Investors with some risk tolerance looking to bulk up their exposure to the consumer discretionary sector may find a few attractive opportunities in the powersports industry. It appears to be a good time to look at some off-the-beaten-track companies whose products are growing in demand due to geographic expansion and rising discretionary spending. These leisure firms make off-road and recreational vehicles -- snowmobiles, all-terrain vehicles (ATVs), utility task vehicles and personal watercraft -- for commercial and consumer markets and offer attractive margins of safety for long-term investors.
While these companies are under duress from weaker demand in key oil-producing regions, these headwinds are temporary, said a Morningstar report, noting that the North American powersports manufacturers are well positioned to maintain share and improve margins given their sustainable competitive advantage, brand equity and brand loyalty that will continue to fuel sales growth.
Last year's statistics further support this positive outlook. Global snowmobile sales were around 150,000 units (up 6% annually over the past five years), side-by-side vehicle sales were approximately 415,000 units (up 12%), and personal watercraft sales were roughly 83,000 units (up 3%), according to Powersports Business, a market data publication for the powersports industry.
The only blip in the positive trend was the all-terrain vehicles (ATVs) segment where sales fell 3%. However, IBISWorld projected ATV manufacturing to pick up and reverse the trend over the next five years as rising disposable income levels stimulate demand for recreational purchases.
Although the industry is not immune from cyclical risk, select businesses exhibit a strong commitment to innovation, recruit the best engineers and enjoy high brand equity, revenue and profit margins -- factors that will help them sustain economic profitability over the next 10 to 20 years or longer, according to Morningstar equity research.
| Arctic Cat Inc. | ||
| Ticker | ACAT | |
| Current yield | 2.31% | |
| Forward P/E | 23.3 | |
| Price | US$16.35 | |
| Fair value | US$26 | |
| Data as of April 15, 2016 | ||
One of the longest-operating powersports manufacturers, 
Arctic Cat (ACAT) designs, engineers, manufactures and markets snowmobiles, all-terrain vehicles, utility vehicles and personal watercraft products. Additionally, it sells related parts, garments and accessories in the United States and Canada through a network of independent dealers, and in Europe, the Middle East and Asia through distributors.
"The firm has robust 2020 goals that include sales of US$1 billion, operating margins that grow more than twentyfold, and gross profit margins that rise more than 1,000 basis points," said Morningstar equity analyst Jaime Katz in a report. "These would represent never-before highs in both the gross and operating margin ratios, above pre-recession levels."
Arctic Cat operates in the concentrated powersports manufacturing space, where it is one of four companies that make snowmobiles and is one of the top four ATV builders that constitute nearly 70% of industry volume.
The company, having grown its global market share from 7% to 11%, has delivered healthy returns on invested capital during periods of economic resilience (38% over the last five years), Katz noted. She pegs the stock's fair value at US$26 and projects gross profit margins of 22% and EBIT (earnings before interest and taxes) margins of 8% by 2020. Katz expects the firm's snowmobile sales to grow around 2% and ATVs to grow at a mid-single-digit rate long term.
"With higher cash flow, the firm could re-initiate its dividend and pursue share repurchases, if acquisition opportunities don't present themselves," she added. "Arctic Cat has historically generated return on invested capital (ROIC) above our weighted average cost of capital assumption (11%) and should be able to achieve ROICs of more than 15% by fiscal 2020."
| BRP Inc. | ||
| Ticker | DOO | |
| Current yield | - | |
| Forward P/E | 9.5 | |
| Price | $19.83 | |
| Fair value | $28 | |
| Data as of April 15, 2016 | ||
Best known for its Ski-Doo, Sea-Doo and Can-Am brands, BRP Inc. (DOO) designs, develops, manufactures, distributes and markets snowmobiles, all-terrain vehicles and personal watercraft. The company, which also makes engines, parts, accessories and clothing, markets its products across 107 countries worldwide.
"BRP has healthy 2020 goals that include a 10% sales compound annual growth rate (generating $6 billion) and earnings per share growth of 15% annually, as gross margins improve and selling, general, and administrative expenses leverage on higher volume," Katz said in a Morningstar report.
BRP is the industry leader in snowmobiles (owning 46% of the units sold), a clear indication of its brand equity and consumer loyalty, which allow the firm to charge competitive prices, said Katz, who appraised the stock's worth at $28, implying a 4% revenue growth and about 13% earnings per share (EPS) growth for the next five years.
With a 50% market share, BRP is also the clear leader in the market for personal watercraft, which provides 36% of its total revenue.
"BRP has [been] delivering healthy returns on invested capital that have averaged 33% during the past five years," Katz said, forecasting these returns to remain around 25% during the next five years as watercraft and ATV production begins in Mexico.
She also projected the firm's gross margin to improve over the next five years, boosted by "lower spending on start-up and transition costs as Mexico ramps up to speed," resulting in additional capacity, rising shipment, and lower material, freight and labour costs.
| Polaris Industries Inc. | ||
| Ticker | PII | |
| Current yield | 2.24% | |
| Forward P/E | 13.1 | |
| Price | US$95.30 | |
| Fair value | US$119 | |
| Data as of April 15, 2016 | ||
One of the most respected and innovative brands in powersports, Polaris Industries (PII) designs and manufactures off-road vehicles, including all-terrain vehicles and side-by-side vehicles for recreational and utility use. The company also makes snowmobiles, small vehicles and on-road vehicles, including motorcycles and low-emission vehicles, as well as related replacement parts, garments and accessories, which it sells across North America and in more than 100 countries outside the continent.
"Polaris has a strong reputation for innovation, and new product lines along with acquisitions have supported its strong performance in both strong and difficult [economic] environments," Katz said in a Morningstar report. She notes that the company "enjoys financial flexibility, owing to the free cash flow generation from its operational excellence and lean initiatives."
Polaris' near-term operating potential faces temporary headwinds due to lower demand in key oil-producing regions, which represent sizable markets for off-road vehicles and snowmobiles. In the long term, however, the firm's operating margins are forecasted by Morningstar to climb to 16%, up 270 basis points from the current estimate.
"We see opportunities for growth outside the off-road segment, in motorcycles and global adjacent markets," said Katz, who assigns a fair value of US$119 to the stock. "International expansion remains promising and could drive revenue upside, particularly as Polaris increases its operating presence internationally with a wider physical presence and recent partnerships with peers in India and China."
The firm's sales trends, she added, are impressive, with average annual revenue growth north of 20% over the past five years, exceeding other discretionary industries.
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