Polaris Industries' Earnings Aren't as Good as You Might Think

The stock market reacted favorably to Polaris Industries' (NYSE: PII) recent first-quarter earnings report, but despite surpassing analyst expectations, they're really not all that good. A lot of the issues are masked by one-time adjustments as the powersports vehicle manufacturer works through its recall-related problems, winds down a motorcycle brand, and integrates recent acquisitions.

Combined with sluggish industry trends in most of its important markets and intensifying competitiveness, the buoyancy of Polaris' stock doesn't seem justified. The business is certainly not about to keel over, but it's hard to get too excited about its potential future performance just yet.

Image source: Polaris Industries.

A lot ofmoving parts

Polaris Industries reported revenue of $1.15 billion for the period, an 18% increase on an adjusted basis that removes the impact of winding down the Victory motorcycle brand. Adjusted net income for the quarter, also excluding Victory's costs and those associated with the acquisition of Transamerican Auto Parts (TAP), was $48.3 million, or $0.75 per share, better than the $0.70 per share Wall Street expected and ahead of the $46.9 million it reported a year ago.

Yet the powersports vehicle maker's performance was helped along by TAP, which added more than $200 million in sales for the period, meaning the rest of Polaris' aftermarket business was flat. When you back out those sales, total revenue was down 2.7% year over year. That was due to snowmobile and Slingshot retail sales both down more than 10% in the quarter, and off-road vehicle sales falling about 5% from the year-ago period. Fortunately, Indian Motorcycle continues to perform well and saw retail sales rise over 10% year over year.

Almost everything is falling

The ORV decline was on top of the 12% drop in sales it recorded last year as the recall problems that continue to plague the vehicle manufacturer really began to filter through the business. While the dip is obviously better than what it was last year, it should have been an easy hurdle to overcome, but was one that not even a heavier promotional campaign could get around because of the persistent manufacturing problems at Polaris.

It can't do much about the weather, and that was largely the reason for the drop in snowmobile sales, which were hampered by a poor snow season. Overall, though, snowmobiles haven't been a strong market lately, which is why its weakened rival, Arctic Cat, ended up being bought out by Textron.

The three-wheeled Slingshot, although going up against a tougher comparable due to Polaris' introduction of its high-end SLR model last year, is also suffering from recall-related issues. Between ending Victory production and Slingshot's woes, motorcycle segment revenue fell 32% in the quarter, a drop not even the 10% increase in sales by Indian Motorcycle could offset. The quarter basically had two bright spots: the Indian and global adjacent markets, which is its small-vehicles division.

Image source: Indian Motorcycle.

Two highlights

Through a series of acquisitions such as GEM, Taylor-Dunn, and Aixam Mega, Polaris has put together a smart mix of businesses that it groups into what it calls its global adjacent market and that helped push sales 24% higher in the period. Yet it's also one that represents just 8% of total revenue, though it is looking to grow that side of the business with additional government contracts, particularly from the Defense Department. Chairman and CEO Scott Wine notes, "Obviously, we do better when there's activity, and certainly, there's a lot of activity in the Department of Defense right now."

Polaris provides the military withspecially designed RZRs, dubbed MRZRs, and last year unveiled a new MRZR-D (so named because it is diesel-powered) to overcome limitations with its original version. Polaris' CFO, MIchael Speetzen, admits that the base from which Defense starts is still very small, but said they doubled their business in the quarter.

Similarly, Indian has given a nice boost to Polaris since the company began producing the big bikes again in 2014, but like the global adjacent markets above, it's still a relatively small contributor to revenue in comparison to ORVs. Where motorcycles accounted for $125 million in sales for the period, ORVs contributed $724 million. Winding down the Victory brand to put all its attention on Indian is smart, but the motorcycle industry is in the midst of a slump. Harley-Davidson also recently reported earnings and its U.S. sales were down almost 6%.

Still an industry leader

Polaris Industries has long enjoyed the leading position in many of its markets, including ATVs and side-by-sides, and has been the runner-up in snowmobiles and motorcycles, though it is a distant second in the latter.While it continues to be a leader, the competition has become much more innovative in its own right. In the all-important off-road vehicle market, it is facing tougher competition from the likes of Honda Motors and John Deere.More intense competition in motorcycles also likely played a part in the decision to wind down Victory.

Although Polaris has also been making some strategically sound acquisitions, these also lend to greater integration problems. They carry the potential for big payoffs, like TAP in aftermarket truck and Jeep gear, but there's risk as well.

Image source: Jeep.

Sales of Jeep vehicles continue to fall year over year, and were down 17% in April. The Jeep Grand Cherokee, however, does continue to grow sales, and was the only Jeep model to register growth in the month. But year-to-date Jeep sales are down 13%, and that's a worrisome trend in the market that TAP targets. Similarly, pickup truck sales are weakening and fell 3.5% last month, though they remain nearly 3% higher so far this year.

The acquisitions also mask just how poorly much of Polaris Industries' legacy businesses are performing. So while the markets may be betting that the purchases will pay off in the future, they're ignoring the real, immediate problems to the Polaris brand as a result of the persistent recalls. While I'm of the mind that this unfortunate period will ultimately be transient in nature, it's not in the rearview mirror yet, and investors might end up with their own case of heartburn if they buy in too soon.

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