Arctic Cat Earnings: ATVs Are A Thorn In Its Side

Summary

• Arctic Cat excels at selling snowmobiles.
• Arctic Cat experienced warranty issues with its ATVs.
• Management turnover could serve as a distraction for Arctic Cat.

On Nov. 6, snowmobile and ATV maker Arctic Cat (NASDAQ: NASDAQ:ACAT) came out with its Q2 FY 2015 quarterly statement which provided further detail on its earnings announcement released on Oct. 23. The company had its fair share of problems over the past few months. Let's take a look to see what is going on with them.

Revenue increases

Arctic Cat did see its year-to-date revenue increase 13% vs. the same time last year. Snowmobiles, its core competency, saw sales increase 35%. After all, its name gives you the impression that its products can help you quickly move through snow. Moreover, its parts, garments & accessories segment saw year-to-date sales expand 12% vs. the same time last year. However, its ATV segment saw sales decline 10%.

Nasty factors contributed to net income decline

Arctic Cat saw its year-to-date net income decline 34% vs. the same time last year. Artic Cat has had difficulties with its ATV product line and with management transition. Arctic Cat's ATV troubles extended to the company bottom line. A recall notice issued on Sep. 30 caused a $5.4 million warranty charge. This also probably served as the catalyst for the decline in ATV sales. A severance package for an ousted CEO as well as unspecified legal expenses also contributed to the decline in net income. Management turnover is never a good sign. This means that the company's senior management is preoccupied with leadership transitions instead of focusing on moving products.

Free cash flow declined

Arctic Cat saw its year-to-date free cash flow decline 65% vs. the same time last year. Unfavorable changes in assets and liabilities, deferred income tax expenses and a 12% increase in capital expenditures contributed to the decline.

Dividend sustainability waned

Arctic Cat paid out $3.2 million in dividends so far this year. This equated to 95% of depressed free cash flow vs. 27% the same time last year. I prefer companies with dividend to free cash flow ratios of 50% or less so that they can retain some cash for reinvestment back into the business and to get them through tough times. In all of 2013 Arctic Cat only paid out 25% of its free cash flow in dividends. Hopefully, Arctic Cat will sell plenty of Snowmobiles in the winter months to boost free cash flow and make the dividend more sustainable. Currently, Arctic Cat pays its shareholders $0.50 per share per year and yields 1.5% annually.

Looking forward

Arctic Cat trades at a modest P/E ratio of 15 vs. 19 for the S&P 500, and 14 on a forward basis vs 18 for the S&P 500, meaning this company exhibits low market price risk. Additionally, its earnings yield registers at 7% vs. 5% for the S&P 500. However, I would wait to see how this management transition and its ATV troubles play out. Also, the global economic slowdown is expected to hit Arctic Cat. It lowered guidance due to expected lower sales in Russia. Arctic Cat may face some long-term issues if it can't turn around the consumer perception of its ATVs.

Analyst’s Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.