Description

BRP stands as the preeminent North American powersports vehicle manufacturer, boasting substantial market share growth momentum, yet paradoxically languishing at historically depressed valuation levels. This discrepancy is primarily fueled by exaggerated concerns surrounding the prospect of overearning.

Post-COVID, BRP has witnessed a remarkable surge, achieving a staggering revenue growth of approximately 78% and an even more impressive EBITDA surge of about 127% through the last twelve months ending October 2023. Despite such stellar performance, the company is currently undervalued, trading at a mere 5.4 times the adjusted EBITDA for the same period, a valuation nearly two standard deviations below its pre-COVID average historical multiple of 9.2 times the last twelve months EBITDA.

Thesis Key Summary

BRP, despite being the clear market share gainer in an increasingly attractive market, is trading at a significant discount on a mid-cycle basis and is cheap even on trough earnings. I believe that despite industry retail weakness and BRP's "reset", BRP's earnings will be higher than FY2023/2024 levels in the next 3-5 years primarily driven by BRP market share gain, continued efficiency unlock, and stronger than expected spending environment. Trading at ~6x LTM EBITDA and ~11% LTM FCF yield, BRP can generate 2+x MOIC from re-rating to historical trading levels and FCF generation alone. BRP will likely grow earnings and see further multiple expansion (at least higher than PII) - BRP could easily be a ~3x here. 

BRP's earnings are poised to exhibit greater resilience than what the market anticipates. This misjudgment stems from the market's failure to grasp the enduring nature of BRP's growth trajectory, its position within the industry cycle, and the transformative structural changes unfolding within the industry.

- Growth Durability: The lion's share of growth post-COVID has been propelled by significant market share expansion in North America, soaring from 27% pre-COVID to an impressive 37% (10-percentage-point increase or 37% increase). Importantly, this gain is not transient but rather resilient and sticky. Furthermore, BRP remains strategically positioned for continued advancements in market share.

- Industry Cycle: The retail sales within the industry have undergone a correction from the peak observed during the COVID period, primarily attributed to supply chain bottlenecks. Retail sales for the years 2022 and 2023 have largely stabilized, hovering around levels comparable to those of 2019. Additionally, any benefit derived from restocking has already dissipated.

- Industry Structure: 1) Since the Global Financial Crisis (GFC), there has been a notable transformation in the Off-Road Vehicle (ORV) market, witnessing a substantial shift towards side-by-side vehicles (SSVs) from the traditional dominance of All-Terrain Vehicles (ATVs). Currently, SSVs account for over 60% of industry units, a stark contrast to the less than 20% pre-GFC. Notably, the majority of SSV sales are utility-oriented, multi-purpose vehicles, which inherently possess less recreational appeal compared to ATVs. Consequently, this structural shift suggests that the industry will exhibit a reduced degree of cyclicality. 2) Since the Global Financial Crisis (GFC), the powersports dealer market has undergone a process of consolidation and fortification. This consolidation has resulted in a strengthened dealer network, better equipped to weather the potential impacts of a recession. The enhanced resilience of the dealer network positions the industry more robustly in the face of economic downturns.

The secular tailwinds propelling the powersports market, combined with BRP's ongoing momentum in capturing market share, are poised to fuel sustained and robust earnings growth over the long term.

- The powersports sector is experiencing sustained benefits stemming from permanent shifts in lifestyle induced by COVID, favorable population migration trends, and significant demographic changes. Moreover, ongoing product innovations are effectively broadening the industry's customer base, further bolstering its growth trajectory.

- BRP's commitment to an innovative cycle and its distinctive dealer-friendly approach position the company strongly to continue capturing market share across all market conditions, notably in recessionary environments. This resilience underscores BRP's capacity for sustained growth and market leadership.

BRP offers a margin of safety with several levers poised to deliver compelling returns, including potential multiple re-rating, sustained earnings growth, and robust free cash flow generation.

- BRP has demonstrated an impressive 19% compound annual growth rate (CAGR) in EBITDA since the fiscal year ending January 2016. Despite this stellar performance, the company currently trades at a multiple of 5.4 times the adjusted EBITDA for the last twelve months ending October 2023, representing a considerable discount compared to its historical trading multiple of 9.2 times. Even in the face of a recessionary environment, BRP has the resilience to swiftly rebound to its current EBITDA level and continue to capitalize on secular tailwinds and market share gains for sustained growth.

- BRP boasts substantial cash flow generation capabilities, currently offering an approximate 11% levered free cash flow yield based on the last twelve months ending October 2023 GAAP figures.

Key Risks

Demand in the powersports market could stabilize at levels below those seen before the onset of the COVID-19 pandemic.

- The surge in powersports sales during the COVID-19 pandemic may have pulled forward future demand, particularly as mix of new customers increased

- Mitigants: The fact that retail sales growth in 2023 has reached or even surpassed pre-COVID levels implies that the phenomenon of COVID pulling forward demand may not have been as substantial as initially perceived.

A recession could indeed have a significant impact on powersports demand

- During the Global Financial Crisis (GFC), retail sales units experienced a substantial decline of 40-50% from peak to trough, largely due to the discretionary nature of powersports vehicle purchases

- Mitigants: 1) The industry's significant shift towards less recreational Side-by-Side Vehicles (SSVs) diversifies its product offering and may mitigate some downturn effects, 2) while overall sales may decline, demand in premium will be relatively muted, 3) BRP's ongoing market share gains will further accelerate during a recessionary period, and 4) recession impact is already priced in

The competitive landscape could witness a notable escalation in intensity should competitors exhibit irrational behavior

- In an effort to safeguard their market share and manage inventory levels, manufacturers might significantly escalate rebates or discounts, potentially leading to margin compression

- Mitigants: Competitive intensity remains controlled today. The powersports industry is primarily a duopoly between BRP and Polaris and competition has generally remained rational, even during the Global Financial Crisis.

The potential for wage and input commodity inflation presents a risk of margin compression.

- Consumer resistance to pricing increases has already begun, and continued cost inflation could further squeeze margins.

- Mitigants: BRP has implemented lean value initiatives aimed at enhancing operational efficiency.

Why Does the Opportunity Exist and Why the Stock will Work

The current opportunity in BRP stems from the market's perception of the company as a one-time COVID beneficiary that has peaked in earnings potential. However, this narrative has been proven wrong as BRP continued to exhibit strong performance throughout 2023. Unfortunately, this resilience has been underappreciated, particularly amidst warning signs of demand reduction or performance deterioration in broader consumer cyclical sectors, including outdoor recreational sub-sectors. I firmly believe BRP will diverge from these trends for several reasons:

1. The company has effectively navigated through the surge in COVID-related demand and subsequent overearning.
2. The majority of BRP's growth is characterized by its sticky nature.
3. BRP possesses significant momentum in gaining market share, enabling it to grow into and beyond its current earnings power.
4. The powersports industry stands to benefit from secular tailwinds.
5. The impact of a potential recession on BRP is expected to be relatively muted compared to the broader consumer cyclical sector.

Given the significant pessimism already priced into the stock, I am confident that BRP offers a superior risk-adjusted return opportunity, with multiple avenues for success across various market environments.

Catalyst

Continued market share gain. Powersports retail recovery/growth. Share buyback. Earnings growth.