Better Buy: Polaris Industries Inc. vs. Arctic Cat

By Travis Hoium Markets Fool.com

Polaris Industries Inc. (NYSE: PII) and Arctic Cat Inc (NASDAQ: ACAT) have long been rivals in the power sports market, but they've been very different experiences for investors. Polaris has been a growth stock since the end of the recession, but Arctic Cat has been mired in markets that never seem to grow, and has misstepped with its product strategy and branding for years.

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As 2017 begins, both companies have exposure to the exciting power sports business, but they have very different prospects and present investors with very different risks. And Arctic Cat's potential buyout by Textron (NYSE: TXT) complicates matters further. Let's take a look at where these stocks stand.

Image source: Getty Images.

Where they stand today

Polaris and Arctic Cat have both gone through rough patches in the past year, for different reasons. Polaris suffered some self-inflicted wounds with recalls that both increased costs and negatively impacted sales during the year. Arctic Cat has been fighting a huge headwind of warmer winters that have hampered its bread-and-butter snowmobile business. The result is the difference in revenue and income trends you see below.

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PII Revenue (TTM) data by YCharts.

The big divergence really came in 2010, when Polaris expanded beyond its traditional product lines. And that's what investors should be watching today.

Diverging strategies

When Polaris started its growth streak, it did so by moving beyond snowmobiles and ATVs (all-terrain vehicles). The Victory motorcycle brand had been established, but the company placed a new focus on motorcycles in 2011 when it bought Indian Motorcycles. When it launched the Slingshot in 2014 it brought another innovative product into the lineup.

At the same time, side-by-sides became a bigger market, and the Ranger and RZR products fit the market's need nicely. Polaris was able to simultaneously ride the market's growth and expand into new on-road markets, driving the growth you see above.

While Polaris was expanding, Arctic Cat was trying to improve products in the competitive ATV and side-by-side market while maintaining its position in snowmobiles. But as winters have gotten noticeably warmer, particularly in Arctic Cat's home base of Minnesota, the company has struggled. A restructuring and investment in new products led to the $77.5 million in losses you see above.

A savior to the rescue?

On its own, Arctic Cat's business is in serious trouble. The core winter business is getting weaker because winters are getting shorter and ATVs and ROVs (recreational off-highway vehicles) are in a broad decline. It's hard to see how the company can dig out of the hole on its own.

Textron is its best hope for survival, and its $18.50 per-share cash offer for the company in late January was welcome news. Shares are currently trading above the buyout offer on the assumption that Textron will raise its bid or someone else will swoop in with an offer. But there's no reason to think either will happen given the cash drain any acquirer would be taking on.

I think the bigger risk would be Arctic Cat's business continuing its decline and Textron pulling out of the deal altogether. So there's very little upside potential in Arctic Cat, and a lot of downside risk.

The best stock in power sports

Polaris is facing its fair share of challenges today, but I like its strategy of expanding into new markets with innovative products. And it's proven that it can execute on its growth strategy profitably.

Arctic Cat could be an interesting turnaround stock, but given the Textron buyout offer, there's no upside even if a turnaround takes place. Investors today are taking on mainly downside risk if the deal falls apart, and with shares trading above the offer price, I don't see why the risk is worthwhile today.

Polaris is the better of these two stocks right now, and if the past year's recalls turn out to be an aberration, the stock could be a great buy for investors.

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Travis Hoium has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Polaris Industries. The Motley Fool has a disclosure policy.