Recreational-vehicle manufacturer Arctic Cat (NASDAQ: ACAT ) has been riding a multi-year rebound in the domestic recreational-vehicle market to new heights, powering a strong five-year run for its stock price. Sadly, that upward trend experienced a minor setback last month after the company reported poor quarterly results and forecast lower near-term results.
Still, record snowfalls in the Northeast and Midwest U.S. this winter are expected to produce a windfall for snowmobile manufacturers, which should benefit the industry's major players, including Arctic Cat. So, is the company a good bet at current prices?
What's the value?
Arctic Cat has leveraged its strong franchise in the snowmobile space, roughly half of total sales, into a more diversified portfolio of recreational products and a brand that touches all four seasons. The strategy has reduced the company's reliance on the winter sports season and moved it into high-growth industry segments, like the side-by-side-vehicle product category. It has also broadened Arctic Cat's brand exposure, allowing it to capture greater sales of high-margin accessory items with an associated positive effect on overall profitability.
In fiscal year 2014, Arctic Cat has generated mixed results, with a small top-line gain being more than offset by a drop in operating profitability. The company's push for greater market share, especially in the snowmobile segment via a product partnership with Yamaha, has come at the expense of lower average price realization, hurting Arctic Cat's gross margin. Ultimately, though, Arctic Cat expects the partnership to lead to higher operating profitability as it leverages Yahama's marketing budget, ultimately enhancing shareholder value.
Trying to catch the kingpin
Undoubtedly, Arctic Cat has benefited from the more favorable winter weather, evidenced by a double-digit gain in volume for its snowmobile segment during the year-to-date period. However, the company's growth story lies squarely in the off-road-vehicle segment, an area in which management has tried to create momentum through active product development, including a growing portfolio of products for its popular Wildcat brand.
Unfortunately, that operating strategy has the company trying to take market share from industry kingpin Polaris Industries (NYSE: PII ) , holder of the No. 1 domestic market positions in both all-terrain and side-by-side vehicle categories.
Relative to Arctic Cat, Polaris has enjoyed a superior sales growth trajectory lately, reporting a 17.7% top-line gain in its latest fiscal year, partially aided by acquisitions in its European small-vehicle segment. More significantly, the company generated a double-digit-sales gain in its key off-road-vehicle segment during the period thanks to research and development efforts focused on the fast-growing, side-by-side-product category. The net result of its efforts, as well as its ability to use its brand power to maintain strong pricing, was a solid increase in its level of operating profitability.
Clearly, Polaris' management has been wise to create as wide a product portfolio as possible, a strategy that allows growth to come from once-dormant areas. A case in point is the company's rejuvenated motorcycle segment, which has enjoyed new life thanks to a rebirth of the Indian motorcycle brand. New product development efforts, including the recent introduction of three new Indian brand models, allowed the motorcycle unit to generate double-digit growth in fiscal year 2013, powered by the Indian brand's very strong performance.
While the motorcycle category is a slow-growth area, with domestic industry sales estimated to have posted scant growth in 2013, there are a couple of reasons for Polaris to commit capital to this product niche. First, the motorcycle business is a relatively high-margin business for top brands, evidenced by Harley-Davidson's (NYSE: HOG ) 35.4% gross margin in fiscal 2013, a number that far exceeds the overall gross margin of either Polaris or Arctic Cat.
Secondly, international growth opportunities for the motorcycle business are favorable, especially in areas of rising affluence like Asia Pacific and Latin America, where Harley-Davidson generated top-line growth of 9.8% and 13.1%, respectively, in its latest fiscal year.
The bottom line
Arctic Cat's stock price received a big haircut in January, but that doesn't necessarily make the company a screaming buy. Arctic Cat's future growth lies in its ability to build a stronger sales footprint in the off-road-vehicle segment, an area where industry kingpin Polaris seems to have the sales momentum. With Polaris' diverse product line and growth drivers, including a greater presence in the motorcycle space, investors should take a pass on Arctic Cat and stick with the industry leader.
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