Polaris Industries RZR side-by-sides have been a favorite since they were first introduced and propelled the company into a leadership position, but recent quality control issues are likely to weigh on its performance. Image source: Polaris Industries.
With Polaris Industries (PII 1.29%) set to report second-quarter earnings on Wednesday, July 20, investors need to keep an eye out for some potholes in the powersports-vehicle manufacturer's path. While its motorcycle business seems to be firing on all cylinders, the much bigger and more important off-road vehicle division is facing a more challenging environment.
|
Metric |
Q2 2015 |
Q2 2016 est. |
% Change |
|---|---|---|---|
|
Revenues |
$1.12 billion |
$1.10 billion |
(1.8%) |
|
EPS |
$1.49 |
$1.05 |
(29.5%) |
These are some of the big areas that investors should be mindful of when Polaris posts Q2 results.
RZR recalls
The biggest wildcard is the impact of the numerous recalls the company's had to initiate as a result of "thermal issues" with its all-terrain vehicles.
In April, Polaris was forced to announce a massive recall of more than 160,000 RZR 900 and RZR 1000 side-by-sides that could catch fire, and just this month it had to send out notices that its 2015 and 2016 Ranger 570 side-by-sides were also subject to possible fire hazards. It recalled all 43,000 vehicles. Last December saw 4,700 snowmobiles recalled because of steering problems, in addition to 2,200 2016 RZR XP Turbos for oil leaks that could result in fire.
The big RZR recall, however, happened just a week before the company's first quarter ended yet still resulted in gross margins tumbling 180 basis points. Now that Polaris has been dealing with the issue for a full quarter, the impact is likely to be substantial. It began shipping repair kits out to dealerships toward the end of April so that customer vehicles could be repaired first, then it needed to tackle the inventory that was sitting on dealer lots.
The recalls are coming at a bad time for Polaris because its rivals are ramping up production of their own competing brands, particularly Arctic Cat (ACAT), which has also improved upon its Wildcat side-by-side. With Polaris' off-road vehicle sales down 9% to $720 million in the first quarter, we may see an even more substantial decline this time around.
ATV industry weakness
As if the recalls weren't enough, they're occurring at a time when there's already broad industry weakness in the ATV market, particularly in oil-dependent states.
First-quarter oil-state sales fell 8% from the year-ago period, though that was better than the decline in the category last year, suggesting the bottom may have been reached. Also, oil trades at around $47 a barrel now, down from the $52 level it hit last month, but better than the mid-$30s range it was at in the first quarter. That doesn't mean, however, that oil companies will be expanding, so those regions will continue to weigh on performance.
Motorcycles still humming
Of course the brightest spot in Polaris Industries' portfolio remains its motorcycle division, with revenues rising 18% in the first quarter primarily as a result of the 50% gain in Indian Motorcycle sales. Of course, the category was starting from a negligible base, so the growth looks exponential, but as Polaris introduces models across all styles and price points, it ought to be able to maintain its current growth trajectory.
Indian Motorcycle sales are likely to remain strong as Polaris Industries has introduced models across all styles and price points to aggressively compete for sales and market share. Image source: Indian Motorcycle.
Most notable are the gains being made as industry leader Harley-Davidson (HOG 0.48%) continues to falter. It still owns half the big-bike market, but Polaris has been able to take large swaths of share from its rival. Polaris new Scout Sixty model that's priced under $9,000 is an affordable introductory motorcycle for new riders and customers new to the brand. Even though Harley has the lower-priced Street 500 and 750 models, the ubiquity of the brand has caused it to lose some of its cache. Indian, with an even older pedigree, yet much less common on the road, is attracting new adherents.
Also keep a watch on the Victory brand as it's in the midst of a turnaround. Retail sales were down in the single-digit range in the first quarter, but that's a significant improvement. It will be well worth seeing if the sales will stop declining, and maybe even turn into growth.
Utility vehicles
At 7% of total sales, Polaris Industries' utility vehicles remain a small part of Polaris' overall business, but with its recent acquisition of Taylor-Dunn, the company is looking for the stability that it doesn't have with ATVs or even motorcycles, for that matter. The utilitarian nature of the business and the broad range of vehicles available from brands like GEM, Goupil, and Aixam could allow the division to produce workman-like growth in a $4 billion industry for Polaris.
A bumpy ride
Shares of Polaris Industries are up 32% from the lows they hit in January but still remain some 40% below their 52-week highs. Because the off-road vehicle market accounts for nearly three-quarters of the powersports-vehicle manufacturer's total revenue, sales and recall impact are going to have the biggest influence on its performance.
While the hit may be large, it should still be transitory, and assuming Polaris Industries' reputation isn't unduly harmed, the company should be able to bounce back. With support from its burgeoning motorcycle division and a steady rise in UTVs, this remains a good long-term business that's only just run into a few potholes.
