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  • KPB & Co Research


Tariffs, Tariffs, Tariffs. This word has been on the lips of many CEOs recently, particularly those who are in charge of companies that export manufactured goods to European and Chinese markets. Polaris Industries and Harley Davidson, which both manufacture and sell motorsport vehicles and parts, repeated this word several times during their Q4 of FY-18 conference call, as they explained why the year was challenging for them. Miraculously, despite the challenges Polaris faced, they managed to put up ok numbers, which was the opposite for Harley Davidson. Polaris' resilience reflects their continued leadership position in key markets, and diversified product offerings. Overall we are satisfied, but given the performance of one of their recent acquisitions we think it is time the company take a break on focus on streamlining operations for businesses that already have.

Fairly OK Q4 Results

In light of the fact that there were significant disruptions throughout the year, and that monetary conditions got increasing tight during the 4th quarter, adjusted growth of 3% was fairly acceptable. Q4 corporate level sales increased by approximately 14% to US$1.6Bn due primarily to the recent acquisition of Boat Holdings Co. Excluding the US$145.3Mn provided by boat holdings from the second half of the year onwards, sales increased marginally by 3%. The segment breakdown of the company's top line shows that there were differing performances across business lines. The motorcycle segment declined 15% on the back of a marginal increase the Indian brand, and the failure of the slingshot brand to gain momentum. The global adjacents segment grew 4% on account of solid growth in Aixam and Polaris Adventures. ORV and snowmobile sales increased 7% during the quarter due mainly to the ramp in snowmobile sales before the winter. The after market segment declined 3%. Company wide gross profits increased 6%, but gross profit margins declined by 1 percentage point on the back of a 56% decline in gross profits for the Motorcycle segment, and a 14% decline in the after market segment (owing to Transamerican Auto Parts).


Our Concerns

We are concerned about general economic conditions which we expect to impact Polaris across the board given that their products are largely discretionary. Of course, tariffs are also a concern, and if trade tensions continues to increase Polaris' margin will likely take further hits. Tariffs can also lead to an impact on the demand side of the equation, as the company currently exports ORVs and Indian motorcycles to Europe. Our biggest concern however, lies in the performance of recent acquisitions. According to data provided by management, the company's debt as proportion of total capital has reached 69%. The company has a net debt (Total Debt LESS Cash and Cash Equivalents) of approximately US$1.8Bn. Most this debt was taken on to make several large acquisitions such as Boat Holdings Co. and TransAmerican Auto Parts, and if these don't pan out the debt will come back to bite shareholders.


In previous years, the company successfully merged acquisition into their operations with very little negative spill off effects, for example the Indian Brand executed well and today is still taking market share from Harley. With TransAmerican Auto Parts (TAP), for which the company paid a 9X EV/EBITDA multiple, growth has been dismal since it was acquired, and margins have shrunken. The softer performance of TAP came within the context of strong macroeconomic tailwinds in the first half of 2018. In previous conference calls management blamed the early signs of weakness on a slow start to the company's product cycle. TAP makes parts that enhances the appearance of vehicles that come fitted with stock parts, and so TAP has to actually reverse engineer those parts to fit new models when basic the design of these vehicles change. On the Q2 conference call the company said:


Aftermarket sales were up 1%, with TAP sales up a similar amount and our other Aftermarket brands increasing 8% on a combined basis. TAP continues to realize growth in its four-wheel part stores and online sales. However, sales of its proprietary brands were below expectations given the limited number of accessories developed to date for new Jeep Wrangler platform.


Without solving the slow product cycle issue the company then entered into a new market with the acquisition of Boat Holdings Co at 9.5X EV/EBITDA (which is not particularly high, but one would prefer to see 7-8). In addition to this acquisition, the company went on to acquire fishing boats from the Marquis-Larson Boat Group such as the Larson, Larson FX, Striper and Escape brands for an undisclosed amount. Finally, the company acquired a minority stake in the fishing league worldwide which is essentially a fishing competition. We we like the fact that management is getting very creative in the recreational space, but we think that they are taking on too many unfamiliar markets at once. Given the performance of TransAmerican Auto Parts in Q4, we are not entirely convinced that they understand what part of the business cycle these businesses are at.


Overall Polaris Industries remains a good business with great products. Over the last 10- years they have managed to generate industry leading return on capital, and profit margins. However, the Q4 performance of the company reflects to some degree that management maybe losing focus as they go off into new markets through an acquisition strategy. Most acquisitions fail especially when these acquisitions are outside the circle of competence of the management team. In the case of Polaris they have had a good track record with tuck-in acquisition where they could use their expertise in engineering and design to add value. It remain to be seen whether this can be translated to boats.


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