Previously, we looked at analysts’ estimates for Harley-Davidson’s (HOG) revenues and margins in 1Q16 and beyond. It’s also important for investors to pay attention to a company’s leverage position. High debt levels increase the risk profile of a company since debt is a contractual obligation that a company must fulfill regardless of market conditions. In this article, we’ll take a look at Harley-Davidson’s rising leverage position and what it means for investors.
At the end of 2015, HOG generated a free cash flow of $840.1 million, ~$74 million less than in the previous year. This decrease was primarily due to the lower net income and increased wholesale lending during the year. The company funds the majority of its motorcycle business operations through cash flows generated by operations.
Nevertheless, in 2015, Harley-Davidson borrowed $750 million to fund the repurchase of its common stock, which increased the company’s leverage. At the end of 4Q15, HOG’s net debt to EBITDA stood at 4.52x, higher than 2.9x a year ago.
At the end of 4Q15, ~45% of Harley-Davidson’s capital structure was made up of debt while the remaining portion was made up of equity. This weight of debt is much lower than that of other mainstream automakers such as General Motors (GM) and Ford (F), which have ~55% and ~70% weights of debt in their capital structure, respectively.
Note that while higher leverage can magnify earnings, it can also squeeze margins as interest rates rise. Fiat Chrysler Automobiles (FCAU) has higher leverage than other mainstream US automakers (FXD).
Interest coverage ratio
At the end of the most recent reported quarter, Harley-Davidson’s interest coverage ratio stood at 9.4x. The interest coverage ratio defines a company’s ability to meet its debt and interest-related expenses. In Harley-Davidson’s case, this high interest coverage ratio shows that the company’s balance sheet is sound enough to cover its interest expenses.
It’s also notable that the auto industry is highly capital-intensive in nature. For this reason, auto companies tend to utilize debt extensively. Therefore, it’s not always bad for a company to have high leverage. What matters most is a company’s ability to pay back its debt and related interest with ease.
Continue to the next article to read about Harley-Davidson’s 2016 outlook.