Polaris Inc. (PII) Earnings Call Transcript & Summary

All right. Good morning, everyone. Thank you for joining us for our next presentation from Polaris. The company is the leader in the North America powersports industry, competing in a number of segments, including off-road vehicles, snowmobiles, motorcycles and boats. Here to tell us about it are the company's CEO, Mike Speetzen; and CFO, Bob Mack. I believe Mike has a few slides he would like to go through. And then right after that, we'll go into Q&A. So with that, let me give the floor to Mike.

All right. Thanks, Joe. I'm going to start off by correcting Joe. We're not the leader in North America, and we're the global leader in powersports. So anybody who's new to the story, Bob and I came into our positions 3 years ago. It's been a whirlwind 3 years. And one of the biggest things we had to do was essentially recalibrate the strategy of the company. The company had kind of gone off in a lot of different paths. And it was in powersports, it was in urban mobility, it was in jeep and truck aftermarket. And so what we've done over the past 3 years is really righted the ship. We jettisoned about $1 billion of noncore businesses and got back to being focused in powersports, where we've had a leadership position. Because of those distractions, we have lost some share over the years. And we thought it was really important to get back to focusing on the things that we're really good at, that we're passionate about and could make a lot of money at. And it's really given us the opportunity, as you've seen over the past 3 years, to reinvigorate the product lineup across all of our businesses. We're really excited about the new products that we've put in across all 3 segments. Last year was challenging for us financially. Putting that aside, we're really happy with the fact that we gained share in all 3 of our segments. So strategy is remaining consistent. We're not making changes to it. It's something that I continue to reinforce with our employees, with investors, with our Board of Directors because it's really important for us to stay laser-focused on this. We think there's a huge opportunity to continue to grow in powersports. And we think there's a huge opportunity to make our company better operational, and I will talk about that here in a second. This slide -- I probably went too far, this slide is just kind of a snapshot of our company on a page. And what I would tell you is, like I said, #1 in powersports, not #1 in every category. Motorcycles is a prime example. Indian is a clear #2. But then when you look beyond that, there's a fair amount of distance between us and the next competitor. I talked about the challenges we had last year financially. There are really 2 things at play. One is we did see the market soften up relative to where we thought things would be. And as a result of that, we pulled back on shipments. And we did that varying times through the year based on what we were seeing in retail trends as well as what dealers were telling us. And one of the things that we talk a lot about in our January call is we are anchoring ourselves to dealer inventory. Dealer inventory is in a better spot by and large for the company than it was back in 2019. And it's important for us to keep our dealers healthy. And so if we see the economy moving, we're going to adjust our shipments to make sure that inventory in the channel remains at what we deem as an optimal level, and it's complex. I mean, we have 4,000 dealers globally, and a lot of different product lineup. So this is something the team spends an awful lot of time on. Capital deployment is something that we've spent a lot of time thinking through. It's a big change from what we were 3 or 4 years ago. We're really investing heavily in the company. Bob and I have talked a lot about this over the years in terms of the investment we've made inside the factories, whether that be to upgrade systems that we have, expand to handle additional volume or just general upgrades that we've done to be able to in-source components that over the years we had let outside providers do and was costing us a lot of money. And really now we're at the phase where we've got to see those investments pay off. And so that's going to be a very large focus for us. But every first decision is really about what can we do to make the company better. Second is the dividend, with 28 years of an increasing dividend, dividend aristocrat. And then from there, it's really about share repurchase, and then, potentially M&A. Given where our share price is at, given what we know the intrinsic value of the company is, it's going to be really tough for us to justify buying anything other than Polaris stock. We talked about when we launched our strategy, taking 10% of the float out. We are well ahead of that trajectory given the opportunities that we've seen, given the stock trading over the last couple of years, the ups and downs. So we're doing everything we can to make sure we get the company positioned. The other comment I'll make relative to our financial performance last year is operational performance. We fell down in our factories, specifically our Huntsville and our Monterrey factories. We saw the supply chain challenges start to abate coming out of the second quarter. What we didn't see was a commensurate improvement in our ability to execute coming out of our factories. We also did not get the cost out. And so we essentially set ourselves back about a quarter or so because we were not able to react fast enough. Now the good news is, as we talked about in the call, November and December, we saw things moving in a much improved direction. In our first meeting this morning, somebody asked how are things going so far? And I said, look, the first 2 months of the year, the team has been executing on track with what they had told us from an operational perspective. We're getting costs under control. The output out of those factories has improved substantially. The line rate fidelity, the first pass yield, all those things are moving in the right direction. Now, that said, it's still a long journey that we have. We talked on the call that we've got to get $150 million of cost out plus commodity costs that will come out on top of that. And so the team is laser-focused on that. I have a lot of confidence that not only can we get back to where we were pre-pandemic, we are actually going to get the company back in a much, much better position. And that will help us in terms of getting after the margin targets. This is just a snapshot of the company. I mean the reality is we are a largely off-road business. And you can see we've got a really strong position in our marine portfolio as well as in the on-road segment within the motorcycle and Slingshot. We've had this chart in for a few years now in terms of the competitive moat. And I think it's just important to keep it in perspective. We're still 1.3x larger than the next competitor. And you can see the positioning across each of our segments. And this isn't just because we've always been big, it's because we continue to put money into the distribution channel, making sure that we're upgrading, making sure our dealers are healthy, making sure we've got the network positioned in the right spot. It's the products that we bring to market. If you look at the innovation that we've launched over the last 3 years, across every part of our business, I couldn't be more happy and pleased with the lineup that we have, and there's a lot more yet to come. And I think that's really the benefit of getting ourselves back to being laser-focused on the company as opposed to trying to grow a portfolio of something that isn't core to powersports. And that's really served us well. And so we feel good about the competitive positioning that we have, and we feel this really puts us in a strong advantage relative to the competitors. I'd be reminisced not to talk about geared for good. I'm not going to use the terms ESG because this is much bigger than that. This is really about how we run our company the right way. We spend a lot of time talking about this to our employees because this is important to them. The environment matters to us, making sure that we maintain the trails and the waterways that our products are used in. Our employees give a ton of money, and they give a lot of effort to this, and we have some really strong partnerships with Forestry Foundation, for example, and a lot of the local trail clubs to make sure that we do everything we can. And if we can run our business better and save some money along the way, make the environment better than it was the day before, then we believe in doing that. It's nothing that we do for the purpose of doing, it's because we do it because of the business and it's the right thing to do long term. So I'll just wrap up because I know there's time for Q&A. Look, this is a -- it's a great company. When I look at where we're at and the progress we've made over the past 3 years, I couldn't be more pleased with what we've done with new products, getting the company refocused, making sure we're investing back in our facilities. Now we're in the phase where we've got to show that. We've got to prove that out in terms of getting the margins up. That is the #1 question that we get asked is, hey, can you really get yourself into that mid to high teens from an EBITDA standpoint? The answer is yes. Now it's not going to be easy, but we have a path. We've got the team focused on it. I don't think anybody saw the last couple of years of ups and downs in terms of consumer sentiment and where the market is and supply chain challenges coming, but we're staying focused and we're going to power through that. And I'm convinced with the operational plans that we have, the talent that we brought into the business, some of the org changes that we made to make sure that we put the power and the horsepower right where it needs to be inside the business. It's going to position us really well. And then we've made a lot of investments. You've seen some of them in terms of the new products. There's a lot more coming out, and we're really excited about that. So with that, turn it over for any Q&A.

Thanks, Mike. I want to start big picture. You mentioned retail softened last year and you cut back on production. Your retail was up actually in the last 3 quarters of the year. How would you describe as we go into '24, the overall demand environment for powersports? And how are you thinking about market growth this year?

Yes. I think when we look at the industry, we think the industry is down to maybe flat. For us, we think there's an opportunity to grow for a couple of reasons. One, the new products, we were late getting into market with XPEDITION and XD. And so that, from an off-road standpoint, puts us in a good spot. If I look at our marine portfolio, we just went through a complete refresh of the entry level of Bennington, and we're now moving into the midrange. You couple that with a complete refresh of the Godfrey lineup and Hurricane lineup, puts us in a really good spot. Dealers are healthy and well positioned. And then we're thrilled about where we are with Indian from a brand standpoint. The products that we've launched with completing the product lineup with Chief and Super Chief. So we feel like from a new product standpoint, there's a lot of excitement, there's a lot of momentum. For us, it's really going to be all about consumer sentiment. And if you remember, the off-road business is about 60% to 70% utility. And that segment has held up quite well. In fact, the demand for things like our North Star Rangers has never been better. I mean, it just continues to hold up really well. Where we've seen the softness in off-road is really on that rec side, and that's going to be all about consumer sentiment. It's going to be about interest rates. And so what our assumptions in the plan that we put together is that we're not going to see interest rates start to move until the second half and that, that market is just probably not going to be great. And that's why we've worked hard starting last year and into this year making sure we've calibrated dealer inventory, making sure we've got the right product in the right regions. And so it's really going to come down to that positioning. And like I said in the presentation, dealer inventory is the key for us, making sure we keep our dealers healthy, making sure that they're not carrying too much interest. I can't control what the others do, given 70% of our network is shared. But certainly, if we're behaving that way that sets a tone on an expectation, and we know from commentary from some competitors that they are talking more and more about this and the importance of making sure they keep dealer inventory healthy.

How important are rate cuts in your outlook for this year?

It's something that Bob and I talk a lot about. What's interesting is the -- it's different for marine because the value of some of the product is so much higher. But the actual incremental impact on people's payments isn't enormous. It's more of a psychological barrier, I think, and it's rolled into a lot of other things because the interest rates are high, gas is still expensive, groceries are expensive. So it's just -- it's everything is weighing in on it. I think when you see the first rate cut, I think it's going to start to move sentiment in a more positive direction. I don't think you see an overnight shift where all of a sudden everybody rushes in and buys a razor. But I do think you're going to have people that the discussion is going to stop being on the negative, and it's going to start to talk about, okay, we're moving now in the right direction. I think the second rate cut things start to move a little bit faster because I think consumer sentiment will move pretty quickly. It moved pretty quickly in the wrong direction when interest rates started going up. And I think it's going to put people in a spot where, okay, well, you know what, there wasn't a catastrophic recession, people held on to their jobs, interest rates were moving in the right direction. Now they're going to start to feel more comfortable. When you marry that up against a category like, I'll use, razor or rec in general, these people tend to only hold on to those products for 2 to 4 years. They are well at the end of that cycle. They're very innovation-driven. They like to have the latest and greatest stuff. And so there is a pent-up level of demand out there that we know that when people start to get to a point where they feel more comfortable in their job, their financials that, that they can start to move forward. So that could bode well as we get into either the second half of this year into '25.

Got it. You've been very vocal about the promotion environment. Where do we stand today? And I guess, maybe more importantly, what's assumed in your guidance in terms of when that starts to slow down a little bit?

Well -- so I'll say a couple of things. I've been vocal because we have tried to operate. And this is not a perfect industry. And you're always trying to catch up at some point in time because you're following movement from a consumer standpoint that's tough to predict. But we've been clear from the moment the pandemic hit and dealer inventories went into the tank, that dealer inventory was going to be a guidepost for us. And I believe we've lived up to that. It's frustrating because the rest of the industry doesn't necessarily behave like that. And the problem is that you then end up in the situation we are now, where you have competitors who weigh over shipped prior year models. I was shocked as Bob and I went through the data with our team, the percentage, the high level of percentage of competitors' retail that is still noncurrent inventory. And that's what's driving massive discounting. And for those of us who've kept our inventory in a healthy position, that starts to put pressure on our current model year inventory. And it's pressure that doesn't need to be there because it's all driven by whether the consumer feels like there's scarcity or too much products in the field. And then it turns into this promo game. And that's why we continue to talk about dealer inventory being such an important guidepost because that's a good way to keep the industry in a better spot than it has been. And so it's something that we're going to continue to keep an eye on. There were a lot of smaller players that came into the market and got space and dealerships, didn't happen just in marine -- in off-road, it happened in marine. And so there's an opportunity there for some of those OEMs maybe not to play as big a role in some of the dealers. But we're going to continue to keep ourselves anchored, and hopefully, the rest of the industry will follow suit.

Are you assuming it gets better as the spring progresses?

Well, I mean, implicitly in our guidance, we do because as we talked about, the first quarter is really the heaviest promo hit that we have. And that's -- essentially, as you come out of that, the inventory level is, by and large, in a much improved position, and that's really more around a marine comment. That whole industry is still trying to work through it. And that's why we took our shipments down in that kind of that mid-teens trajectory even though we think retail will be kind of flattish in the marine space. That will allow the inventories to drift down. And I think as we get into Q2, they should be better. Based on what we're doing, they will be better. If our competitors react in a different way, then it could be more challenging. But I do think, given the commentary that we've heard from them, I suspect they realize that they've got to play the right game relative to a software market, not trying to over ship into the channel.

It was actually my next question on inventory. It sounded like you were fairly comfortable with where the channel is right now, maybe a little bit heavy. Is that still the expectation?

Yes. I mean, look, I -- it's always this dynamic of -- overall, I feel good, but the devil is in the details. I wish I had a little bit of more utility volume out in the marketplace. I wish my rec volume for razor was down just a little bit. Marine is playing out as we had planned, which was we knew we were going in with inventory in a higher position than we ultimately wanted. But by the time we get through the first quarter, it will have corrected itself. It's still in a good spot relative to where we were in 2018. So it's not some unprecedented level. But it's just continuing to work through those pieces as we go.

Is the expectation still for a modest destock this year?

Yes. Yes. Yes.

And it's a dealer by dealer, state by state because the retail market is different in every state. Timing is different. Weather is different. So we're spending a lot of time. Like Mike said, it's -- in total, we think it's good, there's pockets, and we're spending a lot of time trying to really optimize dealers that have higher retail potential, that are seeing more velocity, getting them a little more guys that are slow because of weather, because of the market, because of economic conditions, whatever in their market, get them a little less. So we feel pretty good about where we are now.

That's helpful. Turning to you, Bob, in terms of margins, I think many of us in the investment community look at players as in "margin story", right, as Mike laid out. We're going from 11%, 12% EBITDA margins to potentially mid- to high teens. I think Mike talked a little bit about some of the cost pressures you're seeing. So maybe dig a little bit more deeper into that, number one. And number two, help us kind of bridge the 11.5% or so EBITDA margin you did last year with even at 15%, let's call it, by 2026.

Yes. So that's -- it's a mix of long-term and short-term things. Obviously, when the whole journey started, we did all the portfolio things, and so that's all played through now. We -- last year, you heard us talk about $70 million, and it wasn't $70 million of cost that came into the system, it was $70 million that we thought we would get out of kind of pandemic carryover inefficiency and that we didn't. And this year, we're targeting $150 million. I would say I feel better about the $150 million than I did about the $70 million. We've made a lot of changes in the business. We brought in a new operations leader for the off-road business, a lot of experience running plants in Mexico, both fast-moving plants as well as really complex assembly plants. So some new talent there, some new talent at the corporate level, and just a really good refocus. Mike and I, our teams are spending a lot more time in the factories and focused on reviews of the factories. We've got good line of sight for how that money is going to come out. To Mike's point earlier, there's a lag. I mean it's -- anything you do in the plant, you don't really see for a quarter because of how it cycles through inventory. So we were better in November and December. That trajectory has continued in January and February. So we're on track where we thought we would be. That feels good. And we think that there's more opportunity, I think, as we step back and look at it. We probably even pre-pandemic in our biggest plants were not as good as maybe we needed to be and as good as we probably thought we were. And so there's a lot of room to get even better from where the plans were for this year. So that's kind of a constant. You put in all the lean training and the right people and you make progress kind of month-over-month and quarter-over-quarter. We have 2 new facilities in Mexico coming online in 2024. We have a back shop plant that does tube bending, welding and injection molding. That was to bring in stuff that had been outsourced. And so that's coming online right now. We're already starting to make product there. It will get filled up through the course of the year. So you'll start to see more of that run rate benefit in '25. And then we have a new engine assembly plant in Mexico that's just coming online here in April. So those are big structural changes that we'll have benefit as we get into '25 and '26 to drive margin improvement. We've got a new facility for Indian Motorcycles in Vietnam. That comes online here in '24. And so we'll be making all of the midsized motorcycles for the Asian market in Vietnam, which will help a lot with that product. There's a lot of tariffs on that product. And then by assembling it in Vietnam, we can avoid a lot of those tariffs. And so that will be helpful. So there's those kind of structural changes that come in kind of in the '24 into '25. And then really the longest kind of pole in the tent is what Steve Menneto has talked about, which is, if you look at our motorcycle business, they've done a nice job of platforming and being really efficient in their design. So you look at like the Chief, there's multiple derivatives of the Chief, same thing with the Scout because we were the #2 competitor, so we could follow somebody. We knew what the market kind of wanted and needed, and we could learn. In off-road, we invented all these categories. And so we weren't very efficient in our designs. We used to do 2 seaters, separate from 4 seaters with different teams, all those kinds of things, not a lot of commonality in parts. If you look at our product line now versus some of our competitors, we have more brake systems, more exhaust systems, just -- we just hadn't done a good job of platforming. And so as we redesign product, big focus on platforming and part reduction and simplification, but that takes a while because you got to -- you only get it as you redesign products. So that's the stuff that comes in kind of '25 and '26. And all of that together, plus Indian's profitability improving, which we'll continue to do, gets you to the kind of that 15% to probably higher.

Got it. Very helpful. You guys have launched a number of EVs recently. How big do you see that segment in powersports?

Yes. I don't think it's going to be in the near term substantial, but it is important. And when we retooled our electrification strategy back in 2021, at that point, we were trying to electrify everything in the portfolio. And it's important to demonstrate that capability and we have. So we have an electric snowmobile, razor, ATVs, you name it. The issue is that if you try and commercialize across all of that, you may not have going into markets that have any kind of consumer demand, so we spend a lot of time talking to consumers. And what became very clear is utility was the space we could go, a lot of demand from customers, people own multiple acres of land, looking for something quiet. They're using it around livestock or around vineyards and things where there's people touring. They're also looking for something to get some of their environmental goals. And they're accessible to power. And so when you look at all those characteristics, utility was really the big focus area for us. We went there when we launched XP Kinetic, and it was wildly successful. We've gone through 2 ordering windows, and every time we sell out everything that we have in the allotment. So we're going to continue to focus in developing that particular product portfolio because we think that that's where consumer demand is. The interesting thing about it is about 40% of the customers who have bought those vehicles are actually new to Polaris. So we do know that we're reaching people who may not have bought one of our gas combustion engine vehicles because it wasn't suited for the application that they have. But I think we've seen the stout body shift to the right and left on auto EV. We're not going to do that in powersports. It's an important complement to our business. Who knows where it goes long term, but at least in the near term, it will just be small pieces of the portfolio, but an important element of demonstrating our innovation. One of the things we showed our Board was you can put a list of all the competitors in the space that have talked about EV, and you look at the money that they've spent, if you look at the money we've spent, it's about 1/3 of what they've spent. And we're the only business that actually has a product out in market. So I think we're being pretty effective with what we're spending and staying focused on.

Got it. In the last few minutes we have here, I want to talk about capital allocation since it's pretty important. Since you've been CEO, I think that the company has kind of refocused a little bit more on share buybacks, a little bit less on M&A, so to speak. Talk to us about what your priorities -- I know you touched on this a little bit earlier, but your priority is there on the M&A front, what type of acquisitions would you look for?

I mean, look, our track record on acquisitions is pretty mixed. The marine acquisition of Godfrey, Bennington and Hurricane has been excellent. In terms of the cash flow return, the returns that we're getting out of that portfolio, it's accretive to EBITDA margins, great brands. I mean, it's just -- it's been a home run. And I don't want to dilute that. And so, as Bob and I look at the horizon, I'd say one of the big shifts that we've had is it's not an all or nothing, meaning the old was we either have to invent everything ourselves or we got to go buy it. And the reality is, and we've demonstrated this, we don't necessarily talk about it because they're not material, but we do have small investments that we make. It can be as simple as a furniture manufacturer that supports our pontoon business to an e-bike company where we're learning and getting a lot of intel in terms of where would a consumer go if they want an electric motorcycle. But we don't have to go out and buy it, and we don't have to try and invent it ourselves. So we do a lot of partnerships. I wouldn't call them JVs, they are more investments, incubator-type investments. And those are great because they're low-dollar volume. The risk is relatively low, and it gives you an opportunity to see things from a different vantage point. And that's not to say that big scale M&A would be off the charts right now. But given our valuation, I'm not going to go out and buy someone else's business. We are way undervalued relative to where we should be. Assuming you get to a point where the company's valuation we're comfortable with at, then it really is going to be about strategic fit and financial complement. Because I think if you look back at our past, we were outside of our strategic strength areas, and we bought businesses that just structurally were different and had very different financial characteristics and that just didn't work well. So we're going to have a lot of discipline, which means it's going to be really difficult to get through that funnel. But if something gets through, then we'd take a hard look at it.

Got it. Well, I think we're just out of time. So Mike, Bob, thank you. Thank you, everybody. Enjoy the rest of the conference.

All right. Thanks.