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Which Recreational Vehicle Maker is Best Positioned to Win a Stock Price Race?

BA is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Last week's stock market was akin to a Demolition Derby, full of big name revenue and/or earnings misses, including IBM, McDonald’s, and -- in its early release fiasco -- Google. However, a seemingly unlikely company left revenue and earnings estimates in the dust, and saw its stock price cruising in the green while most of the market was wrecked on the sidelines  Polaris Industries (NYSE: PII)

I say "seemingly unlikely" because Polaris is classified as a “recreational vehicle manufacturer,” and you'd not think pricey "toys" would be selling well in this still rather fragile economy, right? It turns out Polaris is a great example of how investors can profit from misconceptions.

Diversified Product Lines & Uncle Sam Smooth Economic Bumps 

Polaris, based in Minnesota, started out as a snowmobile manufacturer. It expanded into all-terrain vehicles (ATVs) and motorcycles (Victory is its best-selling brand) in the 80s and 90s, respectively. It expanded into electric vehicles when it bought GEM (Global Electric Motorcars) from Chrysler in July 2011. GEM makes low-speed compact electric vehicles (EVs). 

While the company is classified as a “recreational vehicle manufacturer,” its vehicles are used for transportation and utility purposes, too. It sells to consumers; commercial, industrial and institutional entities; and the government and military. So, while some products are pricey toys for the consumer market, others help companies increase productivity. And yet others enable our troops to travel over rough terrain in the many countries where we have a military presence.

And the "pricey toys" for consumers conception is not entirely rooted in fact. Sure, for NYC-based analysts and most of us in the U.S., snowmobiles could be considered a luxury product we'd be lucky to zoom around on several times a year. However, for those living in some areas of North America -- many areas of Canada and northern regions of the U.S. -- where it snows up to eight months a year, snowmobiles are for more than just play. The same is true for those living in Scandinavia and Russia, two regions where the company has experienced considerable increases in snowmobile sales.   

The company's primary market is North America, though international sales comprised 11.5% of the third quarter's revenue. Sales in Europe have languished due to the tough economic climate, but the company has done well recently in the Asia-Pacific and Latin American regions. 

Here's the latest revenue breakdown by product category. The off-road vehicle category includes ATVs and side-by-side vehicles. The bulk of government and military sales falls within this category; however, the company doesn't seem to break them down. On-road vehicles include motorcycles and EVs.  


<img src="/media/images/user_13269/pii_large.jpg" />

Chart by B. McKenna, data from Polaris' 3Q earnings release 

Hey Google! Put "Earnings Blowout" in Your Search Engine

While Google jumped the gun and its engine sputtered, Polaris' profit engine was on full throttle. Polaris reported 3Q results on Oct. 18. Its revenue of $879.9 million topped the average analysts' estimate of $832.2 million. EPS of $1.37 handily beat the $1.20 estimate. 

Highlights from earnings release:

  • Net income increased 39% with sales escalating 21%, setting third quarter sales and earnings records.
  • All product lines experienced double digit percentage sales increases.
  • Gross profit margins expanded 120 basis points to 29.5%.  
  • Raising guidance for full year 2012 earnings to a range of $4.32 to $4.37 per diluted share, up 35% to 37% over 2011 based on expected full year 2012 sales growth of 19% to 20%. 

Good quarterly results are important, but the rubber meets the road -- pun intended -- over the longer term. We'll look at longer term metrics below.

The Competitive Landscape

Polaris competes in snowmobiles and off-road vehicles with Arctic Cat (NASDAQ: ACAT) and Honda Motor. In motorcycles, the mighty Harley-Davidson (NYSE: HOG) is its main competitor. 

Honda is primarily an auto manufacturer, so we'll leave it out of the comparisons. 

<table> <tbody> <tr> <td> <table> <tbody> <tr><th> </th><th><span><span>PII</span></span></th><th><span><span>ACAT</span></span></th><th>HOG</th></tr> <tr> <td>Market Cap</td> <td>6.1B</td> <td>554M</td> <td><span>10</span>B</td> </tr> <tr> <td><span><span>Qtrly</span> Rev Growth (<span>yoy</span>)</span></td> <td>21%</td> <td><strong>49%</strong></td> <td>14.9%</td> </tr> <tr> <td><span><span>Qtrly</span> E</span><span><span>arnings</span></span><span> Growth (<span>yoy</span>)</span></td> <td><strong>39.5%</strong></td> <td>N/A</td> <td>29.7%</td> </tr> <tr> <td><span>Profit Margin (<span>ttm</span>)</span></td> <td>9.2%</td> <td>5.5%</td> <td><strong>12.3%</strong></td> </tr> <tr> <td><span>P/E (<span>ttm</span>)</span></td> <td>21.7</td> <td>20.1</td> <td>14.4</td> </tr> <tr> <td>PEG (5 yr expected)</td> <td>1.24</td> <td><strong>0.93</strong></td> <td>1.08</td> </tr> <tr> <td>% Held by Insiders</td> <td><strong>6.6%</strong></td> <td>2.1%</td> <td>0.4%</td> </tr> <tr> <td>Dividend Yield</td> <td><strong>1.7%</strong></td> <td>N/A</td> <td>1.4%</td> </tr> <tr> <td>Beta</td> <td><strong>1.3</strong></td> <td>2.8</td> <td>1.7</td> </tr> </tbody> </table> </td> </tr> </tbody> </table>

Source: Yahoo! FinancePII data through 3Q, others through 2

Polaris' Stock Price on Mountainous Climb

All three stocks were negatively impacted by the recession, but Polaris much less so. Harley's stock price fell off a cliff starting in about late 2006, considerably before the recession officially started in 2008. Unlike Polaris and Arctic Cat, it has yet to reach its previous peak.

Polaris has risen so steeply over the past few years and Arctic Cat over the past year, one has to wonder if these increases are sustainable? Based upon the PEG valuations in the previous chart, ACAT is slightly undervalued, while PII and HOG are slightly overvalued. However, that doesn't take into account other factors. Additionally, PEGs are based upon estimates, and PII routinely beats estimates. Thus, PII's true PEG is likely less than stated. 

<img src="http://media.ycharts.com/charts/32a33e5543c92575e3b8b3a6877ef0d8.png" />

PII data by YCharts

Polaris' Revenue Ramp-Up Worthy of Evil Knievel

Polaris' 10-year revenue growth has been great, Harley's has been fair, and Arctic Cat's is still frozen in the tundra. One-year growth figures are all good to great, and are included in the previous chart. Of course, all that's in the rear-view mirror now, and it's important to look ahead, too. 

<img src="http://media.ycharts.com/charts/8cd049a3a0a94d1ee0dbc1e2f6b49686.png" />

PII Revenue TTM data by YCharts

Earnings Growth Outpacing Revenue Growth

All three companies' earnings growth has outpaced their respective revenue growth over the past 10 years. This is a positive -- margins have expanded.  

<img src="http://media.ycharts.com/charts/7adebbce3ddb1f8022f9b52ae662c56d.png" />

PII EPS Diluted TTM data by YCharts

Earnings-Smearnings, Show Us Your Cash Flows!

Foolish investors know to always check cash flows -- both cash flows from operations and free cash flows (FCF). It doesn't matter what earnings show, negative operational cash flows mean a company is not profitable. While I did check actual cash flows, the graph below shows changes in TTM cash flows. Polaris is the standout. 

<img src="http://media.ycharts.com/charts/10f4d9d1782dbc51438b894e476fc379.png" />

PII Cash from Operations TTM data by YCharts

Polaris' FCF has always been positive over the past 10 years and has steadily been increasingly over the past couple years. 

Harley's FCF looks like the path of a lunatic weaving across multiple lanes. It included a dip into significant negative territory around 2009 and has been decreasing over the past couple years. Decreasing FCF is not necessarily a bad sign, as a company could be using its cash for expansion and other investment purposes. It just points to the need for additional research. Arctic Cat's FCF has been quite steady, but has dipped slightly into the red. 

<img src="http://media.ycharts.com/charts/af4a48118a3bef4f19e0ef33d4196923.png" />

PII Free Cash Flow TTM data by YCharts

Winners in these Metric Heats Positioned to Win Stock Price Race 

Polaris and Harley both have solid profit margins, at almost 11% and just over 14%, respectively, for their most recently reported quarters. Arctic Cat's 1.8% most recent quarterly margin is anemic. 

As for Return-on-Equity (ROE), Polaris' almost 52% is a turbocharged figure. Polaris has a low debt-to-equity ratio, so the ROE is not inflated due to a high debt load. Harley's 26% ROE appears quite good, however it is largely inflated due to Harley's high debt level (1.99X equity). Arctic Cat's 21% ROE is also quite solid, especially considering the company has a low debt load. 


<img src="http://media.ycharts.com/charts/e97865400d2aa9c232d1e2062fbad1c8.png" />

PII Profit Margin Quarterly data by YCharts

The Finish Line…and Bottom Line

Polaris Industries has many positives -- strong revenue and earnings growth, increasing cash flows, expanding profit margins, low debt, great ROE, reasonable stock price valuation -- so investors may want to research it further. Arctic Cat is a considerably smaller company, so it has more room for growth on a percentage basis. However, given its stock's very high beta and its erratic profitability and other metrics, Polaris looks like the better bet for most investors at this point. Additionally, Polaris has 6.6% insider-ownership vs. Arctic Cat's 2.1%, despite Polaris having a market cap 12 times as large as Arctic Cat's. And Arctic Cat insiders sold 49% of their stock holdings within the last six months compared to only 6% by Polaris' insiders. 

Investing in Polaris would not preclude also investing in Harley-Davidson, as their product lines only very partially overlap. Only about 8% of Polaris' revenue comes from on-road vehicles, which include both motorcycles and electric vehicles. Though there would also be some overlap in the parts, garments and accessories category. 

BAMcKenna has no positions in the stocks mentioned above. The Motley Fool owns shares of Arctic Cat. Motley Fool newsletter services recommend Polaris Industries. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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