Why Polaris Should Keep Cruising in 2014

Polaris Industries  (NYSE: PII  )  cruised past third-quarter earnings estimates on Oct. 22, thanks to strong off-road vehicle and snowmobile sales. Despite earnings powering forward, shares of the stock closed down nearly 4%, though they have since partially recovered. The drop was no doubt due to what investors considered disappointing Indian motorcycle sales. 

First, highlights from the earnings report:

  • Revenue increased 25% to $1.1 billion.
  • Earnings per share from continuing operations increased 23% to $1.64, beating estimates by $0.03.
  • International sales grew 38%, due to the Aixam Mega acquisition and strong organic growth.
  • Full year EPS guidance was raised to $5.30-$5.37, up from $5.20-$5.30.

Motorcycle revenue wasn't tattoo-worthy, but investors still jumped the gun
Investors were likely laser-focused on Polaris' motorcycle sales given its August launch of the 2014 Indian models. These are the first models Polaris has completely designed, engineered, and manufactured since its 2011 acquisition of Indian Motorcycles, America's first motorcycle company.

So when investors saw the earnings release indicating that motorcycle revenue -- from the Victory and Indian lines -- was down 6%, they initially sent shares tumbling 6%.

But as CEO Scott Wine stated on the conference call, Indian shipments to dealers began in mid-September. So we're talking just a couple of weeks of availability in the third quarter.

As President and COO Bennett Morgan said during the call, motorcycle revenue was down:

"... due primarily to the quarterly and year-over-year shipment adjustments necessitated as we transition to our Lean RFM business model. However, we gained market share both for the quarter and year-to-date, as North American third quarter Victory retail sales rose over 30% in a heavyweight industry that grew about 20%. Year-to-date Victory retail is up about 10% in an industry up mid-single digits." 

In other words, the company has been shipping fewer Victory bikes to dealers as it transitions to a more cost-efficient business model. The data to hone into are Victory's retail sales -- perhaps not tattoo-worthy, but solid. 

Motorcycle king Harley-Davidson  (NYSE: HOG  )  also released quarterly results before the market open on Oct. 22, which surely contributed to Polaris' investors needless panic. While Harley's overall revenue was up only a relatively tepid 7.5%, its retail bike sales increase of 15.5% and EPS growth of nearly 24% were tattoo-worthy. Furthermore, the company said its new Project Rushmore line -- launched after Polaris' Indian debut in August -- contributed to its strong bike sales. 

There's an additional factor to consider when comparing motorcycle sales results. It's likely Harley's Project Rushmore bikes were more widely available in the third quarter than Polaris' Indian bikes. Harley has long had an extensive dealer network in place because it's an old company focused on motorcycles; meanwhile, Polaris is in the process of expanding its motorcycle dealer network as it ramps up its bike offerings.

Powering into the quarterly results
Here's how Polaris' revenue mix broke out in the quarter. Keep in mind there is seasonality involved with snowmobile and motorcycle sales.

Data from Polaris' third-quarter earnings report 


Here's how each segment performed during the quarter:

  • Off-road vehicles: up 23% to $702.0 million
  • Snowmobiles: up 25% to $143.6 million 
  • Motorcycles: down 6% to $49.4% million
  • Small vehicles: up 188% to $31.7% million
  • Parts, Garments & Accessories: up 37% to $176.0 million

These are strong numbers, especially since the U.S.economy is still struggling and many European countries have only recently emerged from the recession. Growth in off-road vehicles – which includes all-terrain vehicles and side-by-sides -- and snowmobiles was entirely organic. However, Polaris did move snowmobile shipments to dealers up compared with last year, which inflated the snowmobile number. Thus, investors should hone in on snowmobile sales over the next two quarters.

Sales of small vehicles were turbocharged by Polaris' acquisition of Aixam Mega, a French quadricycle company. Its PG&A segment benefited from its acquisition of Klim, a leader in technically advanced apparel and gear. However, these two segments had strong organic growth as well. Notably, GEM sales continued to accelerate with retail sales up over 50%. Polaris acquired GEM, which makes low-speed compact electric vehicles, in 2011. The PG&A segment sports the highest margin, so the fact that it's the company's second largest segment and growing at a torrid pace should continue to help power earnings going forward. 

Polaris' diversification by product line and customer type -- it sells to the commercial and government/military markets as well as to consumers -- is one main reason I've called the company the best play among recreational vehicle makers. While Harley has been doing a good job coming back from its struggles during the recession, it's largely a one product company selling to consumers.

Arctic Cat  (NASDAQ: ACAT  )  -- Polaris' competitor in snowmobiles and off-road vehicles -- has decent product line diversification; its revenue mix for its fiscal second-quarter ending Sept. 30 was 57% snowmobiles, 30% off-road vehicles, and 13% PG&A.

However, it doesn't have Polaris' diversification by customer type. Further, the off-road vehicle segment -- specifically side-by-sides -- is the highest-growth segment in the powersports vehicles industry. That's Polaris' largest segment, but it comprises just 30% of Arctic Cat's revenue.

Polaris well positioned for the race going forward
Polaris' top management has been executing with the precision one might expect from former military folks. There's no reason to expect that won't continue. Polaris' estimated EPS growth rates for next year and the next five years are 17.9% and 17.5%, respectively. The company regularly beats estimates, so current estimates could prove low. 

Polaris' net profit margin is a solid 9.8% and its return-on-equity is a fantastic 45% – and that's not due to debt leverage, as debt-to-equity is only 0.1. By comparison, Harley's and Arctic Cat's returns-on-equity are 26.1% and 24.7% respectively. Harley is highly leveraged with a 1.8 debt-to-equity ratio, while Arctic Cat has no debt. Not surprisingly, investors will have to pay up for these qualities, as Polaris' stock is fairly richly valued with a forward P/E of 20.5 and five-year price-earnings-growth, or PEG, of 1.5.

Despite releasing disappointing quarterly results on Oct. 24, Arctic Cat has many positive features that include its small size, positive early snowmobile retail results, and focus on growing its off-road vehicle business. Thanks to investors sending its stock price skidding about 18% after its earnings release, the stock is now attractively priced at a 14.1 forward P/E and a a 0.8 five-year PEG. That said, Polaris remains a better option for most investors because of Arctic Cat's very high beta, erratic profitability, and other metrics. Harley's lack of diversification, large size, and high debt load means its stock rides last in this pack.

Polaris sports great metrics, solid diversification, and innovative and acquisition-savvy management, and it should continue to lead the recreational-vehicle maker stock pack in 2014.

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