Polaris Industries Drives Toward Strong Earnings Growth

The economy may be growing only sluggishly, but that isn’t stopping Polaris from boosting its earnings – and doing so in a sustainable fashion.

Uncertain economic times may not seem like a recipe for profitability for companies selling products that are only for leisure, given that consumers typically trim their discretionary spending when their incomes stagnate or they lose their jobs. Nonetheless, Polaris Industries Inc. (PII.N) appears poised to continue generating a healthy stream of earnings from its sales of all-terrain vehicles (ATVs), motorcycles, snowmobiles and the other recreational vehicles that it designs, engineers and manufactures. The company scores 93 on the StarMine Earnings Quality (EQ) model out of a possible 100, a high score that signals that those profits are coming from sustainable sources.

Over the last five years, Polaris has seen its margins creep steadily higher. The chart below shows the three most popular margin measures –gross margin, operating margin and net margin – all of which have improved in each of the last three quarters. In the quarter ended September 30, 2012, Polaris announced that both its operating margin and its net margin reached their highest levels in five years, rising to 15.2% and 10.7%, respectively. This improvement can be traced to the company’s ability to price its products more competitively, in turn attributable to manufacturing efficiencies and reductions in operating costs gained through such measures as moving a plant from Wisconsin to Mexico in order to take advantage of lower wages. That is an encouraging sign for Polaris’s earnings, as revenues also continue to improve. (Indeed, the company has reported quarterly year-over-year gains in revenue of more than 20% in each of the last eight quarters.)

The company also has seen the return on its net operating assets improve, meaning that it is using its assets to generate better returns over time. In the last quarter, this rate of return surged to a remarkable 116%, the highest level seen in the last five years and far above the industry median of 39%.

The component of the EQ model on which Polaris has the strongest score – an impressive 99 out of a possible 100 – is that measuring the strength of its cash flow. As you can see in the chart below, the company’s free cash flow at the end of September exceeded its net income by $58 million (represented by the green section of the bar) and both its free cash flow and net income hit record highs. Whenever earnings are backed by strong cash flows, they tend to be more sustainable in the future. This performance also explains why Polaris’s balance sheet is so strong, boasting more than $400 million in cash (up from less than $100 million only four years ago) and debt of only $105 million, close to its lowest level in five years.

Polaris also is planning for future growth in both revenues and profits. The company announced a joint venture last July with an Indian company, Eicher Motors Ltd. (EICH.NS), which will give it access to India’s large, growing and increasingly affluent market. That country’s middle class is willing to spend on luxuries, as they have more money, time and leisure to devote to recreational activities. Eicher’s existing brands include the iconic Royal Enfield line of motorcycles. Together, the two companies plan to invest $25 million apiece to develop and produce an array of new kinds of vehicles for the Indian market and other emerging markets, with output hitting the market in 2015, which should contribute to earnings growth in the years that follow. This initiative is just another step toward diversification on the part of Polaris, which, when it was founded in the 1950s, was a highly cyclical business based on snowmobiles. Now, however, the company manufactures and sells vehicles for all weather conditions and terrains. In another effort to diversify its stream of earnings, Polaris also bought Indian Motorcycles in 2011, an iconic American brand whose products could become sought after by baby boomers heading toward retirement. It also owns the Victory line of motorcycles.

With this kind of diversification and Polaris’s future growth strategy, it isn’t surprising that analysts also are recognizing the strength and resilience of the company’s profits. It scores 98 out of a possible 100 on the StarMine Analyst Revisions Model, signaling that analysts have been boosting their earnings forecasts for Polaris, and are likely to continue to do so in the future.