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You Shouldn't Have Been Surprised by Harley-Davidson's Big Earnings Miss

Investors shouldn't have been surprised by Harley-Davidson's (NYSE: HOG) dismal second-quarter earnings report, though the sharp drop in its stock suggests they were. It was clear early on the maker of big steel horses was being too optimistic about its numbers because its sales weren't supporting the amount of bikes it was shipping to dealers.

Harley may have limped over the low end of the shipment guidance it provided after the first quarter, but with sales plunging 6.7% compared to last year, the bike maker now says it needs to make dramatic production cuts in the second half of the year to keep pace with weakening demand. It might not be the last time it does so.

Image source: Harley-Davidson.

Stuck in the slow lane

Second-quarter motorcycle sales are down to levels not seen since 2010 when Harley was just emerging from the grips of the recession. It plans to ship only 39,000 to 44,000 motorcycles in the current quarter or as much as 20% below last year's effort. For the full year, Harley said it expects to ship between 241,000 to 246,000 motorcycles, compared to 262,221 in 2016. Previously, the bike maker said shipments would be flat to modestly down, but it still hasn't come to grips with reality.

Data source: Harley-Davidson SEC filings. Chart by author.

Based upon its shipment projections for the third quarter and the full year, this means Harley thinks it's going to be shipping more than 49,000 motorcycles in the fourth quarter -- and it hasn't shipped that many motorcycles in what typically is the weakest quarter of the year since 2011. Let's just say we're probably going to see some downward revisions again.

Harley-Davison's core customer is disappearing, and millennials aren't riding to the rescue. In last year's Motorcycle Industry Council annual statistical report, the percentage of motorcycle owners aged 50 and over had swelled to 46% from just 25% a decade prior. In contrast, owners under 18 years of age had dwindled from 4% of the total to 2%, and those aged 18 to 24 had declined from 11% to 6%.

Harley-Davidson's core customer has been the fairly well-off middle-aged male, but he was largely wiped out in the financial recession and has yet to recover, or simply choose not to spend money on motorcycles anymore. At the same time, fewer younger riders are entering the market.

And because Harley refuses to engage in discounting like its competition is doing, its motorcycles face additional competitive hurdles to get over.

Youthful appeal

There are things Harley-Davidson can do to make a U-turn, but they don't include buying up a low-volume, high-priced prestige brand like Ducati, which won't bring more riders to the sport, and certainly not to Harley-Davidson. Instead, it needs to cultivate the next generation of motorcycle enthusiasts.

Image source: Getty Images.

Harley recognizes a new crop of riders is needed, and it has said it wants to grow not only its own sales, but also the number of riders coming to the sport. It's why many of its new models have been geared toward attracting them and was purportedly one of the reasons it considered making a bid for Ducati. But that would be a mistake and would take Harley-Davidson in the wrong direction.

As the MIC data highlights, the real direction it needs to go is to the youngest riders. If you're not replenishing that end of the market, you're not going to have riders buying your bikes later on. Instead of another big bike or a flashy, expensive sports bike, Harley ought to be thinking about going to the gritty end of the market -- entry level dirt bikes. It's in that segment where many motorcycle enthusiasts get their first taste of the sport, and as they get older, they trade up to street bikes. Cultivating riders from that community would plant the seed for future Harley sales.

Limited gene pool

While there are any number of dirt-bike makers, there's only one that's a member of the U.S. Motorcycle Manufacturers Association, ATK Motorcycles. Along with Harley-Davidson and Polaris Industries, they comprise the triumvirate of the U.S. bike industry. Making a play for ATK instead of Ducati would zero in on exactly what Harley and the motorcycle industry need, and keeps its "made in America" heritage intact. It would also undoubtedly be available for substantially less than the $1.7 billion Ducati is reportedly seeking.

Harley-Davidson knows it needs younger bike riders as its core customer are aging rapidly and selling off their bikes. Still, even buying a dirt-bike manufacturer is a long-term solution to its woes and not anything that will help this quarter or even this year. But it would give Harley's dealers the chance to offer customers a range of motorcycles depending upon where they are in their riding career.

The more immediate concern for investors, however, is Harley-Davidson heading into its slowest sales period and still projecting excess sales. That's not a good look for the bike maker and its weakened stock may get weaker still.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Polaris Industries. The Motley Fool has a disclosure policy.