Moody’s Investors Service, a subsidiary of Moody’s Corp. (MCO) raised its rating of ‘Ba2,’ a non-investment grade rating or junk status to B1, a non-investment grade rating or junk status for Harman International Industries Inc. (HAR), according to the Associated Press (AP).
Harman is an international audio and infotainment equipment company. The company designs, manufactures and markets audio and infotainment products for cars, residences, theatres, as well as electronics for audio professionals.
The rating was raised 2 notches on the basis of Harman’s incremental improvement in credit and free cash flow since 2009. As of June 30, 2010, cash and short-term investments were $646.0 million as compared with $424.0 million as of March 31, 2010.
Moody’s also cited that automotive production has begun to recover from the crisis faced during worldwide economic downturn in 2009. During the fourth quarter 2010 (its most recent quarter), Harman achieved significant growth across all its sectors, particularly from the Automotive division. Automotive sales increased 35.0% year over year (43.0% excluding foreign currency effect) to $627.0 million in the quarter.
During the quarter, Automotive received significant contracts from a number of auto companies such as Chrysler Group, Fiat (combined worth more than $1.8 billion), Toyota Motor Corp. (TM) and BMW. Automotive order backlog increased from $8.8 billion to $12.2 billion at the end of fiscal year 2010.
Moody’s also said that Harman’s debt is low and the company’s profit margins are improving riding on its diversification abilities.
Gross margin in the fourth quarter 2010 increased 550 basis points to 26.3% and 350 basis points to 26.4% in fiscal 2010. Higher sales based on improving factory utilization and productivity drove margins.
Harman remains well ahead of its scheduled $400.0 million in the STEP change permanent cost savings program and achieved 90.0% of it at the end of fiscal 2010. We believe an improved cost structure will drive profitability over the long term.
The year-over-year growth in the fourth quarter was primarily driven by higher gross margins and a lower level of operating costs.
Citing auto market recovery and impressive profit margins, Moody’s raised Harman’s outlook to ‘stable’ from ‘positive’ as Harman’s current financial profile and key credit metrics have improved significantly.
Fourth Quarter and Full-Year 2010 Highlights
Harman’s earnings on a non-GAAP basis were a profit of 30 cents in the fourth quarter of 2010, significantly up from the loss of 43 cents recorded year-ago quarter. However, earnings were two cents below the Zacks Consensus Estimate of 32 cents per share. For fiscal 2010, earnings increased to 85 cents as compared with a loss of $1.23 cents in fiscal 2009.
Revenues increased 29.0% year over year to $851.0 million in the quarter. This was in sync with the Zacks Consensus Estimate. Excluding foreign currency fluctuations, revenues increased 35.0% year over year in the quarter. In fiscal 2010, revenues upped 18.0% year over year to $3.4 billion. The strong top-line growth was primarily driven by a higher demand for Harman’s products.
Results improved for both the fourth quarter and fiscal year, attributable to strong sales across all segments, gross margin expansion and higher cost savings.
Recommendation
We maintain a Neutral rating on a long-term basis (6-12 months) based on Harman’s broadening footprint in the emerging markets such as the BRIC countries (Brazil, India and China). Sales from BRIC countries leaped 330.0% year over year to $0.25 billion in fiscal year 2010.
Harman remains optimistic on a long-term basis, given an increasing demand for its products. Harman doubled its manufacturing capacity in Hungary and China and established research and development and engineering centers in China and India during fiscal 2010.
Harman expects to achieve $1.0 billion in sales from China by fiscal year 2015, up from current sales of around $199.0 million. Harman forecasts a double-digit operating margin based on profitable growth in developed and emerging markets and prudent cost control initiatives over the long term.
Moreover, the company has a solid product pipeline and strong balance sheet. To leverage Harman brands and its market leadership in Brazil, the company’s business strategy includes foray into new market segments and successful launch of new products.
Harman is expected to benefit from its recent acquisition of Selenium, a Brazilian auto unit that will help the company expand into Latin America . With current annual revenues in Brazil of about $55 million, the company is targeting sales of around $250 million by 2015.
However, weak results from the Consumer division remain a concern. Harman continues to face tough competition from Bose Corp., Boston Acoustics Inc., Pioneer Corp., Yamaha Corp., Rockford Corp. (ROFO), Panasonic Corp. (PC) and Sony Corp. (SNE), which may hurt its profitability going forward.
Currently, Harman has a Zacks #3 Rank, which implies a Hold rating on a short-term basis (1-3 months).
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