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Analysis: Polaris Industries: A midcap for daredevils only?

A mechanic checks the engine of an Indian motorcycle at the showroom of Indian Motorcycles of Northern New Jersey in Union, August 20, 2013.
A mechanic checks the engine of an Indian motorcycle at the showroom of Indian Motorcycles of Northern New Jersey in Union, August 20, 2013.

By James B. Kelleher

CHICAGO (Reuters) - Polaris Industries Inc's relaunch this month of the Indian motorcycle, a storied U.S. brand older than Harley-Davidson, has pulses racing on and off Wall Street.

But should investors in the maker of all-terrain vehicles, snowmobiles and motorcycles be tightening their chin straps for more fun ahead - or dumping their shares?

Since 2009, Minneapolis-based Polaris has doubled its sales and nearly tripled earnings - despite a lackluster rebound in consumer spending - by introducing innovative products in the ATV space that have allowed it to snatch share from some world-class rivals, including Honda Motor Co Ltd <7267.T> and Deere & Co .

Now the midcap manufacturer is taking on Harley-Davidson Inc , which sells one out of every two motorcycles purchased in the United States each year and practically owns the "Made in the USA" segment of the market.

It's a bold move. And with its share price up 50 percent over the last 12 months amid the excitement over the reintroduction of the Indian, Polaris has little room for error.

Shareholders have grown accustomed lately to sizzling growth from the nearly 60-year-old company, which spent much of its life as a slow-but-steady manufacturer of off-road vehicles but has, in the past few years, made a big push into the on-road space.

In addition to its Victory brand motorcycles, which are big cruising bikes like Harleys but are marketed - according to Chief Executive Officer Scott Wine - toward riders who care more about engineering than labels, Polaris has also moved into the electric vehicle space with its purchase, earlier this year, of France's Aixam Mega, a privately held maker of light-duty commercial vehicles.

On the strength of a series of buzz-producing product introductions, including this month's relaunch of Indian, triple-digit growth in sales and earnings per share, and a string of intriguing acquisitions and joint ventures, Polaris has recast itself on Wall Street as a growth company.

Over the past five years, under Wine's stewardship, Polaris investors have seen their investment - dividend yield included - jump by almost 500 percent, a return that has left everything else in the dust. Polaris stock now trades at a significant premium to peers, and its shares are rated either a "strong buy" or "buy" by 12 of the 14 analysts who follow it.

But Polaris remains a manufacturer of high-priced, discretionary consumer products in an uncertain and increasingly competitive environment.

Analysts - even ones like Morningstar's Jaime Katz, who calls Polaris "one of the most-liked companies we cover" - concede the stock may be priced for perfection.

"I think the multiples have gotten a little ahead of themselves," he says.

Polaris is counting on the Indian to keep earnings in high gear. The company unveiled the first three Indian bikes, which will sell from $19,00 to $23,000, in a most unlikely place: the Sturgis Motorcycle Rally, hallowed ground for legions of Harley-Davidson enthusiasts who flock to the Black Hills of South Dakota each year.

Even top officials with Harley-Davidson admired the upstart's brass. "Polaris is a smart company," Matt Levatich, the president and chief operating officer of Harley-Davidson Motor Company, told Reuters. "If you're launching a new product and you want to get maximum exposure, you probably do it in Sturgis."

Polaris followed the provocative debut with a national TV ad campaign that coincided with Harley-Davidson's annual dealer convention. The bikes, which can be ordered now, will arrive in dealerships in mid-September. Polaris has said it hopes to have 140 to 170 U.S. dealers and 70 overseas by yearend.

HOG HEAVEN

The company's swagger is big. But so are its challenges. The Indian brand, which it bought two years ago, was founded in Springfield, Massachusetts, in 1901 - two year before Harley-Davidson. The bikes the company made until its demise, in 1953, have become collector's items, and Polaris is not the first to try to resuscitate the brand. Time and time again, those efforts have failed to gain traction. The key problem: Most owners went with low production volumes and high sticker prices.

"In 50 years, nobody else - no other American motorcycle maker - has really been able to give Harley-Davidson a run for its money," says James Hardiman, an analyst at Longbow Research.

"Polaris doesn't have to come close to taking down Harley-Davidson for there to be upside to the story, given how dominant Harley is. But this is a difficult market to compete in. If you've got a Harley-Davidson tattoo on the back of your neck, you tend to be pretty brand-loyal."

This time will be different, insists Polaris CEO Wine. "We have the experience. We have the capability. And we have the financial resources," he told Reuters.

But others have had money, too, including the investment firm Stellican, which purchased Indian in 2004 and sold it to Polaris seven years later after trying unsuccessfully to revive the brand. Even with deep-pocketed backers, nostalgia goes only so far.

Management believes previous efforts have priced Indian bikes too high, so Polaris is inviting direct comparisons with Harley by setting prices in Harley-Davidson's sweet spot, ranging from $19,000 for the Indian Chief Classic to $23,000 for the Indian Chieftain - about half what the Indian was selling for under Stellican.

Tim Conder, an analyst at Wells Fargo Securities, says Polaris hopes to ship 1,500 Indians this year and 8,000 in 2014, targeting riders at the higher end of Harley-Davidson's target demographic of 25- to 55-year-olds "who are not predisposed" to the Milwaukee-based company's products.

Harley-Davidson, by comparison, has said it plans to ship up to 264,000 bikes to dealers this year, up from 247,625 in 2012 but down from the 2006 peak of about 350,000 units.

Like Harleys, Indians will be made in the United States, their engines manufactured in Osceola, Wisconsin, and the bikes assembled in Spirit Lake, Iowa. To a non-enthusiast, they look a lot like Harleys, though with a decidedly retro styling. In its gushing review of the new Indian, Cycle World compared the styling of the top-of-the-line Chieftain to the streamlined trains of the 1950s. It's not a bad description.

Initially, Conder predicts, Indian's impact will be felt largely by Japanese motorcycle makers Honda, Kawasaki, Yamaha and Suzuki. "It will be 2015 at the earliest before Indian is a material threat" to Harley, he says.

Other analysts are more skeptical.

"I don't think that over the next five years you're going to see market shifts and people saying, 'Forget Harley. We're going to go buy an Indian bike'" says Morningstar's Katz. "I don't think it's going to do anything to Harley. Harley will be just fine."

STINGY MARKET

Wine has seen how slowly markets can develop. A former Navy officer who worked at United Technologies Corp , Danaher Corp and Honeywell , he joined Polaris in 2008. At that point, the company had been flogging its initial foray into the motorcycle market - the Victory brand bike - for a decade. It would take a few more years before Victory turned a profit.

Adding to Polaris' challenge this time: The U.S. motorcycle market still has not recovered from the recession, with sales down 40 percent from the 2006 peak. In such a stingy market, there's a risk Indian could gain share only at the expense of Victory.

Wine downplays that risk, citing extensive focus group tests. He also says he's optimistic that Indian will essentially jump-start the slow-recovering market.

"What's been lacking (in motorcycles) is significant innovation," he says. "And with Indian coming back, and it sounds like Harley-Davidson is going to bring some great new products, I think you're going to see a couple of years of good growth as innovation returns to the space."

Another vulnerability for Polaris may be in the ATV area. Although Polaris is the top seller in North America, thanks to innovations such as the Ranger and RZR side-by-sides, Honda, Yamaha and Suzuki are expected to make a renewed push, aided by pricing advantages thanks to the weak Japanese yen.

The company is entering new territory for investors. Once viewed as a cyclical stock, Polaris has seen its shares rise steadily from a recent low of $7.60 a share in 2009 to around $110 in the past few weeks.

"I think they've transitioned into a growth company," says Hardiman at Longbow. "But there's less room for error with a growth company."

Wine has promised to double revenue, to $8 billion, by 2020, which actually would represent a deceleration from recent years. He says he has warned investors that the path may be bumpy.

"I make it very clear to every single shareholder and every single investor that we are not going to grow to the moon," Wine says. "And we've made our fair share of mistakes. Nobody always gets it right."

(Reporting by James B. Kelleher; editing by David Greising and Douglas Royalty)

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