Mar 5th, 2017

Thesis: Polaris (PII) is a top-notch off-road vehicle (ORV) maker in North America. It has a history of superb value creation for its owners, led by a high-value Brand-based intangible moat and scale led EOS cost advantage moat. The ORV market, however, is saturated and possibly in decline – giving Polaris medium to poor reinvestment possibilities. Future growth will likely rely on accretive acquisitions (US-based and international) in related industries. Polaris shows signs of at least four years of outsized growth and a wide spread between ROIC and WACC. Lastly, the 2016 recall debacle has led the market to overreact and offer an attractive price and margin-of-safety. We recommend a BUY.

What does it do?: Polaris designs and manufactures off-road vehicles (ORVs), including all-terrain vehicles and side-by-side vehicles for recreational and utility purposes, snowmobiles, small vehicles, and on-road vehicles, including motorcycles and low-emission vehicles, along with the related replacement parts, garments, and accessories. (See Appendix A for details)

Any Economic Value Creation?: $1 of equity invested into Polaris in 2011 would now be worth $3.2 – a CAGR of 26%. This outcome is highly impressive considering the relative performance of two of PII’s peers: HOG: $1.5 (or 8.5% CAGR), ACAT: $1.2 (or 3.1% CAGR).

Per-share value creation is calculated by taking the growth in BV/sh plus the per-share dividends issued during 2011-2016. Polaris’ BV/sh grew from $7.3 to $13.8 (buybacks are accounted for in share count reduction), and another $9.4/sh was returned as dividends.

(See Appendix B for details on profitability)

Does it stand out?: PII’s value-creating capacity stems from a profitable business – where in five years revenue has grown by 80%, with an average EBIT margin 15%, a Capital Velocity more than 5 times, powering an ROIC averaging 50% on an InvestedCapital/sh that has increased four-fold. Most of PII’s competitors, even those with formidable size and financial strength, hardly compare in terms of performance. Still, PII will be hard-pressed to defend its fat ROICs – because even underperforming competitors have the ability to steal customers and price undercut. (See Appendix C for details on comps and moats)

What does the future have in store?: Polaris will face another tough year in 2017 related to recall and temporarily tarnished brand-perception. Starting 2018, the Company will continue its previous strategy of growth driven by bolt-on acquisitions, extensive R&D and innovative products – albeit at a slower pace and with thinner margins. We think this type of outsized growth will last at least until 2021 – at which point this investment would deserve a revisit. (See Appendix D for details)

Price Implied Expectations (PIE): The idea behind PIE is to start with the current stock price and use the discounted cash-flow model to ‘read’ what the market implies about a company’s future performance. In PII’s case, the implied expectations seem too pessimistic – indicating a favorable opportunity. (See Appendix E for details on what $85.5 implies about the market’s expectations)

Valuation (IV Range): Base-Case: $112, Best-Case: $128. (See Appendix F for details)

Total Return to Shareholder: Base-Case: 21% CAGR, Best-Case: 23% CAGR. (See Appendix G for details)

Appendices here: https://www.dropbox.com/s/v6ngspldeozr8sb/2%20PII%20Appendices.pdf?dl=0