EUR 850.00 For Business Accounts Only

Morningstar | BRP Grabs Share in Most Segments, Supporting Our Narrow Moat Rating; Shares Modestly Undervalued

Narrow-moat BRP posted another solid quarter of market share gains, handily outperforming the industry in every category it operates in, with the exception of snowmobiles. Most impressive were side-by-side retail sales (year-round represents 41% of 2017 sales), rising at a mid-20% clip, while the industry posted mid-single-digit gains, and the personal watercraft segment (seasonal represented 35% of 2017 sales), which ticked up at a high-20% rate, versus an industry that grew in the low teens. For BRP, these represent two key legacy segments that should continue to help profitability metrics expand, particularly if the firm continues to innovate at its existing pace (launching new off-road products every six months, for example). This, along with expansion into adjacent categories (boats), should help the company leverage expenses on a scaled revenue base, leading to an adjusted operating margin that rises to 12% over the next decade, from 9% in 2017.

Despite BRP increasing both its 2018 sales guidance, to 13%-17% growth from 12%-16%, and lifting its EPS outlook, to $2.96-$3.06 from $2.94-$3.06, we don’t plan any material change to our CAD 50 fair value estimate. Our prior outlook called for 15% growth on adjusted 2018 sales, which we expect to maintain, and EPS of CAD 3.12, which we are likely to lower modestly. We still think that with innovation, the company should be able to capture incremental market share ahead, reflected in our average sales forecast of 5% growth over the next decade, whereas the industry could rise at a low-single-digit pace. We don’t have future acquisitions embedded in our model, but management has been vocal about tactical tie-ups in the marine space, which could provide further upside to our current outlook, depending on the purchase price and margin profile.

Overall, the third-quarter performance was solid, with sales rising 14% to CAD 1.4 billion. Year-round shipments increased 21%, while seasonal grew 3%, Powersports PAC and OEM Engines ticked up 13%, and marine jumped 30%, helped by the inclusion of Alumacraft and Manitou. The gross margin declined year over year to 25.6% as an unfavorable mix was more than offset by higher unit volume of side-by-sides and parts and accessories. Adjusted operating expenses expanded around 60 basis points to 14.1% due to inflated technology spending and higher compensation costs. Dealer inventory appears decent, up 9%, with the majority stemming from new Can-Am models moving into the network, with commentary indicating the current inventory represented most of the product in the channel.

While signs of a near top of the discretionary spending cycle appear to be close, we don’t think a sharp downturn in this business is imminent over the next few quarters. While rising interest rates crimp affordability, BRP continues to expand its reach with lower-price products, new technology on hardware to spur replacement sales, and reasonable financing offers to attract new users to remain an appealing option. However, this generally can't offset consumer weakness totally in the event of rising unemployment, slowing consumer confidence, or materially higher financing costs. Even best-in-class peer Polaris suffered setbacks through the last recession, with sales tumbling nearly 20% in 2009, indicating the magnitude of impact discretionary companies can see in an economic downturn. To account for the cyclicality that occurs for these businesses, over the last five years of our forecast we have the top line slowing to a 3% rate, which we believe is a normalized growth opportunity throughout a cycle.