marekuliasz\/iStock Editorial via Getty Images<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Polaris Inc. (PII<\/a>) is a dividend aristocrat that is currently trading at the midpoint of their 52-week range. The company is a well-known brand that is popular among those attracted to outdoor recreation. As consumers continue to gravitate towards more adventure-oriented lifestyles, the addressable market of Polaris will continue to expand. The company is investing in growth but has a long history of returning excess cash to shareholders. For income-focused investors who seek growth at moderate risk, shares of Polaris present an upside opportunity of approximately 20%.<\/p>\n Polaris Inc. designs, engineers, and manufactures various powersports vehicles. In years prior to 2022, they operated in six business segments: Off-Road Vehicles (ORV), Snowmobiles, Motorcycles, Global Adjacent Markets, Aftermarket, and Boats. January 1, 2022, the company revised the presentation of their reporting segments and now expects a more simplified reporting structure that includes only four segments: Off-Road, On-Road, Marine, and Aftermarkets.<\/p>\n As seen in the breakout below from the annual 10-K filing<\/a>, approximately 60% of total sales is derived from the ORV\/Snowmobiles segment.<\/p>\n Sales Breakout – Form 10-K<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Though the ORV\/Snowmobiles segment is the largest driver of sales, it’s not their most profitable unit. On this segment, the company’s margin was 24% in 2021, which was lower than in prior years due to issues and constraints pertaining to the overall macroeconomic operating environment. This is in contrast to their Global Adjacent Markets segment, which supports various commercial work applications and whose margins are consistent and on the higher end when compared to other segments.<\/p>\n Gross Profit Breakout – Form 10-K<\/p>\n<\/figcaption><\/figure>\n<\/p>\n The company’s product offerings in each segment are sold online and through dealers, distributors, and retail stores. From a geographical perspective, sales are principally in the United States, with 80% generated in this region. Other regions that are included in the addressable markets are Canada, Western Europe, Australia, and Mexico.<\/p>\n Geographical Breakout – Form 10-K<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Polaris is the #1 powersports market share leader<\/a>. Despite this, the industry in which they operate is highly competitive. Other notable companies with all or a portion of their sales attributable to powersports include BRP, Inc., Yamaha, Honda, and Brunswick Corporation. Aside from Honda, which is the most diversified company among the group, most peers included in the table below from Seeking Alpha<\/a> trade at similar market caps. Honda is included in the group because they do offer a product line of ATVs and other side-by-sides that compete directly with the offerings from Polaris.<\/p>\n Seeking Alpha<\/p>\n<\/figcaption><\/figure>\n<\/p>\n On market performance, Polaris is outperforming both BRP, Inc and Yamaha. Over the past nine months, however, Polaris is down 7% and down 5% over the past six.<\/p>\n Seeking Alpha<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Polaris currently trades at a forward earnings multiple of 12x and has an EV\/EBITDA multiple of 9x. The company appears richly valued compared to their peers, but the multiples are lower than their own historical averages of 16x and 14x, respectively, and of the broader market in general.<\/p>\n Seeking Alpha<\/p>\n<\/figcaption><\/figure>\n<\/p>\n One notable figure is the short interest of nearly 10%, which is quite high. As a well-known name in the powersports industry with ambitious growth plans, the expectation of outperformance is elevated. The company, however, is exposed to downside risk relating to bottlenecks in the supply chain and factors associated with the general macroeconomic environment. Since their product lines are big-ticket discretionary items, they will be the first cut from household budgets in the event of a downturn in the economy.<\/p>\n Seeking Alpha<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Polaris was founded in 1954, and over time they have developed into a global leader in powersports. They benefit from brand awareness across all age groups and ethnicities. Additionally, they are ranked as having the best customer experience<\/a> with a strong internal culture with team members that are committed to the vision of the company<\/a>. From a management standpoint, their executive team has largely been promoted from within and have many years of experience navigating various economic operating environments. Furthermore, among its peers that were compared earlier, Polaris is the only dividend aristocrat. This commitment to returning cash to shareholders is an advantage in attracting income-focused investors that desire a stable flow of cash.<\/p>\n 2022 Investor Presentation<\/p>\n<\/figcaption><\/figure>\n<\/p>\n As an adventure lifestyle company, Polaris benefits from the growing interest in outdoor recreation. Beginning in 2020, Americans gravitated to the outdoors in record numbers as an escape hatch from COVID-19. During 2020, half of Americans six and over participated in outdoor recreation at least once, which was the highest participation rate on record.<\/a> Furthermore, at the Outdoor Recreation Roundtable meeting, promising figures<\/a> were provided with regards to the growing interest in outdoor activities. As it relates to Polaris, industry-wide sales of off-road motorcycles were up more than 46 percent compared to 2019 levels. Even more, sales of ATVs were up over 30% from prior year levels.<\/p>\n Another activity indirectly related to sales growth in ORVs is hunting. Traversing through the forest in search of the prime hunting location is easier on an ORV than on foot. Moreover, ORVs facilitate the transport of equipment and the harvested animal. In 2020 and 2021, there were a record amount of new hunters<\/a>. In Michigan, the state saw a 67% increase in new hunting licenses compared with 2019 and a 15% increase in female hunters. As seen in the chart below, hunters represent a significant growth prospect for the company.<\/p>\n 2022 Investor Presentation<\/p>\n<\/figcaption><\/figure>\n<\/p>\n In addition, some of the most well-known national parks had record visitation in 2021.<\/a> Visitation at the parks was up over 60 million from 2020 levels. In addition, six parks broke the visitation record that they had just set in 2020. This matters because near many of these parks are large areas of land that are permitted for ATV use. Visits to these areas will provide increased visibility to Polaris’ product lines as individuals explore the various things to do<\/a> and places to go section of the parks’ webpage.<\/p>\n To transport the ATVs, boats, and snowmobiles offered by Polaris, consumers will need either an SUV or truck. Recent trends<\/a> are working in the company’s favor. As demand for sedans<\/a> wane, automakers are shifting their lineups to more rugged SUV’s and trucks with more towing power and with more features that are compatible with the adventure minded consumer.<\/p>\n As a leisure product, the financial health of the consumer is critical. As a result of the pandemic, to the surprise of many, the strength of most consumers became stronger<\/a> not weaker. This was due to an unprecedented amount of fiscal and monetary stimulus that resulted in increased savings, rising home values, and significant investment portfolio gains. Even with reduced stimulus, the consumer still continues to spend<\/a> on durable goods.<\/p>\n Other macroeconomic trends that are favorable to the company include millennial spending habits, which tend to focus on experiences and on brands that appeal to their values. In addition, access to recreational opportunities continues to expand as more residents relocate from urban to rural<\/a> areas. Finally, the increasing focus on sustainability and electric vehicles works to the company’s favor as it continues to diversify its product lines.<\/p>\n Polaris finished 2021 with record<\/a> sales and earnings, despite working through challenging supply chain related operating constraints for the majority of the year. Sales increased 17% from 2020, and adjusted net income came in at a record $9.13 per diluted share, which surpassed expectations. In addition, the company returned over +$600M to shareholders in the form of dividends and share repurchases. Furthermore, their Parts, Garments, and Accessories (PG&A) segment surpassed +$1.5B in sales for the first time and represented over 20% growth from 2020. Moreover, the size of this segment has now doubled from levels over the last five years. From an international standpoint, their business experienced growth of 34% and exceeded +$1B in sales.<\/p>\n The company continues to capture market share and continues to add new vehicles and accessories to their product offerings. In 2021, the company introduced over thirty new vehicles and over five hundred new accessories. Additionally, they expanded their customer base 16% from the prior year.<\/p>\n Despite strong sales as a result of favorable pricing, Polaris was negatively impacted by the global operating conditions. For the three months ended December 31, for example, Polaris suffered a large decrease in gross profit due to higher input costs, as well significant costs related to supply chain constraints.<\/p>\n Earnings Release<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Another setback for the quarter was dealer inventory levels. Levels ended the quarter down 30% year-over-year and 70% compared to the fourth quarter of 2019. As seen below, this affected sales in their most critical segment, ORV\/Snowmobiles. The declines were offset, however, by strong performance in their commercial and boat segments.<\/p>\n Earnings Release<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Looking ahead to 2022, the company expects<\/a> dealer inventory levels to remain depressed for the entire year, with improvements occurring in the back half of the year. Margins are also expected to remain pressured throughout the year. Despite this, total sales are expected to increase 12-15% on strong demand and favorable selling prices. Additionally, adjusted EPS is expected to be up 11-14% and total operating expenses are also expected to improve as a percentage of sales.<\/p>\n On a longer-term basis, the outlook for Polaris is ambitious. They are expecting mid-single digit CAGR sales growth through the year 2026 and an adjusted EBITDA in the mid to high teens. Moreover, they are expecting double digit adjusted EPS growth, driven by strong sales, a reduction in shares, and consistent tax rates. The company is expected to invest heavily in organic growth through higher CAPEX and capacity expansion. At the same time, they expect to continue maintaining a strong balance sheet, while also giving priority to returning excess cash to shareholders.<\/p>\n Author’s Metric<\/p>\n<\/figcaption><\/figure>\n<\/p>\n In the period ended December 31, 2021, Polaris reported +$2.6B in total current assets and +$2.2B in total current liabilities. As seen in the snapshot below, inventory is the largest component of total current assets. In the current year, it accounted for nearly 65% of the total versus 53% in 2020. The increase was due to purchases in response to rising customer demand. In addition, it’s important to note that the company reports inventory using the FIFO method. In periods of rising prices, such as in 2021, the FIFO<\/a> method results in a larger ending inventory balance and a lower cost of goods sold. Since inventory is reported at cost on the balance sheet, the increase can thus be partially attributable to the valuation methodology.<\/p>\n Balance Sheet – Form 10-K<\/p>\n<\/figcaption><\/figure>\n Balance Sheet – Form 10-K<\/p>\n<\/figcaption><\/figure>\n<\/p>\n The ratios in the chart below provide a more extensive look into the liquidity position of the company. The ratios are generally consistent from year to year. However, in 2021, operating cash flow was negatively impacted due to the large acquisition of inventory during the year. Furthermore, the company held more revenues in cash and paid their suppliers slightly longer than normal. This could be partially attributable to delivery delays stemming from supply chain constraints. From a business perspective, the company would be best suited to hold payment until delivery. The large increase in the number of days payables remained outstanding from 2019 to 2020 is in-line with expectations, given that is when supply disruption began.<\/p>\n The quick ratio is well under 1.00, and that is expected given that over 50% of total assets is attributable to inventory. Because of this, it’s critical that Polaris can quickly turn over their inventory so that they are not left bearing the costs of unsold goods, which include storage, insurance, and overhead. In addition, they should not be having any collection problems on their AR. Upon examining the results below, there does not appear to be any major issues.<\/p>\n On another note, one can see that the current ratio is hovering right around 1.15. This ratio measures the company’s ability to meet its total current liabilities with their total current assets. Since inventory, which is the largest component of this ratio, is reported at cost, it’s helpful to determine the excess cash the company expects to receive upon sale of the inventory. For example, Polaris has a COGS\/Sales ratio of approximately 0.76. Thus, the company’s inventories have a selling price of 1.3 times the amount reported on the balance sheet. This provides further support and confirmation to the strength of their current liquidity position.<\/p>\n Author’s Calculations<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Since inventory is major component of operations, it’s critical to ensure that the company is not experiencing rising obsolescence. The summary below does indicate a rise from 2019, but the totals do not appear to be material. Moving forward, it’s important to continue monitoring the totals reported each period.<\/p>\n Inventory Reserve – Form 10-K<\/p>\n<\/figcaption><\/figure>\n<\/p>\n The table below provides insight as to the number of days of other financing required after accounting for the number of days to collection and sale, and the number of days to pay suppliers. The figures are consistent from year to year. At present, there are no concerns.<\/p>\n Author’s Calculations<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Overall, Polaris has adequate liquidity to meet their current obligations. There are no apparent issues in collecting on their AR, and the company has a reasonable amount of cash on hand. Inventory balances are high, but demand is expected to be strong. Liquidity will be negatively affected, however, by any downturn in economic conditions or further disruption in their operations.<\/p>\n Author’s Metric<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Polaris reported net debt\/EBITDA of 1.5x in 2021, which is lower than 2018 and 2019 but higher than 2020. Nevertheless, the low ratio indicates a sufficient ability to cover their debt obligations.<\/p>\n 2022 Investor Presentation<\/p>\n<\/figcaption><\/figure>\n<\/p>\n In addition, the company reported +$1.8B in debt due in one year or more. Of this total, more than 70% is due after 2025. Therefore, there are no concerns with regards to repayment risk.<\/p>\n Debt Maturities – Form 10-K<\/p>\n<\/figcaption><\/figure>\n<\/p>\n The chart below summarizes the various solvency ratios over the past five years. The figures reported are consistent with prior years. Operating cash flow is down due to the reasons mentioned earlier, but this is expected to improve in the years moving forward.<\/p>\n Author’s Calculations<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Overall, the company is in a very strong financial position for the long-term. They have strong coverage on their interest obligations due to low interest rates, and they have adequate access to capital. The Z-Score above indicates negligible bankruptcy risk. And all other ratios are consistent with expectations.<\/p>\n Author’s Metric<\/p>\n<\/figcaption><\/figure>\n<\/p>\n At present Polaris is underperforming their peers on the various profitability metrics below. This is largely a result of the current operating environment and the level of demand the company is experiencing. In response to the demand, the company took actions to expand capacity, incurring significant costs in the process.<\/p>\n Seeking Alpha<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Moving forward, margins are expected to be in the upper teens and in-line or better than their peers. Two areas of outperformance include return on equity and revenue per employee. ROE is coming in at 42%, which indicates sustainable income growth and a strong ability to maintain shareholder payouts. In addition, revenue per employee is also higher than their peers, which indicates a high degree of productivity. In a tight labor market, this is an important advantage to have.<\/p>\n Overall, the profitability readings are currently mediocre compared to their peers. That is expected to change, however, especially beginning in 2023. At that time, the company is expecting to see significant growth in sales, EPS, and EBITDA. Until then, it’s appropriate to remain neutral.<\/p>\n Author’s Metric<\/p>\n<\/figcaption><\/figure>\n<\/p>\n In 2021, Polaris generated approximately +$300M in operating cash. This was a large decrease from 2020 and 2019, as shown below. The decrease, however, was due to large purchases of inventory during the year. Normalizing the figure would bring operating cash in-line with 2019 levels. Moving forward, the expectation is that the inventory will be sold in accordance with their historical turnover times. Assuming net income continues to increase, operating cash is expected to be significantly higher than current levels.<\/p>\n Cash Flow Statement – Form 10-K<\/p>\n<\/figcaption><\/figure>\n<\/p>\n The chart below summarizes the cash flows over the past three years. Dividends paid, which are a part of financing activities, was broken out for further analysis. As mentioned earlier, the company experienced a net use of cash in 2021. Historically, however, the company generates ample cash flow to more than cover their investments in CAPEX and their returns to shareholders. In 2021, Polaris had net borrowings but at historically low rates. Moving forward, the debt is expected to be repaid and dividend coverage is expected to return to historical levels.<\/p>\n Author’s Summary<\/p>\n<\/figcaption><\/figure>\n<\/p>\n Overall, the company is poised for significant cash flow generation as the inventory acquired in 2021 is sold out over 2022 and 2023. Additionally, as margins expand over the long-term, Polaris should be in a strong position to continue to expand capacity and return excess cash to shareholders.<\/p>\n The intrinsic share of Polaris is approximately $150.00, as supported by the DCF model below.<\/p>\n The first step was to obtain the key sales and operating figures from the past five years and input them into the table below. For this model, Total Operating Capital was defined as the combination of Total Current Assets and Net PP&E less Total Current Liabilities. Furthermore, Net New Operating Capital was defined as the year-over-year change in each period. FCF, then, was the difference of NOPAT<\/a>, which is after-tax net operating profit, and Net New Operating Capital. The tax rate used in the computation was 23%, which is the expected rate that was disclosed in the most recent earnings call.<\/p>\n Author’s Calculations<\/p>\n<\/figcaption><\/figure>\n<\/p>\n The next step in the model was to input the various assumptions for the next five years and to calculate the discount rate. As stated in the earnings guidance, sales growth in 2022 is expected to be in range of 12-15%. Thus, for this model, 12% was used for the first period and 13% was used for the following period. Sales are then assumed to slow to upper single digits in later years.<\/p>\n In the actuals provided above, operating costs and depreciation expense trended at approximately 88% of sales and 20% of operating capital, respectively. As such, operating costs are expected to remain consistent in the earlier periods and decrease in future periods, while depreciation is assumed to remain consistent moving forward.<\/p>\n For the discount rate, the CAPM<\/a> formula was utilized. The key inputs for this formula are the beta, the risk-free rate, and the expected return on the market. The beta for Polaris is 1.67, as reported in Morningstar<\/a>. The risk-free rate is 2%, which is the yield on the 10yr Treasuries, as reported in The Wall Street Journal<\/a>. Finally, the expected return on the market is 8%, which is in-line with historical averages.<\/p>\n The final assumption for the model is long-run FCF growth, which, at present, is assumed to be 6%.<\/p>\n![\"Polaris](\"https:\/\/static.seekingalpha.com\/cdn\/s3\/uploads\/getty_images\/1314198456\/image_1314198456.jpg?io=getty-c-w750\")
<\/picture>Business<\/h2>\n
![\"Sales](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471673725963.png\")
<\/a><\/span>![\"Gross](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471673842235.png\")
<\/a><\/span>![\"Geographical](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-1646147165959303.png\")
<\/a><\/span>Competition<\/h2>\n
![\"Seeking](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471658037343.png\")
<\/a><\/span>![\"Seeking](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-1646147165872036.png\")
<\/a><\/span>![\"Seeking](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-1646147166671509.png\")
<\/a><\/span>![\"Seeking](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471658473537.png\")
<\/a><\/span>Competitive Advantages<\/h2>\n
![\"2022](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471674645846.png\")
<\/a><\/span>Future Catalysts<\/h2>\n
![\"2022](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471682536576.png\")
<\/a><\/span>Earnings & Outlook<\/h2>\n
![\"Earnings](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-1646147167533803.png\")
<\/a><\/span>![\"Earnings](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471675295708.png\")
<\/a><\/span>Short-Term Liquidity Analysis<\/h2>\n
![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471666349866.png\")
<\/picture>![\"Balance](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471671086648.png\")
<\/a><\/span>![\"Balance](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-1646147167404333.png\")
<\/a><\/span>![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-1646147167552495.png\")
<\/a><\/span>![\"Inventory](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471674637413.png\")
<\/a><\/span>![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471666305482.png\")
<\/picture>Long-Term Solvency Analysis<\/h2>\n
![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471666263075.png\")
<\/picture>![\"2022](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471666399584.png\")
<\/picture>![\"Debt](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471682073145.png\")
<\/a><\/span>![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471673902106.png\")
<\/a><\/span>Profitability Analysis<\/h2>\n
![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471666306944.png\")
<\/picture>![\"Seeking](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471673914676.png\")
<\/a><\/span>Cash Flow Analysis<\/h2>\n
![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471666660175.png\")
<\/picture>![\"Cash](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-164614716818918.png\")
<\/a><\/span>![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471674087672.png\")
<\/picture>Intrinsic Share Price (DCF Methodology)<\/h2>\n
![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471666461773.png\")
<\/picture>
![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471666264372.png\")
<\/a><\/span>![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-16461471674957833.png\")
<\/a><\/span>![\"Author\"](\"https:\/\/static.seekingalpha.com\/uploads\/2022\/3\/1\/49921492-1646147166650627.png\")
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