Three leisure vehicle companies making an ascent

Rising disposable income in much of the world has created a favourable environment for the consumer cyclical sector. The trend has paved the way for long-term growth for the recreational vehicles industry in particular. The sunny outlook for the industry suggests this may be an opportune time for buy-and-hold investors to venture off the beaten track and look at some attractive opportunities in the powersport industry.

Companies operating in the arena of powersport and other recreational vehicles manufacture snowmobiles, all-terrain vehicles (ATVs), high-end motorcycles, and personal watercraft. These products are becoming increasingly popular for their aspirational value and as symbols of adventure coveted by thrill seekers.

U.S. ATV manufacturing has grown by 3.3% to rack up US$6 billion in revenue in 2018, according to an IBS World Report. The study forecasts ATV industry revenue to grow at a steady clip over the next five years, which it attributes to improving economic conditions and discretionary spending resulting from rising disposable income levels. In a similar trend, global snowmobiles market clocked 5.2% growth to swing back to growth trajectory, according to the International Snowmobile Manufacturers Association.

While operating in a cyclical industry prone to periodic risks, the following leading industry players remain profitable and have the wherewithal to withstand economic turbulence. Innovative products, the best industry talent, strong brand equity, and favourable economic conditions position them well on a long growth runway, according to Morningstar equity research.

The Milwaukee-based maker of iconic motorcycles, Harley-Davidson (HOG) is the world’s leading manufacturer of custom, cruiser, and touring motorcycles and associated merchandise and riding gear. The company’s financial services division provides wholesale financing to dealers and retail financing and insurance brokerage services to customers.

“With a long history of manufacturing experience, Harley-Davidson has brand strength and a dealer network that give the company a wide economic moat and dominant position in the U.S. motorcycle market,” says a Morningstar equity report, noting that more than 115 years old brand resonates globally with a wide consumer base, “particularly its core market (men over 35).”

Strong brand loyalty and the breadth of its distribution channel underpin Harley's sustainable competitive advantage and have helped it gain 50% share of the domestic heavyweight motorcycle market. “The robust dealer network allows the company to have a broad reach with its products, [making its] distribution channel difficult and expensive to replicate,” says Morningstar equity analyst, Jaime Katz, adding that the motorcycle maker’s “record for product innovation and reliability over a long time frame is difficult to copy.”

She cautions, though, that Harley premium price tag has proved problematic during cyclical downturns and periods of competitive pricing. Katz puts the stock’s fair value at US$44. More lightweight products are planned for 2020.

Further, international sales could “offer some upside as Harley puts effort into its outreach programs to penetrate new audiences and offers up new lower-displacement bikes that are likely to be at compelling price points,” notes Katz.

BRP Inc (DOO) designs, manufactures, and markets snowmobiles, all-terrain vehicles (ATVs), and personal watercraft. The company owns popular brands such as Ski-Doo, Sea-Doo and Can-Am, and sells its products through 3,600 independent dealers and 185 distributors across more than 100 countries.

BRP is the industry leader in both snowmobiles and personal watercraft and enjoys loyal consumer base which allows it to charge competitive prices. “[The firm’s] brand equity and awareness could prove difficult for competitors or new entrants to replicate,” says a Morningstar report, noting that the powersport company’s strong relationships with dealers would be hard for new entrants to capture.

The firm operates in the concentrated powersports manufacturing space where a handful of players account for more than 90% of the market. BRP also remains the leader in a concentrated and slow-growing snowmobile industry, owning just under half of all units sold. “Snowmobiles are included with personal watercraft in the seasonal product segment, which represents 35% of BRP’s 2017 revenue base,” says Katz, who recently nudged the stock’s fair value from $50 to $51, and projected total sales growth of around 7% and double-digit EPS growth (about 18%) over the next five years.

Polaris Industries Inc (PII) designs and makes off-road vehicles, including ATVs and side-by-side vehicles (SBS) for recreational and utility purposes. The firm also manufactures snowmobiles, small vehicles, along with replacement parts and garments, which it sells in North America and internationally. The firm recently moved into the boat market with the acquisition on Boat Holdings, gaining exposure to the outdoor lifestyle market.

“Polaris is one of the longest-operating brands in powersports,” says Morningstar equity report, noting that its brands, innovative products, and lean manufacturing create a wide economic moat and that the company “stands to capitalize on its research and development, improving quality, operational excellence, and acquisition strategy.”

The firm has been delivering healthy adjusted returns on invested capital, averaging 35% over the past three years, well above the 8.3% average cost of capital.

Innovative products, organic growth and strategic acquisitions have positioned the business to continue to capture increasing volume and profits. “We anticipate the resumption of consistent low-single-digit top-line organic growth in 2020 and beyond, as opportunities in the after part and global adjacent markets are capitalized on, offsetting secularly slower growth in the leisure businesses (particularly, off-road vehicles, snow, and motorcycles),” says Katz, who pegs the stock’s fair values at US$105.

As Polaris increases its global footprint, through physical presence and partnerships, its international revenue could provide further upside, she adds.