Polaris: A Solid Long-Term Value Prospect
- Polaris has demonstrated consistent revenue growth in recent years, even as profitability has been volatile.
- This year, growth continues and the firm looks to be trading at a cheap level.
- Shares of the enterprise look cheap, though they are not deep-value cheap.
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One interesting area for investors to look into right now is the recreational vehicle space. Strong demand and shortage of inventory are causing a rise in revenue that could prove to be a boon for the companies operating in this space. And what better way to play this opportunity than to buy into a company like Polaris (NYSE:PII). Leading up to and even through the COVID-19 pandemic, the business continued to grow on the top line and generated consistent operating cash flow and positive earnings. On a forward basis, shares of the enterprise looked to be trading at pretty attractive levels. Even if this surge in opportunity for the company will be of a short duration, its fundamental condition is appealing enough to still make investors a nice return.
Polaris is a fairly small company but one that caters to a global audience. At present, the company has a market capitalization of just $7.9 billion. However, it sells its products internationally. Admittedly, recent data shows that 78.3% of its revenue is attributable to the US. However, another 7% of sales comes from Canada. 10.6% is attributable to the EMEA (Europe, Middle East, and Africa) regions, and the remaining 4.1% is attributable to the Asia/Pacific and Latin America regions.
According to management, 62.6% of its revenue comes from ORV (Off-Road Vehicles) and snowmobiles. Next in line we have motorcycles, which account for 9.3% of its revenue. It generates 6.9% of its sales from what it calls the global adjacent markets business, which consists of selling ancillary products to its customers. 11.5% of revenue is attributable to aftermarket sales, and the remaining 9.7% involves the sale of boats and related products. So, in all actuality, while the company is concentrated largely on a specific niche, it is simultaneously a diverse operator. It sells all of these products through its network of over 2,300 independent dealers spread throughout North America. It also has 1,400 independent dealers that it works with globally, supplying them through the more than 90 distributors that it has spread throughout no fewer than 120 countries.
*Taken from Polaris
What's really exciting for shareholders is that, from the second quarter of the 2019 fiscal year to the end of the second quarter this year, the dealer inventory in the North American market has plunged by 85% for the ORV category of products. For snowmobiles, inventories are down by 45%. And for motorcycles, they are down by 65%. In the month of June alone, 80% of all retail sales were pre-orders compared to just 3% in the first quarter of 2020. This can all be chalked up to the fact that the COVID-19 pandemic caused companies to reduce their expectations when it came to future sales and caused them to sell off their inventories to generate cash so that they could survive. The just-in-time inventory system that regularly provides flexibility and higher margins for companies came back to bite those same businesses. This is compounded by the fact that an estimated 70% of all customers coming to Polaris are new, compared to the 30% that are return customers. This shows the demand is coming from people who previously never were interested in these kinds of activities before. That serves to only exacerbate the problem.
Over the past few years, the financial performance generated by Polaris has been impressive. Revenue increased from $4.52 billion in 2016 to $7.03 billion in 2020. Despite the COVID-19 pandemic, revenue in 2020 was 3.6% higher than the $6.78 billion the company generated in 2019. Net income, on the other hand, has been more volatile. This can be seen by looking at the graph below, which shows it bouncing around from a low of $124.8 million in 2020 to a high of $335.3 million in 2018. Similarly volatile has been operating cash flow. Between 2016 and 2019, it ranged from a low of $477.1 million to a high of $655.1 million. Then, in 2020, it soared to $1.02 billion.
Where things get interesting is when we start looking at the current fiscal year. In the first half of 2021, revenue came in at $4.07 billion. This compares to just $2.92 billion for the same period last year. The company went from generating a net loss of $240.8 million to generating a gain of $292.5 million over this window of time. You might expect for operating cash flow to improve, but this was not the case. Instead, it dropped from $309.7 million to $195.6 million. To understand why, we should discuss management's expectations for the current fiscal year. At present, management expects revenue to come in at between $8.375 billion and $8.5 billion. That implies a midpoint of about $8.44 billion. This represents an increase of 20.1% compared to what the company generated in 2020. With revenue rising, midpoint expectations call for net profits at the company to come in at around $574.2 million. However, operating cash flow should be around 30% lower than what the company achieved in 2020. This appears to be driven by the fact that management, like so many other companies dealing with the crisis, manipulated their working capital to maximize cash flow when times were uncertain. So now, the shoe is on the other foot. This year, this should result in operating cash flow of around $662.4 million.
When it comes to pricing the business, the process is fairly simple. Using the estimates for 2021, the firm seems to be trading at a forward price to earnings ratio of about 13.8. And the forward price to operating cash flow multiple stands at 12. Some investors may be worried about this demand being a short-lived thing. But if you look at financial performance expected for 2021, at least from a cash flow perspective, it is not materially different than what the company generated in the years 2016 to 2019. So even a return to normalcy would not prove to be a problem for investors in my opinion.
At this point in time, Polaris strikes me as a fundamentally attractive investment prospect. No, the company is not a deep value play. It is unlikely to make investors extraordinarily wealthy. However, shares do look cheap, especially relative to the broader market. Throw in the potential that demand could always come in stronger than anticipated and I don't see why this company wouldn't fit onto a list of top prospects for long-term, value-oriented investors.
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This article was written by
Daniel is an avid and active professional investor. He runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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