This Unlikely Sector Is Posting Surprising Gains

We’re told as children (and even as adults) that you can’t have your cake and eat it too. You can’t turn a hobby into a paying job, and if an activity is fun, there’s probably no money in it.

Good news: You can.

It’s true that the economy has changed our way of life over the past five years. We’re more conscious of saving and downsizing to match our spending habits. The proliferation of fuel-efficient automobiles has crossed into a market that was once thought purely recreational.

Harley-Davidson, Inc. (NYSE:HOG)Winnebago Industries, Inc. (NYSE:WGO) and Harley-Davidson, Inc. (NYSE:HOG) are up nearly 75% and 35%, respectively, as baby boomers take to America’s roads. Clearly, recreational vehicles are in full swing, but there’s yet another type of vehicle that hasn’t gotten the attention it deserves: all-terrain vehicles (ATVs).

This category includes snowmobiles, ATVs and utility task vehicles (UTVs). Sales of UTVs have exploded in the past year: The two leading UTV manufacturers have posted quarterly earnings growth of 217% and 185% year over year. Polaris Industries Inc. (NYSE:PII) has been the undisputed leader in UTV, ATV and snowmobile sales, but Arctic Cat Inc (NASDAQ:ACAT) has been taking market share away from its larger competitor in the past year and posting better returns on equity while Polaris’ return on equity has been in decline.

Brand recognition in the snowmobile segment, aided by its popularity in the Winter Olympics, has allowed Arctic Cat to increase sales in the offseason by 70% from the same period last year. Sales of Arctic Cat’s side-by-side ATVs grew 23%, driven by the popularity of its Wildcat and Prowler models. For fiscal year 2013, UTV and ATV sales were up 32% from 2012, led primarily by the ever-growing UTV market where they are generally put to work in a variety of industries from security to golf course management.

A case for the short term can be made by looking at recent results for Vail Resorts, Inc. (NYSE:MTN), a mountain resort company. Vail reported less disappointing earnings than widely expected recently, and investors haven’t lost a step, sending MTN up 34% this year. Revenues from Vail’s mountain segment — an environment in which Arctic Cat products thrive — was up 13% year over year.

Arctic Cat has had annual earnings per share (EPS) growth of 78% over the past five years. The future is looking bright as well, with a price/earnings-to-growth (PEG) ratio of just 0.81 and a price-to-sales ratio of just under 1. Arctic Cat holds zero long-term debt and increased its cash holdings by $16 million, to a total of $40 million. For 2013, the company has authorized a stock repurchase plan of $30 million in shares.

Risks to Consider: Seasonal weather changes may weigh on sales, and recreational sales are highly dependent upon income levels which could face pressure in the future from growing political concerns regarding debt levels and the impact of the government shutdown.

Actions to Take –> The recent earnings miss should be viewed as a buying opportunity at this price. The company maintained positive guidance for 2014 with EPS between $3.27 to $3.37. The sharp sell-off appears to be an overreaction, and based on the relative strength index, ACAT appears oversold. Arctic Cat now looks to be undervalued by around 20%.

David Goodboy
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