PII - Polaris: Built For A Rocky Macro Terrain

2023-06-07 09:41:34 ET

Summary

• Polaris is a market leader in powersports vehicles and is a beneficiary of its name recognition.
• PII stock expects new product launches and healthier inventory levels to drive market share gains throughout the year, despite currency headwinds and a more promotional selling environment.
• At current trading levels, I view the stock as attractive due to its strong market share gains and its promising outlook for the remainder of the year.

Polaris ( PII ) is a market leader in the design, engineering, and manufacturing of powersports vehicles, which includes a wide variety of off-road vehicles ("ORVs"), as well as a strong line of on-road and marine-based offerings.

Name recognition is one notable trait that keeps a healthy floor on demand levels. Though some may shy away from the stock in the current market environment due to the "big-ticket" nature of their offerings, it's important to note that they derive a significant portion of their sales from commercial and utility purposes.

And with regards to their retail customer base, their target customers skew towards the upper end of the income spectrum. While there's evidence of a pullback in spending from even these customers, the demand outlook remains largely intact.

In fact, the company is seeing outsized demand for their more premium and newer offerings, which is notable since it cuts against the grain of what one would expect. The higher demand is perhaps due to the sustained interest in outdoor recreation.

I've previously estimated a target price in the $130/share range. At current pricing, this would represent upside potential of over 15% from current trading levels. In my prior upside, I noted that shares were a "hold" due to dealer inventory levels, which weren't viewed to be at optimal levels. This outlook has changed significantly due to normalization in the operating environment.

And this was affirmed on PII's most recent earnings release. As such, I believe the company can continue gaining market share in the periods ahead, which I expect will add further to topline revenues. Combined with further margin expansion on a lower cost base, I can see the valuation in the shares tracking back towards their five-year averages.

PII Q1 Topline Revenues

In Q1FY23, PII reported total quarterly sales of +$2.2B. This was up over 20% from the same period last year and +$220M better than expectations . Driving the increase was a 12% increase in volume. This was largely attributable to increased shipments of ORVs and Indian Motorcycles. In addition, favorable product mix and price also contributed 11% to topline figures.

Currency headwinds did tick 1% from total sales during the period, but their international segments still performed strongly. Apart from Canada, sales to all other international countries were up 16%, due to strong contributions from Australia, Mexico, and France.

PII Q1 Off-Road Segment

On an overall basis, sales were up 19% YOY on increased volume and an increase in unit prices of approximately 11%. In addition, sales to customers outside of North America were up 6%.

High single-digit growth in international retail sales also provided an offset to an overall 10% decline in North American retail, led lower by a mid-teens percentage decline in ATVs. Though the unit turned in a YOY decline, it's important to note that the unit was up 6% over the same period in 2019.

PII Q1 On-Road Segment

Overall sales were up 42%, with 54% and 30% growth in both North American and International, respectively. Their Indian Motorcycles continued to be a strong point for sales. Though retail sales were flat in North America for the period, they were up 11% relative to the same comparable period in 2019.

In addition to strong sales In North America, their Indian Motorcycles contributed to gains in Australia. Furthermore, their two European brands both turned in record revenues for the quarter.

PII Q1 Marine Segment

Though overall sales were up 25%, retail sales were down in both their pontoons and deck boats, but more so for their pontoons, which were down about 30% and 16% relative to 2019. Interestingly, sales were driven by consumer preferences for more premium boats.

Overall, the selling environment is presently more reflective of the pre-pandemic era, with more normalized inventory levels and more characteristic buying patterns among consumers.

What Does PII Expect Moving Forward?

PII maintained guidance that was provided in January. This called for full year sales to be flat to up 5%, which represents a range of between +$8.6B and +$9.0B. In addition, full year adjusted EPS is expected to fall within a range of $10.10/share to $10.75/share or down 3% to up 3%. It's also worth noting that 40% of their annual EPS is expected to be derived in the first half of the year.

Based on Q1 results, management believes product mix will continue to be a tailwind moving through the year. This is due in part to their various new product launches planned for the year. From a timing standpoint, the contribution is expected to be weighted more heavily towards the back half of the year. This would coincide with the delivery of their new product offerings.

The combination of new product launches, as well as healthier overall inventory levels, which are near optimal levels for their dealers, is expected to result in increased market share gains throughout the year.

In individual facets of their business, their commercial, international, and parts, garments & accessories ("PG&A") businesses are expected to be continued drivers of growth. The strength here, however, is projected to be offset by currency headwinds and a more promotional selling environment.

Despite the expected uptick in promotions, margins are still seen in expansion mode due to favorable volume and product mix. Input costs are also seen as declining throughout the year. Interest expense, on the other hand, will likely offset some of these benefits.

More immediately to Q2, seasonality is returning, but it's not yet in-line with historical patterns. As such, the company expects a lower level of shipments and sales for the quarter. This is attributable in part to the timing of their snowmobile shipments, the effects of which were realized in Q1.

Why PII Is A Buy

During Q1, PII gained market share in all three of their major reporting segments. In addition, each turned in double-digit sales growth, with sales particularly pronounced in their on-road segment, which was up 42% YOY, led by continued strength in sales of their Indian Motorcycles.

Though North American retail was down 5% YOY, it was still up 14% relative to the same comparable period in 2019. And looking ahead the outlook appears promising due in part to a slate of new product launches. These launches figure to be a key aspect of their future performance moving forward.

As it is, demand continues to be weighted to their premium product offerings. This can be chalked up to their customer base, which tends to skew towards the higher end of the income spectrum. Credit scores also continue to hold up well against benchmarks, even despite the higher rate environment.

Through the date of their release, for example, the average FICO score reported was 687. This is up several notches from the five-year average of 680. There has also been no meaningful reduction in approval or penetration rates.

I expect PII to remain propped up by a more normalized inventory environment and by more favorable cost/price dynamics. This should contribute to positive margin expansion as the company moves through the year.

At about 11x the midpoint of their FY23 earnings estimate, shares appear to be trading at an attractive price for entry. Though some investors may be hesitant due to the discretionary nature of their business, it's important to note that a large portion of their sales are attributable to commercial and utility customers.

And though their retail metrics are softer, commercial and utility sales continue exhibiting strength. Steady market share gains also warrant a step up in current trading multiples. At a 13x multiple, shares would trade closer to their 5-year average .

At this multiple, the stock would have implied upside of over 15% from current trading levels. This would be more generous than the 3% average upside implied by consensus estimates , but I view my mark as attainable, given the future outlook. The stock, therefore, is viewed as a "buy".

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