EUR 850.00 For Business Accounts Only

Morningstar | Mixed Performance Across Segments Leads Polaris to Maintain 2019 Outlook; Shares Fairly Valued

A litany of puts and takes across wide-moat Polaris’ first-quarter performance leaves our 2019 outlook (which incorporated sales of $6.7 billion and EPS of $6.07) largely unchanged. The first quarter remains the smallest contributor of earnings power at Polaris, with less consistency surrounding weather intermittently impacting performance at times, which draged on North American retail sales (down 3%). However, despite weaker-than-optimal retail sales it appears Polaris has, at a minimum, held its overall market share across weak performing industries, with snowmobiles and boats gaining share and motorcycles and off-road vehicles losing share. With the company’s 2019 sales outlook unchanged at $6.75 billion-$6.90 billion and its EPS range lifted by a nickel on both ends to $6.05-$6.30, we don’t plan any material change to our forecast or our $105 fair value estimate. We view shares as fairly valued trading at 16 times the midpoint of 2019 EPS guidance versus low-double-digit EPS growth annually on average over the next five years (post-2019).

The biggest drag on our valuation is the secular expectations for the industries Polaris operates within. Even with our expectation of share gains for the legacy snowmobile/ORV segment, we still believe that would lead to just low-single-digit top-line increases for the category. And while global adjacent markets and aftermarket parts have broader growth opportunities, we believe together they might attribute mid-single-digit growth to the overall business over time. However, as Polaris continues to scale we do expect cost efficiencies to arise, leading to a 2028 gross margin around 27% and above 12% operating margin. These metrics underlie our existing fair value and supports adjusted ROIC performance that rises above 50% over the next decade (from 41% in 2018).

In the first quarter total sales increased 15% to $1.5 billion, with about one third of the increase stemming from acquisitions across the boat segment. ORV/snowmobile sales rose 4%, helped by PG&A (up 12%) and off-road and hindered by the timing of snowmobile shipments. Gross margin in the ORV/snow segment held up well, declining just 20 basis points to 29.1%, as average selling prices increased 11%, mix improved and pricing increases passed. Similarly, boat sales held up, rising 12% on a pro-forma basis to $185 million and represent the business line that could surprise to the upside over the remainder of the year; we previously expected around $150 million in sales during the first quarter, which the company handily surpassed.

On the other hand, motorcycle sales declined 10%, as weak industry demand and peer promotion weighed on overall segment performance. This led to significant gross margin pressure in the motorcycle segment, which was at 5.9%, versus a mid-teens rate historically. Aftermarket parts and global adjacent market sales also languished, at flat and a 7% decline, respectively. However, we expect the TAP business (in the aftermarket parts segment) to gain its footing over the remainder of the year and return to positive sales growth.

The wild card for Polaris remains around the tariff environment, which is expected to add an incremental $80 million to $90 million in headwinds on the gross margin line in 2019. In fact, tariffs, along with foreign exchange and higher interest rates, are set to cost the business $1.50 in EPS in 2019. Part of this headwind, we would argue, could be managed with lower leverage on the balance sheet, which we expect will occur over time as the company pays down its existing loans. That said, we don’t think net debt/adjusted EBITDA of 2.25 at the end of 2019 is a particularly elevated metric for a manufacturer and believe Polaris has proper liquidity to operate seamlessly, even in a downturn.