Polaris: Inflation Has Shrunk Profit Margins

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Investment thesis

Polaris Inc. (NYSE: PII) is a designer and manufacturer of powersports vehicles headquartered in Minnesota, USA. In this thesis, I will mainly analyze PII’s second quarter 2022 results and its future growth prospects. I’m going also analyze the risks facing the company and their impact on its performance. I assign a maintenance rating to PII after considering all growth and risk factors.

Company presentation

PPI designs and manufactures off-road and off-road powersports vehicles such as snowmobiles, motorcycles, boats and defense vehicles. The Company operates in six business segments, namely snowmobiles, motorcycles, global adjacent markets, aftermarket, boats and all-terrain vehicles (ORVs). The company currently produces 58 different models of snowmobiles and sells these snowmobiles through a network of over 580 dealers in the North American region and 300 dealers in international countries. As for the motorcycle segment, the company currently produces three types of motorcycle cruisers, touring (including 3-wheelers) and four standard motorcycles. It sells these motorcycles through 200 dealers in North America and 350 international dealers. The global adjacent market segment consists of commercial vehicles used for light industrial purposes. The Company’s aftermarket segment deals in aftermarket parts, apparel and accessories to complement these vehicles. The Boats segment includes motor boats and deck boats. It has a great advantage in the boat industry with over 600 active dealerships through which the company caters to its customers. The ORV segment is one of the most important segments of the business. It has a network of more than 1400 dealers in North America and 1100 dealers in the international region to distribute these ORVs.

Q2 2022 results

PII posted weak results in Q2 2022 with underperformance across many metrics. The company experienced a decline in gross margin as well as net profit margins. The cost of sales increased disproportionately due to inflationary pressures. The company believes inflationary pressure will continue through FY22. Additionally, the supply chain disruption has caused serious problems for the company and is limiting its growth. However, the company has revised its guidance for FY22 and estimates revenue to be 13% to 16% higher than FY21 sales compared to previous estimates of a 12% to 15% increase. The company has EPS estimates of $10.10 to $10.30 for FY22. The business failed to impress with contracted margins and increased costs.

income statement

SEC: 10Q PII

PII recorded sales of $2.06 billion, an 8% increase over second quarter 2021 sales of $1.91 billion. The main revenue driver was an average increase in product selling price and strong demand in the ORV segment. The company reported a gross profit margin of 23%, a decline of 303 basis points in gross margin compared to the corresponding quarter last year. According to my analysis, the main reason for this decline was an increase in production costs due to inflation. The company reported net income from continuing operations of $142 million, down 8.5% from $155 million in the same quarter a year earlier. The company reported diluted EPS from continuing operations of $2.34, a decrease of $0.13 from Q2 2021 diluted EPS of $2.47.

Overall, the results reflect the cost pressure the company is currently facing, but the company gave a strong guidance for FY22, citing increased demand. I think the company needs to address the inflation and supply chain issue, and before that I wouldn’t have much confidence in the company’s FY22 results.

Mike Speetzen, President and CEO of Polaris Inc, said:

Our results in the second quarter reflect our team’s commitment to our customers through industry-leading innovation and exceptional execution, despite continued supply chain constraints impacting the global economy. As we closely monitor a number of demand indicators to understand consumer resilience in this environment, we continue to see a healthy consumer and stable demand. Although this trend is expected to continue in the second half of the year, we remain diligent and ready to react should headwinds materialize. Our focused strategy to be the number one player in powersports, coupled with the significant opportunity to return to optimal inventory levels at dealerships, gives us confidence in our ability to drive continued performance for Polaris and create revenue. value for our shareholders.

Key risk factor

Commodity prices and supply chain disruption: Aluminum, steel, petroleum-based polymers, some earth metals used in the company’s charging station, and diesel fuel to deliver goods are the main raw materials used in the production chain. The cost of transportation and delivery to acquire materials, commodities and other parts needed to assemble the products could affect the profitability of the business. These resources and raw materials are becoming significantly more expensive for the economy due to high demand, an inflation-fueled climate, and supply chain disruptions caused by the Russian-Ukrainian war. Additionally, changing policies, trade restrictions and trade agreements could further sabotage the supply chain or drive up the price of commodities and raw materials used in the manufacture of products. Current economic conditions may weaken consumers’ disposable income, resulting in lower demand for products. All of these have the potential to increase operating costs and negatively impact business operations and financial health.

Evaluation

The company is currently trading at $117.2 with a market capitalization of $6.98 billion. Currently, the company’s PE multiple is 27.16x. The company has seen an increase in demand, but due to supply chain disruption, the sustainability of demand is uncertain. I kept my estimates conservative after taking this factor into account. I estimated the company’s EPS for FY22 at $10.15, which gives the main PE multiple of 11.76x. At this assessment, it is not advisable to create new positions in this stock due to uncertainty due to supply chain disruption. The company has a dividend yield of 2.18% at the current share price level, which is a good reason to keep the stock in the portfolio. Once the supply chain disruption is resolved, we could have certainty of future growth.

Conclusion

PII has seen strong demand across all segments, but inflationary pressure and supply chain disruption have become a big challenge to the company’s future demand growth. After considering these factors, it is not advisable to create a new position in this company. The company has a stable dividend yield of 2.18%, which can be a good reason to own the company if you already have a long position in the company. I think the company could fix the supply chain issues by FY23, and after that the company could experience better profit margins. I assign a sustain rating to PII after considering all of these factors.

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