Polaris Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Polaris Inc. is a leading global manufacturer of powersports vehicles, including snowmobiles, ATVs, and motorcycles. The company is also involved in adjacent markets, including commercial and government vehicles.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Polaris Inc. (PII) is a diversified player in the powersports market, focusing on Off-Road, On-Road, and Marine vehicles. While their historical financials have shown impressive growth, there are a number of headwinds impacting the company.

Business Overview

  • Revenue Distribution: Polaris operates through three primary segments:
    • Off-Road: This segment comprises all-terrain vehicles (ATVs) and side-by-side vehicles (UTVs), designed for recreational and utility purposes.
    • On-Road: This segment includes motorcycles and snowmobiles, known for their performance and recreational appeal.
    • Marine: This segment includes pontoon boats and fishing boats.
    • Additionally, PII has a small but expanding global parts, garments, and accessories (PG&A) operation that generates its own stream of revenues.
  • Industry Trends:
    • The powersports industry is cyclical, and revenues are highly dependent on consumer discretionary spending, macroeconomic trends, and availability of credit.
    • The industry has seen an overall increase in participation by both traditional outdoor recreation enthusiasts, as well as new entrants attracted by the appeal of unique and adventurous products.
    • The supply chain has been a mess in the past couple of years and has caused massive backorders on products and is now in a state of normalization.
    • Prices for equipment have also seen a big increase in a high inflation environment, which has had mixed impacts on PII’s results.
  • Margins:
    • Gross profit margins for PII are good and average around 25-30%. It is noteworthy that there have been some recent headwinds in input costs. Also, there is a change in the mix of products sold.
    • Operating margins fluctuate much more and also depend on what kind of segment they are being used for. They are higher for off-road sales.
  • Competitive Landscape:
    • The powersports market is competitive, with players including Arctic Cat (Textron), Honda, Yamaha, and other specialized manufacturers.
    • There is also increased competition from manufacturers based outside the United States.
    • Polaris has a history of gaining market share in its categories, showing their success at taking share from competitors.
  • What Makes Polaris Different?
    • Polaris has a diverse portfolio of brands and distribution channels and has a loyal customer base.
    • They are also heavily vertically integrated.
    • Their presence in multiple outdoor recreation vehicle markets, from snowmobiles to all-terrain vehicles and motorcycles, makes them less vulnerable to the downturn of a single category of vehicles.
  • Polaris also has a strong focus on innovation and new product development. * They are targeting new markets with their electric vehicles.

Financials

The following financial analysis is based on PII’s Q3 2023 results unless stated otherwise.

  • Balance Sheet
    • Total assets were $7.485 billion as of Q3 2023.
    • Total liabilities were $5.347 billion. Long term debt is roughly 1.8 billion, and short term debt is $1.18 billion. The remaining amount is comprised of operating liabilities.
  • The Company does not provide details on operating and nonoperating liabilities.
  • Shareholder’s equity was $2.138 billion. They have had increasing amounts of equity over time
  • Income Statement:
  • Sales for the quarter were $2.3 billion, an increase of 10% YoY. For the first nine months of 2023, revenues totaled to $6.4 billion.
  • Gross profits for the quarter were $595.5 million, representing a 26.7% margin.
  • Adjusted Net Income was $151.3 million, or $2.60 per share, in the third quarter of 2023, compared to $2.29 in 2022.
  • Sales growth was driven primarily by higher volumes, and slightly by higher prices.
  • Cash Flow:
  • The company’s free cash flow was negative at $256 million for the quarter, and has been consistently negative over the previous years, which is a result of building up inventory levels, and is expected to turn positive by the end of the year.
  • They are still facing increased costs and are having to cut back on inventory.

Moat Rating: 3 / 5

  • Justification:
    • Polaris has established a strong presence in the powersports market, enjoying brand recognition and a loyal customer base. However, this moat is not very wide due to the presence of many competing companies.
  • They have well established supply chain and distribution networks. This makes it hard for new entrants to establish themselves in the market. * While Polaris consistently introduces new and innovative products, they are not protected by patents or regulation and competitors can easily copy their products and compete at lower prices.
  • While there is a sense of ‘brand loyalty’, there are several competitors with strong brands and very similar products, limiting any meaningful ‘brand’ moat.
  • While their vertically integrated manufacturing does make it difficult for competitors to compete at the same efficiency and cost, it still does not represent a sustainable moat.
  • Overall, the moat is a narrow one due to high competition and limited moats.

Risks to the Moat and Business Resilience

  • Economic Downturn: A recession, or other economic downturns would decrease discretionary spending by consumers, and might negatively affect demand for powersports vehicles, reducing both PII’s revenue and profits.
    • They have taken steps to lower inventory which can help protect the bottom line in the event of a downturn.
    • As seen in their financials and the performance of companies in that segment, it is clear that the companies with a strong ROIC can survive through a downturn, and potentially thrive, but companies with weak ones cannot.
  • Supply Chain Disruptions: Global supply chain disruptions and fluctuations in component costs can reduce profits and revenues.
    • They are taking action to normalize inventory, but there might be more supply chain shocks that they cannot control.
  • Competition: Increased competition from both established and new players could put pressure on prices and eat into profits.
  • Product Liability Issues: Recall, or product liability claims can also lead to expenses or lower their revenue or margins in the short-term. This is especially harmful for a high-cost product such as a motorcycle.
  • Shift in Consumer Preference: There may be a shift in consumer preferences away from traditional powersports vehicles towards newer forms of entertainment, or other types of vehicles such as electric vehicles. They are trying to address this by entering EV market.
  • Regulation: There may be changes in regulation with regard to production of gas-powered vehicles. This might be the biggest risk to their business.

Understandability: 2/5

  • Justification: While the company produces fairly simple vehicles, the way its supply chain and financials are organized and reported makes it difficult to understand and calculate any value.
  • The multiple business lines and varying levels of disclosures also add to the complexity.

Balance Sheet Health: 3 / 5

  • Justification:
    • They have high levels of debt in their balance sheet and have not been able to generate enough cash flow, though they have shown some ability to generate operating profit.
    • However, their liquidity position should improve in the coming years as they normalize their inventory levels.

Recent Concerns, Controversies, and Management Response

The latest earnings calls have mentioned increasing worries about inventory management and rising costs.

  • Management has explicitly stated that the company is making an effort to cut back on high inventory levels. They are expecting inventories to reduce by the end of 2023, which means more free cash flow for the company.
  • In early 2023, the company had to suspend production for a while and has also seen some effects from raw material inflation. These factors are still influencing the results of the company, though they have been managing it well.
  • However, the company is trying to maintain a strong relationship with dealers. They are also pushing ahead with innovative and competitive products to increase market share.

Overall, Polaris is a decent company with a narrow moat, but they need to improve their cash flow profile and keep an eye on rising costs and competition. The company also needs to reduce inventory. There are also many risks to the business, like changing regulation that might force them to spend more on research and development, and the cyclical nature of consumer demand that can cause large fluctuations in income. The company has a medium-sized understandable, and an ok balance sheet. If they can increase their ROIC, especially in their main segments, and continue innovating, then the company can potentially become a good long-term investment, provided that they are bought at reasonable prices.