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Entertaining Profits: Recreational Vehicles

September 20, 2013 | About:
When the 2008 recession hit, recreational vehicles turned into an unnecessary luxury good. A recovering economy, however, gives the industry a second chance to continue growing. Here, two recreational vehicle manufacturers where guru Steven Cohen has been active will be analyzed in order to find a suitable stock for a long-term investment. The companies in case are: Harley Davidson (HOG) and Polaris Industries (PII).

Turning into an All-American Brand

ATV, snowmobiles and NEV developer and manufacturer Polaris is based in Medina, Minn. After dropping its watercraft division, the firm focused on manufacturing in the U.S. Hence, some of its products are 100% made in U.S. A remaining 20%, however, is not fully made in the U.S. because Fuji continues to aid with engine development, or the product has been assembled in Mexico. Lately, outdoors fanatics have praised the introduction of its latest ATV model with a more powerful engine.

Polaris has increased the strength of its economic moat by creating relationships with companies involved in related industries like electric vehicles, construction and military equipment, and motorbikes. Also, sales volumes have increased across all segments. However, innovation remains a key factor because switching costs remain low. Moreover, operating margins have seen a slight reduction in line with the launch of future products and Aixam’s integration. Nonetheless, the short-term outlook remains positive and full-year guidance has risen in kind.

Although Polaris is wrestling with a slow European economy, focus on operational efficiency, the opening of a new facility in Poland, and joint ventures in adjacent businesses are expected to improve financial indicators and fuel long-term growth. Moreover, further growth is expected from international exposure to emerging markets; Brazil and India specifically.

Financially, Polaris is strong. Debt levels remain low, while revenue, net income and cash flow continue to increase. The stock trades at 26 times its earnings, or a 23% premium to the industry average, and is overvalued. I share Ken Heebner’s optimism, the largest guru holding a position with 600,000 shares, but do not think the premium is worth paying at this point because the stock has recently experienced a price hike and is expected to grow at more moderate rates. Hence, I read Steven Cohen’s sell as the right moment to step out and cut dividends.

An All-American Brand

With headquarters in Milwaukee, Wis., Harley Davidson is one of the two motorbike companies that survived the Great Recession. Today, the firm designs, manufactures and markets heavyweight motorcycles, and has divided its operations among two segments: Motorcycle and Related Products, and Financial Services. Steven Cohen has recently opted out completely from this stock, after turning into the guru with the second largest position in the company.

Today, helped by higher prices per unit, Harley is enjoying overall performance improvements, amid an adverse economic environment. The existence of an important economic moat supported by a wide dealer network and sales growth over the industry average, the firm continues to grab market share from competitors. Hence, future prospects for the short to medium-term remain positive as efficiency policies continue lowering the bottom line. As with Polaris, product innovation is a key for further growth.

For the long road, demographics indicate a negative trend for Harley as its trademark customer base will be shrinking. Hence, its marketing strategy aimed at African Americans, Hispanics, and women with the purpose of widening customer base is expected to continue. Also, strongly organized workers may threaten future profits if decisive action is not taken with respect to contract renegotiation. In the short-term, however, neither demographics nor organized labor will affect performance. The impact of such catalysts is expected to be felt five years from now, and the company has already developed strategies to counter those negative catalysts.

Harley presents a good balance sheet. Most importantly, operating margin has shown great improving signs, but debt continues to rise without putting the business model at risk. Currently the stock is trading at 20.8 times its earnings, slightly below the industry average. I share Steven Cohen’s pessimism that is reinforced by the guru holding the largest position, Chris Davis.

Break

I prefer Polaris over Harley Davidson because buying an ATV is cheaper than a heavyweight motorcycle. Such characteristic automatically widens the base for potential customers. Additionally, its yield is higher than the other two, margins will improve as acquisitions fully integrate, and joint ventures help to diversify risks.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


Rating: 5.0/5 (1 vote)

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