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TMFPostOfTheDay (< 20)

Polaris Motors On



January 31, 2014 – Comments (0) | RELATED TICKERS: PII

Board: Pencils Palace

Author: TMFPencils

Today Polaris (PII) reported 4Q 2013 results. (Polaris makes just about any motorized vehicle except cars and trucks -- things like ATVs, motorcycles, snowmobiles, and more.) Earnings beat analyst estimates for the quarter, but apparently 4Q revenue and 2014 guidance were lower than what analysts were expecting (boo hoo). Shares were down nearly 7.5% at some points today after the results were reported. I own Polaris indirectly through an account I help manage, and I think this is a business with extensive long-term potential. I might add to my position here, especially if the stock continues to fall a bit.

Year-over-year sales increased 20% in the quarter and 18% overall to $1.12 billion in 2013. Earnings increased 23% year-over-year in the quarter and 22% overall in 2013 to $381.07 million. Margins increased across the board for the quarter and year (10.1% profit margin in 2013 compared to 9.7% in 2012). Operating cash flow for the year increased to $499.15 million from $416.11 million in 2012. Hardly numbers to scoff at; I wish more quarterly "disappointments" looked like this.

My understanding is that this was the first quarter that the new Indian motorcycle models were released, which helped motorcycle sales increase 94% year-over-year in the 4Q for Polaris. I like the approach the company is taking with the iconic Indian brand by lowering prices of the new Indians to better compete with Harley Davidson:

The ambitious rollout by parent Polaris Industries, the $3.2 billion-a-year maker of snowmobiles and all-terrain vehicles, comes after a series of false starts by previous owners in the 60 years since Indian went bankrupt.

One big difference is the price: Polaris repositioned the brand to go head-to-head with Harley by cutting thousands of dollars off the sticker of each of its new models.

The new lineup includes the Indian Chief Classic, starting at $18,999; the Indian Chief Vintage, at $20,999, and the Indian Chieftan, at $22,999. Until now, Indian bikes were priced as high was $37,000 but suffered from marginal quality. They will arrive in dealerships in September.

Polaris management is projecting 14%-18% earnings (EPS) growth in 2014, accompanied by a 11%-14% increase in sales for the year. Analysts are expecting Polaris to increase earnings at 15% annually for the next five years. We can use the Future Value valuation method to gauge where the stock might likely trade in five years based on these projections. As a recap, here is the Future Value method formula:

Current EPS * (Expected Annual EPS Growth ^ # Years) * Expected Future P/E = Estimated Future Stock Price

Using the Future Value valuation technique, here is what Polaris shares would trade at in five years if earnings expand at 15% annually for the next five years and the stock trades at a P/E of 18 in 2019 (these numbers use the company's new TTM EPS of $5.35):

5.35*(1.15^5)*18 = $193.69

An unofficial rule of thumb I have is to look for stocks that could reasonably double over the next five years. In other words, it would be great to plug in "reasonable" projections for annual earnings growth for five years (along with a reasonable future P/E multiple) and see that the stock can become a double over the next five years with that scenario. In the case above with our "reasonable" Polaris projections, the stock would return roughly 8.5% annually -- a likely market-beater over the long run.

Stocks have to return an annual average of roughly 15% to double after five years. Let's see what Polaris looks like with 18% annual earnings growth (the high end of the company's EPS growth guidance for 2014) and a P/E of 20 (Harley Davidson, Polaris' larger and slower-growing competitor, currently trades at a P/E of 20):

5.35*(1.18^5)*20 = $244.79

Now we're talking! This would result in a very close double over a five year period, and almost a guaranteed market outperform. With either of these two projections, Polaris is likely to beat the market. I am impressed by the company's management team (from what I have researched) and expect that the company's continued R&D and product innovation will lead to consistent sales and earnings growth for the foreseeable future.

Let's see what the stock would look like in five years if the company grows earnings at a mere 12% annually and trades at a P/E of 15 in five years:

5.35*(1.12^5)*15 = $141.43

In this scenario, the stock essentially treads water for five years and likely lags the market.

Currently Polaris trades at a P/E of 23.95 with a market cap of $8.87 billion. I am tempted to add at today's levels, and would jump on the opportunity to add more to my position should the stock fall below a P/E of 20 in the relatively near future. I think it is likely for the company to expand earnings at an average annual pace of 15% for the next five years, in which case the stock will very likely beat the market over that time period.

Polaris has an innovative (and expanding) product line, an experienced CEO and management team with proven innovative streaks, and solid earnings growth and overall financial strength. I'm watching closely and may add shares around current levels, but would welcome more irrational behavior from Mr. Market to drive shares down to even more attractive levels.

I encourage anyone interested in Polaris to check out the entire 4Q 2013 earnings report here (it includes a thorough recap of the various segments of the business):

David K 

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