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Polaris' Profits Headed North

The business is stabilizing, although it’s not quite out of the woods yet.

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 Polaris (PII) is one of the longest-operating brands in powersports. We believe that its brands, innovative products, and lean manufacturing yield the firm a wide economic moat and that it stands to capitalize on its research and development, high quality (which has admittedly taken a few steps back in recent periods), operational excellence, and acquisition strategy. However, Polaris’ brands do not benefit from switching costs, which makes it hard to capture incremental share in the off-road segment; peers are innovating faster than in the past, jeopardizing the company’s ability to easily take price, particularly on the heel of recent recalls.

Polaris has sacrificed some near-term financial flexibility by financing most of its recent acquisition of TAP, which could lead to crimped free cash flow gains as operational excellence and lean initiative benefits are offset by higher debt-service costs. The firm’s manufacturing footprint should finally be the right size, with Alabama open and the consolidation of some smaller facilities, yielding distribution savings and improved capacity utilization. We anticipate the resumption of top-line growth in 2017 bolstered by the TAP addition, despite pricing pressures persisting in the off-road vehicle segment. With Polaris plagued by ORV recalls and delayed shipments for model year 2017, we think it will take some time for the firm to rebuild brand goodwill and pricing power in the ORV segment, which will weigh on segment growth potential. We plan to watch market share trends unfold, and we think if share erodes persistently, it could signal that the firm’s competitive edge is deteriorating. For reference, the ORV/snowmobile segment represented 74% of total sales in 2016 (versus 84% in 2014).

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Jaime Katz does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.