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By Jaime M. Katz, CFA | 02-18-2016 10:00 AM

An Off-the-Beaten-Path Wide-Moat Idea

Temporary headwinds aside, Polaris is a standout among powersports companies, says Morningstar's Jaime Katz.

Securities mentioned in this video
PII Polaris Industries Inc

Jaime Katz: We believe the powersports companies on our coverage list, including Polaris (PII), Arctic Cat (ACAT), and BRP offer attractive margins of safety for long-term investors. Over the past 18 months, these companies have been under duress, owing to missteps in inventory management by certain participants and the uncontrollable effects of foreign-exchange headwinds. We view the newest risk factor, weak demand in key oil-producing regions, as a medium-term risk that could increase volatility materially for these businesses over the next one to three years in tandem with the recovery of futures prices. In our opinion, these temporary headwinds will eventually dissipate, and the North American players will be solidly positioned to at least maintain market share and improve current operating-margin levels.

Our long-term outlook still anticipates industry growth, but we forecast unit sales for traditional powersports business lines will rise more than 2% on average over the next five years with total dollar sales growing slightly higher as some price is taken--slower than the mid-single-digit pace they had grown over the prior five years. We believe there is an economic basis supporting this discretionary spend, with the wealth effect increasing consumers' willingness to purchase these high-ticket items. The U.S. consumer is still riding on rising housing prices, still-higher-than-previous equity prices in the broad stock market, and unemployment at healthy levels.

Polaris is the name that remains on our Best Ideas list, currently trading at around a 27% discount to our fair value estimate. While the argument exists that Polaris' brand equity in its off-road segment may be degrading and that its wide moat rating could be at risk, we believe that the company is improving brand equity in other categories that are more stable than in the past, including motorcycles and global adjacent markets. Our outlook includes off-road and snowmobile sales that remain depressed through 2016 and then tick up to a low-single-digit rate over the remainder of our explicit forecast, supported by modest volume growth and price increases over time.

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