industry is domestically.

America will likely remain the largest market for Harley Davidson motorcycles and ancillary products regardless of international tariff developments. Nonetheless, Europe is the largest foreign market, and the company likely hopes this will remain true- the largest concentration of non-U.S. independent dealers is in that market. It’s also a larger market for motorcycles than the U.S. Any tariff against the company or any of its products in Europe could deeply impact the growth prospects for Harley Davidson. The company is broadly diversified in terms of regional market exposures, but Europe does matter a great deal.

We want to emphasize that this is not to be taken as advice on whether or not to buy or sell Harley Davidson’s stock. This is by no means an adequate substitute for proper Securities analysis. It is, as we stated above, an excellent initial case study in what a trade war could look like for the bottom line and growth prospects of an individual company with an international presence.