Iconic U.S. motorcycle manufacturer Harley-Davidson (HOG - Free Report) announced last Monday that it would shift some production out of the country to avoid newly enacted European Union tariffs on imports from the United States. Their plan is to manufacture motorcycles bound for the E.U. in facilities Harley already operates in Australia, India Thailand and Brazil. Exports from each of these countries to the E.U. will not be subject to the additional 25% tariffs – bringing the total to 31% - which would raise the price of an average Harley Davidson motorcycle $2,200, which the company says it cannot pass along to its dealers and customers without materially damaging sales.
The most recent round of E.U. tariffs are a retaliation for trade penalties imposed by the Trump administration.
The company estimates that the total incremental cost of the tariffs will be $30 to $45 million for the rest of 2018 and $90 to $100 million on a full-year basis. Net Income in 2017 at Harley Davidson was $522M, so the tariffs would have a significant impact on the bottom line.
HOG shares sold off more than 6% on the news and are currently trading 25% lower than the 52-week high reached in January. Standard and Poor’s warned last Wednesday of a possible downgrade in the company’s credit rating due to near-term cost increases as a result of the E.U. tariffs.
Harley’s U.S. sales were off more than 8% in 2017, while sales in the E.U. were steady - making it an important market for the quintessentially American brand. The transition is expected to take 9 to 18 months to complete. Manufacturing of motorcycles for domestic sale will remain in the U.S.
In an 8-K disclosure to the S.E.C. – required in the case of an “unscheduled material event” – Harley specifically declares that the move is solely intended to avoid the impact of the tariffs, which went into effect on June 22nd.
The company stated:
Harley-Davidson maintains a strong commitment to U.S.-based manufacturing which is valued by riders globally. Increasing international production to alleviate the EU tariff burden is not the company’s preference, but represents the only sustainable option to make its motorcycles accessible to customers in the EU and maintain a viable business in Europe. Europe is a critical market for Harley Davidson. In 2017, nearly 40,000 riders bought new Harley-Davidson motorcycles in Europe, and the revenue generated from the EU countries is second only to the U.S.
Pushback from the Chief Executive
President Trump quickly responded to the news with a series of tweets critical of Harley’s intentions to move more production offshore.
It’s unclear what exact retaliatory measures the president could actually take against Harley Davidson and it would be logistically difficult – and possibly not even legal – to implement additional taxes on a single company, but the message was loud and clear. Trump wants manufacturing to stay in the U.S. and will use any means available to make it so.
Speaking at the groundbreaking ceremony for a massive new production facility in Wisconsin for Taiwanese electronics manufacturer Foxconn, Trump continued to criticize Harley’s plan to shift production offshore, saying, “Harley-Davidson, please build those beautiful motorcycles in the United States,” adding, “don’t get cute with us. Build them in the U.S.A, your customers won’t be happy if you don’t.”
Widespread Trade War Uncertainty
Management at public companies has a responsibility to shareholders to do everything possible within the law to maximize profits. While not every company produces everything they make in the cheapest possible environment – it can certainly be an important image or marketing decision to be “made in the U.S.A.” even if it costs more – in general, decisions have to be made that best support the bottom line.
With regard to taxes, multi-national corporations routinely manage activity across multiple jurisdictions to minimize taxes paid. Though occasionally referred to as “Un-American” to shift tax burden to countries with lower rates, it would actually be irresponsible of management not to do so – a waste of shareholder resources. The recent corporate tax cuts in the U.S. were largely an attempt to level the playing field and included incentives to repatriate profits held in other countries.
Often management from the CEO down can’t know with certainty what the effects of taxes and other factors will be on future earnings and have to make an educated guess about how best to adapt to anticipated policy decisions. As we saw with the Harley-Davidson production shift, large-scale changes can take months or years to implement, during which time conditions can change dramatically.
The current situation is extremely challenging for executives who are forced to make large-scale decisions based on hastily enacted tariffs and speculation about future retaliatory actions.
Motorcycles are only two items out of more than 200 products affected by the recent 25% E.U. tariffs, including 71 agricultural and tobacco products and 85 varieties of raw and processed steel, as well as appliances, boats, Bourbon whiskey, and assorted household items – including playing cards, which inexplicably are subject to only a 10% import tariff.
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Which Industries Will Move Next
U.S. tariffs on imported steel will affect roughly 6.4 billion Euros worth of imports from the E.U. The retaliatory tariffs are intended to be a direct response, with the first round affecting 2.8 billion Euros of American goods and the remaining 3.6 billion to come later. A release from the European commission states:
The EU will rebalance bilateral trade with the US taking as a basis the value of its steel and aluminium exports affected by the US measures. Those are worth €6.4 billion. Of this amount, the EU will rebalance on €2.8 billion worth of exports immediately. The remaining rebalancing on trade valued at €3.6 billion will take place at a later stage – in three years' time or after a positive finding in WTO dispute settlement if that should come sooner.
The EU rebalancing measures will be effective for as long as the US measures are in place, in line with the WTO Safeguards Agreement and EU legislation.
It has been speculated that the initial list of goods subject to tariffs was chosen specifically to target industries in areas of the U.S. that supported President Trump in the 2016 elections and a quick glance at the list does seem to support that theory.
It’s also been conjectured that the addition of Playing Cards - at the end of the list and with a smaller percentage tariff than everything else - was a tongue-in-cheek joke meant to signify that the E.U. is “playing the hand it’s been dealt.”
When considering whether other American companies might follow Harley-Davidson’s lead and shift production to other countries, it quickly becomes obvious that most of the other industries would be unable to make a similar move. Agricultural producers simply cannot relocate at all – you can’t move a farm – and steel foundries are considerably less portable than factories assembling finished goods like motorcycles.
The only remaining industries that could possibly shift some production out of the U.S. are appliances and boats. It’s unclear whether any U.S. manufacturers have the capability to easily shift the site of production the way Harley could because of its existing operations. Building or purchasing new facilities in reaction to tariffs that might be temporary would be a foolish expenditure. The news-headline value of these moves would also likely be just a fraction of the attention that’s already been paid to Harley’s move, which was exacerbated by the president’s reaction.
It’s also not possible to know which goods might be on the E.U.’s second list if the trade war continues and the other tariff shoe drops.
So Harley-Davidson seems to be uniquely unlucky to have been singled out both by the E.U. tariffs and also president Trump’s displeased reaction to their otherwise rational strategy. They are essentially between a rock and a hard place.
It’s often said that “Nobody wins a trade war” and that certainly seems to be true, but some companies lose much more than others and unfortunately for Harley-Davidson, that list includes them.
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