2023-07-20 01:50:07 ET
Summary
- BRP has demonstrated strong growth and created shareholder value.
- Despite impressive growth and good operating margins, BRP's earnings are highly sensitive to macroeconomic trends, making it a volatile investment.
- While BRP has potential for future growth, current economic risks and the possibility of margin decreases make the stock a hold recommendation.
- I believe the stock is currently fairly valued given potential risks.
BRP Inc. ( DOOO ) (DOO:CA) is a company that sells snowmobiles, watercrafts, off-road vehicles, boats, and accessories. The company holds quality brands and has grown remarkably into its current size both organically and through acquisitions. I believe the stock is currently fairly valued considering the company’s earnings capabilities and possible risks, which is why I have a hold-rating for the stock.
The Company
Founded in Canada, BRP is most known for its Ski-Doo brand, a globally recognized snowmobile manufacturer. In addition, the company also owns brands such as Lynx, Can-Am, Rotax, and Alumacraft. The company’s main regions of operations are Canada, the United States, Mexico, Finland, and Australia.
BRP has had a good history of creating shareholder value, as seen in the company’s Q1 earnings presentation :
Financials
BRP has achieved remarkable growth in the company’s history, as their compounded annual growth rate has been around 7.5 percent for the past twenty years, that has been achieved both organically and through select acquisitions:
In FY24’s first quarter the company achieved a remarkable growth of 34% that the company attributes to a higher volumes, a favourable product mix and, and increased pricing in their quarterly presentation. This growth isn’t expected to carry onto the rest of the year, though, as the company only guides towards a growth of 9-12 percent:
BRP has grown its operating margin in recent years – in the company’s earlier history, EBIT margins have been slightly below ten percent, but in FY23 the margin was 13.5 percent:
The current margin could be boosted by Covid-related demand, but as margins have stayed consistently high to this day, I believe the margins are likely to stay quite near current levels. The company’s analysts seem to agree, as BRP’s consensus EBIT margin for FY27 is at 14.0%. This is yet to be seen, though – margins could theoretically see downward pressure.
The company has interest-bearing debts totalling CAD2.83 billion , which I consider a healthy amount as the company produces well over a billion in operating profit in a year. Almost all of this debt is in long-term liabilities, not creating near-term needs to pay back the debt; only CAD61 million of the debt is in current debt on BRP’s balance sheet. The company has a cash balance of CAD213 million.
Valuation
The company seems cheap at first glance, as the company trades at a trailing P/E ratio of 10. I believe this valuation is justified, even with the company’s growth, as the company’s earnings are highly sensitive to macroeconomic trends.
To demonstrate further, let's use a capital asset pricing model to determine a fair cost of the company’s capital:
I expect the company to have a cost of debt of around 6.5%, a typical rate for a similar company with current interest rates. As the company leverages debt quite well for its capital, I believe the company’s debt-to-equity ratio should stand at around 30% going forward.
On the cost of equity side, Canada’s current 10-year bond yield stands at 3.39%. Professor Aswath Damodaran currently estimates the country’s equity risk premium to be exactly five percent. As the company’s earnings correlate very highly with the macroeconomic climate, the company has an astonishingly high beta of 2.49 according to Yahoo Finance . Finally, I believe a half percent liquidity premium is justified for the stock, leaving the company’s cost of equity at 16.71%, and a WACC of 13.16%.
Using this WACC, I constructed a discounted cash flow model using moderate estimates:
I expect the company to achieve its guidance of 9 to 12 percent growth in FY24 with quite high margins. After that, my forecasts for revenue are that the company has good growth for a few years, although after FY25 the growth falls below historical figures, slowly slowing down into a growth of around two percent, on pace with the economy.
The model’s forecasts have operating margins that stay at current good levels. At this point I believe this to be the base case for BRP, as margins are guided to stay quite good for the entire year of FY24 even with current macroeconomic turbulence. The company should convert its accounting earnings quite well into free cash flow, as my model takes into account small working capital additions over time and capital expenditures a bit above the company’s depreciation and amortization, but nothing large.
With these expectation the stock’s estimated fair value stands at $84.55, very near the stock’s price at the time of writing with an upside of two percent.
These numbers could be offset by possible M&A, as the company has a history of doing some select acquisitions. I do not believe, though, that possible acquisitions should currently be priced in – we don’t have good visibility into the potential price of such acquisitions, and whether those are to happen anytime soon.
Risks
The company’s margins have been well over their historical averages in recent years – a drop from these levels could create downside for the stock. BRP’s historical operating margin has been at an average of 10.3 percent for the past ten years, well below current levels as mentioned before. From the current trailing level of 13.7%, this would represent a drop of almost 25%.
BRP is also extremely volatile in regard to the larger economy, as the company’s beta is 2.49 – snowmobiles, boats and similar products are a recreational investment that can be easily cut. As central banks tighten their monetary policy around the world, a downturn in the economy could still be due, possibly creating large risks for BRP’s shareholders.
Closing Remarks
With macroeconomic and margin risks, I believe BRP’s current valuation to be correct. If economic risks subside and the company proves its margins to be sustainable in the long run, the stock could be worth to add into a long-term portfolio as they’ve historically created impressive shareholder value. Currently, though, I believe risks and possible rewards to be quite balanced, hence I rate the stock at hold .
For further details see:
BRP Is A Risktaker's Pick