Description

Polaris Industries (PII) designs, engineers and manufactures ATVs, snowmobiles and motorcycles together with related replacement parts, garments and accessories. PII markets its products through a network of 1,800 dealers in North America and 40 distributors in Europe (approximately 11% of sales are outside of North America). PII is headquartered in Medina, Minnesota and has been doing business since the early 1950s. PII was a pioneer in the snowmobile business and later expanded into ATVs, utility vehicles and motorcycles, which has eliminated some of the seasonality of the business.

Why should VIC members be interested in PII? To cut to the chase, the current share price affords investors the opportunity to buy a very good business at a reasonable price. Why do I say that this is a good business? Well, PII earns pretax returns on tangible invested capital of over 70% and after tax returns on tangible invested capital in the mid 60% range. ROE was 38% last year. 2005 will be the 24th consecutive year that PII has grown earnings per share. For the last 10 years, PII has grown revenues at a 9.9% compounded annual rate and has grown EPS at an 11.9% compounded annual rate. In April, the company publicly stated its goals for the next five years: $3 billion in sales (11% compounded growth rate) and a net income margin of 9% (15% compounded growth rate) by 2009.

Why do I say that this is a reasonable price? PII traded above $73 in March but fell to $44 in October. The current price of $48 values PII at only 9x EBIT and 13x EPS on 2006 estimates. The balance sheet is rock solid: PII has only $18 million in debt with $13 million in cash. The market cap is $2.1 billion. This company could easily support more debt, but I am assuming that management will remain conservative. (A private equity firm could also become interested in PII at current levels or below.)

Will management take advantage of the low share price to create value? History suggests that they will: From 1995 through 2004, management has spent $450 million to reduce average shares outstanding by 19%. And that’s not all: the company has paid out over $320 million in dividends over the same period. This year is no exception: the company has repurchased $111 million of stock through 3Q and will pay approximately $49 million in dividends. The board authorized an additional 4 million shares for repurchase in October, bringing the total amount available for repurchase to approximately 12% of the common shares outstanding. Without using additional debt, the company ought to be able to buy back over $100 million per year.

Another nice feature of the PII story is that management happens to be first rate. CEO Tom Tiller spent 15 years at General Electric before joining PII in 1998 and becoming CEO in 1999. Tiller has lowered costs by reducing plant defects by more than 70% in the past three years. In addition, he has shown a willingness to walk away from unprofitable growth, which is evidenced by his decision to close down the struggling marine products division in September 2004. And Tiller’s sharp eye for attractive deals is demonstrated by his decision to acquire a 25% equity interest in Austrian motorcycle manufacturer KTM for $85 million in July with an option to become the majority shareholder in 2007. This deal should help PII accelerate growth in Europe.

How does PII’s business break down? 66% of sales come from ATVs, 16% from snowmobiles, 4% from motorcycles, and 14% from parts, garments and accessories. Domestic ATV and snowmobile sales have been weak lately due to the soft consumer environment, which led to higher dealer inventories and caused the company to lower its 2005 guidance. The market appears to be fearful about a difficult macro environment due to higher gas prices and weakened consumer confidence. There is also fear about higher promotional activity in the industry. Although there is no doubt some legitimacy to these fears, the share price already more than adequately compensates long-term investors for such risks.

Catalyst

Not looking for any real catalyst other than simply continued execution and share repurchases