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Morningstar | Polaris Raises Prices in Tough Marketplace, Implying Intact Competitive Edge; Shares Undervalued

Wide-moat Polaris continues to grow in a slowing market, with second-quarter results that included 18% sales growth (ahead of our 15% forecast) and a modest 2% earnings per share decline (to $1.73 versus our $1.54 forecast). The company was hindered by higher tariff costs but helped by a calculated effort to maintain its price leadership, even though that meant sacrificing some volume gains. While most of its segments performed in line with our sales estimates, both motorcycles and boats grew faster than we anticipated, with motorcycle shipments rising 14% (thanks to the FTR1200) and boats delivering $182 million in revenue (versus our $150 million estimate and no comparable sales in the year-ago period). More important, gross margin performance in every segment, with the exception of aftermarket parts, was modestly ahead of our forecast, sending the overall metric down just 100 basis points to 24.9% despite trade war headwinds. We think this along with controlled costs helped Polaris raise its guidance to the high end of its prior range, with the company calling for sales growth of 12%-13% (versus our 10% outlook prior) and EPS of $6.10-$6.30 (modestly ahead of our $6.07 forecast).

Because the updated outlook doesn’t materially differ from our full-year forecast, we don’t plan any significant change to our $105 fair value estimate. We view the shares as undervalued even after a high-single-digit percentage lift after the results. Our five-year forecast calls for organic revenue growth of 3% and high-single-digit EPS growth, bolstered by the faster-growing global adjacent market and aftermarket parts segments but offset by the secularly slow-growing off-road vehicle and snowmobile segments. We anticipate significant gross margin improvement (more than 100 basis points) if tariffs roll off, but for now we model the metric at 26% in 2022, well below the 30% the company had targeted before the trade war.

At first glance, it appears that the company lost share at retail overall during the second quarter, with Polaris retail sales falling 2% in an industry that was modestly positive. However, some of this was due to Polaris’ unwillingness to participate in unnecessary competition, allowing the firm to take 9% average selling price increases in the ORV segment. In turn, the Ranger, General, and RZR remained strong performers, while value, youth, and trail (which lacked newness) ceded share and acted as a drag on retail category sales. Indian bikes fell at a high-single-digit clip at retail, faster than the market, as the FTR1200 began to sell. Boats, which declined at a low-single-digit rate because of difficult weather, beat the industry, which fell at a mid-single-digit rate. In our opinion, protecting the ability to increase prices helps insulate the brand intangible asset, as consumers are likely to perceive the brand as more aspirational rather than a substitute good. Contingent on product innovation ahead, we expect Polaris to track more closely with industry growth, as it already holds a leadership position in many of its segments.

We still believe Polaris is better positioned than many of its powersports peers, thanks to many of its smaller acquisitions over the last decade, which have helped stabilize the overall revenue base. Polaris has turned into a more diversified industrial business, a topic we covered in our January 2019 report, "Polaris Revs Up Profit Growth With Adjacent Business Tie-Ups." Digesting sizable businesses like Transamerican Auto Parts in 2016 and Boat Holdings in 2018 pushed Polaris back into the discretionary spending camp but helped provide a growth hedge against slower-growing categories like motorcycles and snowmobiles.