#delinquencies

Nothing to see here

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Chinese regional bank, Guangdong Nanyue Bank Co said it won’t exercise an early redemption on its 1.5 bn yuan (US$215 million) 6% tier-two bond in December.

According to Bloomberg,

Chinese banks reported 2.2 trillion yuan (US$315bn) of non-performing loans at the end of June, which, according to the China Banking and Insurance Regulatory Commission (CBIRC) is the highest level in over 15 years…Troubles facing Guangdong Nanyue’s biggest shareholders may also add to its woes. Neoglory Holding Group Co., which is going through a court-led bankruptcy restructuring after defaulting on its bonds, is the largest shareholder of Guangdong Nanyue with a 16.52% stake, followed by Gionee Communication Equipment Co., which is in liquidation, according to a report published by China Lianhe Credit Rating in June. The two hold a combined 25.4% stake in the lender.

Note in recent times, Baoshang Bank was taken over by the government in May and the Bank of Jinzhou was rescued in July.

We shouldn’t forget “special mention” loans which are not classified as NPLs but potentially at risk of becoming so (equivalent to being 90+ days in arrears), rose to 3.63 trillion yuan (US$521bn), accounting for 3.3% of the total loan volume for commercial banks according to the CBIRC.

Harley Davidson sneaks in a 50% cut to future hoping no one would spot it

Harley-Davidson’s (HOG) Q3 results continued the poor run. Declining global unit sales and 30+ day delinquencies plus annualized loss experience are at 9-year highs. The company sneakily halved its outlook on plans to cultivate its rider base which further shows the management is clueless and running out of options. It smacks of desperation.

Shares bounced almost 10% on the numbers. The funny thing is that quarter after quarter, the earnings releases read like Groundhog Day. Of any positive news, international ended up slightly positive (+2.7% for Q3, -3.9% for 9M) but were was still below expectations). Japan was cited as a positive. Then again Japan sales are 40% below the peak and have been dwindling for 10 years. Australia was ok but EU weak.

Only two thing worth paying attention to in these results.

1) Targets

For the last few years, HOG has been banging on about how it will create 2 million “new” US riders into the Harley fold by 2027. Indeed CEO Matt Levatich was adamant on the conference call that “the team is laser-focused on building riders today and preparing us and our dealers to welcome a broader array of new riders moving forward.” Typical bluster.

Levatich must be using lasers from The Dollar Store given their accuracy to date.

In Q3, HOG has shifted that language to 4m total riders in the US by 2027. It currently stands at just over 3m. So that 2m new US rider target has effectively more than halved but no explanation for the change was given which proved CM’s hunch. It was snuck in. HOG management said “we’ve done the math“. CM would argue, “what, so you hadn’t done it properly beforehand?” This only reveals the ineptitude within management ranks. Instead of investigating where the problem is needless share buybacks are continuing at a heady clip. $112.5m for the quarter.

CM has written in the past sets of results,

HOG’s 2mn new riders in the US by 2027 seems an irrelevant target. 200,000 “new” riders per year by definition should not include existing customers. Management combine new and used sales using IHS Markit Motorcycles in Operation (MIO) data, not their own! That is fine if all are new Harley customers yet the brand has some of the highest loyalty rates of any maker period. Are we to believe that long term Harley owners didn’t upgrade?

Of the 138,000 new domestic US sales in 2018, the brand assumed 278,000 new riders to the family. It also cites that 50% of that were 18-34yo (implies poorer product mix), women (smaller capacity hence poorer product mix) or ethnically diverse (irrelevant) riders. So by definition at least 140,000 sales were used bikes. Harley used bike sales in America are around 2.5x new, or 350,000 units. So assuming half were new customer sales for new bikes, 60% of used sales must have been to ‘never owned a Harley’ customers. Seems high.”

Yet Levatich continued in the conference call by saying,

guiding all our efforts is deeper analysis and insights on why people engage, participate and disengage from riding. Our advanced analytics capabilities and rider migration database has evolved into a powerful asset and a wealth of information and inspiration for us.

But Mr Levatich, HOG unit sales and revenues have been in retreat for 5 years in a row. Sure, motorcycle markets are tough but it hasn’t affected other premium makers BMW Motorrad, KTM, Ducati and Triumph at the luxury end. HOG sounds a bit like the Australian Wallabies. Lots of positive talk despite overwhelmingly negative signals, results and glaring problems with the management structure. It is time to wake up. HOG is missing the simplest of things – product that customers want.

This is a company that continues to rely on its 116-yo divine franchise. Basing its future on what seems to be a marketing company puffing up fanciful predictions in the face of a dire outlook. The worst thing about it is that management is in denial.

2) Finance

HOG is the ultimate discretionary spending item. Doesn’t seem that they are spending at HOG. If anything, the financial services business shows current customers are struggling to pay their loans. An interesting anecdote from Polaris (PII) Q3 results overnight was the claim that its Indian brand (which competes directly with Harley) admitted,

North American consumer retail sales for Polaris Indian motorcycles decreased mid-teens percent during the third quarter of 2019 primarily due to the weak mid to heavy-weight two-wheel motorcycle industry that was down high-single digits percent and retail pressure from heavy competitive promotional spending.”

If HOG is cranking up the finance and promotional spending shouldn’t investors be wary of a further deterioration in the types of customers they are lending to? When CM covered HOG as an analyst 20 years ago, the then management told CM that Harley owners would forgo the mortgage before payments on the bike, such was the rock-solid nature of the finance arm.

No, HOG’s loan book is unlikely to bury it but the signals are such that it is having to resort to pushing so much harder to make sales. That is evidence of a soft backdrop which management is not being open and transparent enough about.

HOG fortunes are bound to get a lot worse before they get better. The hopes and dreams of the delayed electric LiveWire e-bike is too expensive to attract eco-mentalist millennials and completely unattractive to overweight bearded men covered in tattoos to desire. Harleys were always an escape tool. Products where owners could hide away in the man cave tinkering. That isn’t to say that Harley doesn’t need to innovate but at the moment it isn’t staying true to itself. That is why customers are disengaging.

Expect the 2020 numbers to follow the trend of the last 5 years. An utter disaster.

NB this piece does not constitute as investment advice. CM has no positions in HOG.

Seen this all before

What is it with the US auto market that throws up so many canaries in the coal mine? Several years back CM wrote about the growth in sub-prime auto loans. What triggered this boom? Easier access to finance? That was one reason. As it happens the largest factor was driven by the ability for finance companies to shut down a vehicle by remote and repossess the vehicle should the buyer be unable to afford the monthly payments. This lowered risk and allows these long-dated loan products to thrive. Average subprime auto loans carry 10% p.a. interest rates. More than 6 million American consumers are at least 90 days late on their car loan repayments, according to the Federal Reserve Bank of New York.

About a 1/3rd of all US auto loans issued today are stretched out to seven years and beyond, according to the WSJ. A decade ago, the seven-year loan only made up about 10% of all loans. Even 10% of 2010 model year bangers are being bought on 84-month term loans.

After the tech bubble collapsed at the turn of the century do you remember the ‘Keep America Rolling’ programme, which was all about free financing for five years? While sales were helped along nicely, the reality was it stored up pain. As new car sales became harder to achieve, new financial products offered sweeter upfront incentives and buyback guarantees (because cheap finance was everywhere and not a differentiator) helped keep the fire stoked.

However, as front end incentives kept getting juicier, the cars on guaranteed buybacks were starting to return to the market at prices well below the ‘guarantee’ leaving automotive finance arms in a whole world of hurt and huge losses. Goldberg & Hegde’s Residual Value Risk and Insurance study in 2009 suggested on average 92% of cars returned to leasing companies recorded losses on return of up to 12%. Any company can guarantee the price of its used product, in theory, the question is whether used car buyers will be willing to pay for it.

In the last decade, auto loans have ballooned from $740bn to $1.3 trillion. Auto dealers are now making a majority of their money on the finance deal as opposed to the sale of the actual car. Even worse, the US car market is experiencing a third of trade-ins in negative equity meaning the gap is being added to the price of the new car, hence the push out of the loan period to keep a lid on the size of monthly payments. This was 17% in 2008.

CM is sure there is nothing to worry about. It is consistent with nearly everything else that has occurred in finance since the GFC. Just double down, spend more, close your eyes and hope nothing bad happens. Ultimately it will be someone else’s problem.

Serious auto-loan delinquencies – 90 days or more past due – in 2Q 2019, jumped 47 basis points year-over-year to 4.64% of all outstanding auto loans and leases, according to New York Fed. This is equivalent to the delinquency rate in Q3 2009, just months after GM and Chrysler had filed for Chapter 11 bankruptcy. The 47-basis-point jump in the delinquency rate was the largest year-over-year jump since Q1 2010. Actual outstanding delinquent 90 day + delinquencies stand at $60bn in 2Q 2019, almost double the amount of 4Q 2010.

Did CM mention gold?

Harley-Davidson- Delinquencies vs Denial

Harley-Davidson (HOG) announced 2Q figures overnight. Shares rallied 6.42% on the back of awful numbers in 1Q. In a nutshell:

Motorcycle revenue fell 6% vs 2Q 2018 and group operating income crashed 26%. US retail sales fell 8.0%. Operating margin fell from 16% to 12.6% in 2Q. 11% for 1H down from 14% in 1H 2018. Supposedly these were better than market expectations.

-Market share in 2Q 2019 down 1.8% to 46.6% in domestic market, and European market share at 8.8%, down 1.6%. No doubt Trump to blame for this.

-Volumes down 5.3% for 2Q and 6.5% for 1H

-Operating margin down. HOG expected 8-9% in 1Q. This has now been lowered to 6-7% in the 2Q statement for the full year.

– weak volume guidance unchanged at 217,000-220,000. This marks 5 years of straight volume declines.

– 30+ day delinquencies on finance up again to almost a 9 year 2Q high to 3.3% of the book. Note HOG in Q1 delinquencies at 3.73%.

– 2Q annualized loss experience up to an 8 year high to 1.82%

Never mind the company embarked on a $42.9m share buybacks in Q2 and $95.5m for the year so far. Happy days.

The company’s presentation pack still smacks of denials with all the mystical customers that aren’t being converted into new customers.

Harley delinquencies at 8 year high

Just noted from the conference call that Harley-Davidson (HOG) motorcycle loan delinquencies (30+ days in arrears) are at an 8 year high of 3.73%. While actually loss experiences have tracked sideways for the past few years, they are still higher than 8 years ago.

Interestingly, HOG loans outstanding were $7.53bn in 1Q 2015. In 1Q 2019 that figure was $7.63bn. So next to no loan growth against c.20% lower unit sales. In 1Q 2015 HDFS made $683.6m in new loans, 80% prime out of $1.5bn in 1Q motorcycle (incl parts/accessories) sales (43.6% financed). In 1Q 2019, $685.3m in new loans were made with a claimed 80-85% “prime” against $1.124bn (61.0%) of m/c and P&A sales. Essentially total sales would be worse without the finance arm. Why does CM smell Ford Credit all over?

So delinquencies up against a strategy to pump more bikes through financing. Is it the non-prime portion is faltering at greater rates? Or the prime?

Luxury motorcycles are generally considered discretionary spend items. Are aspirational consumers just tapped out?

HOG’s 2mn new riders in the US by 2027 seems an irrelevant target. 200,000 “new” riders per year by definition should not include existing customers. Management combine new and used sales using IHS Markit Motorcycles in Operation (MIO) data, not their own! That is fine if all are new Harley customers yet the brand has some of the highest loyalty rates of any maker period. Are we to believe that long term Harley owners didn’t upgrade?

Of the 138,000 new domestic US sales in 2018, the brand assumed 278,000 new riders to the family. It also cites that 50% of that were 18-34yo (implies poorer product mix), women (smaller capacity hence poorer product mix) or ethically diverse (irrelevant) riders. So by definition at least 140,000 sales were used bikes. Harley used bike sales in America are around 2.5x new, or 350,000 units. So assuming half were new customer sales for new bikes, 60% of used sales must have been to ‘never owned a Harley’ customers. Seems high.

It doesn’t much matter if HOG hit targets for new riders, the actual financial results point to further deterioration across the board at the top of the cycle. Most competitor luxury brands are ticking along just fine.

100 new high impact motorcycles has all the hallmarks of chucking spaghetti at the wall and hoping some of it sticks.

This stock should continue to flounder. CM thinks it will get back to the GFC $8 handle.

CM is not invested in HOG nor short the stock. This doesn’t constitute financial advice.

New cars for 40% off

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Looking for a new car? This maybe last year’s model but it’s new and 40% off. I recall seeing such lunatic deals the last time we headed for a collapse in auto sales. Mac Haik Ford in Houston is practically giving it away.  Even some of the 2017 models are getting chunky discounts.

Jim Glover Chevy near Arkansas River is also trying to shift 2016 metal. Why buy used when a 2016 new Malibu is $7,000 off?

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Chrysler is also chucking discounts left, right and centre. Northwest Dodge Houston is taking $14,000 off new Rams.

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ZeroHedge wrote:

If GM piles on incentives at this rate three months in a row, it would spend nearly $4 billion on incentives, in just that quarter, just in the US alone. How much dough is that for GM? In Q1 2015, GM reported global net income of $2.0 billion. In Q1 2015, it reported global net income of $0.9 billion. These incentives can eat an automaker’s lunch in no time. And they did in the years before the industry collapsed during the Great Recession.”

The National Automotive Dealer Association (NADA), a division of JD Power wrote,

Manufacturers dialed up incentive spending 18% last month to help reduce new vehicle inventory levels that are at a decade-plus high.”

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The NADA Used Car Guide’s “seasonally adjusted used vehicle price index fell for the eighth straight month, declining 3.8% from January to 110.1. The drop was by far the worst recorded for any month since November 2008 as the result of a recession-related 5.6% tumble. February’s index gure was also 8% below February 2016’s 119.4 result and marked the index’s lowest level since September 2010.”

WolfStreet noted “Used vehicle wholesale prices determine the value of the collateral for $1.11 trillion in auto loans that have boomed on higher prices, higher unit sales, longer maturities (the average hit a new record of 66.5 months in Q4), and higher loan-to-value ratios (negative equity)”

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It doesn’t bode well.