Posted on the Value Lab 9/15/22
BRP Inc. (NASDAQ: DOOO) is a company that we have been following for some time. While things seem to be looking up for them despite the current economic environment, supply chain issues are slowly resolving and income coming in, we worry about consumer discretionary spending after the release of pent-up demand. Additionally, due to the hedges in place, opportunities for margin expansion are more limited in what may be the last year for a while of favorable industry conditions. It’s a premium title, but it’s about as discretionary as it gets, so we have to be careful.
BRP Inc. Q2 results
DOOO did well where it counts. Side-by-sides and three-wheelers were growing in the mix, lending a helping hand with price effects to revenue growth. But volumes were generally much better too, and better than the industry as a whole. Semiconductor inventory isn’t as hard to find anymore, which means an acceleration of retrofit sales with clusters and gauges arriving faster now, as well as the ability to stack more, although inventory still limited, with dealerships creating more speed in sales.
The supply chain releases helped the business a lot and came at a good time where some catch-up on the component supply side could be achieved while factories were not operational due to the cyberattack of this quarter.
Revenues were up 28% year-over-year, but Normalized EPS was down slightly once we reversed the currency effects that made flagship lineups very favourable. Taking into account the incidental benefits of FX, EPS increased by 20%. Unfortunately, the growth in volumes and prices was fully offset by inflation, so gross margins fell about 500 basis points year-over-year and gross profit remained flat. Additionally, due to the hedges in place, gross margins are unlikely to improve later in the year, despite peak season and new supply chain releases contributing positively to earnings due to scale and composition. These hedges expire next year, but the macroeconomic situation being what it is, one would have hoped that more leverage would capitalize on these strong sales results. Nevertheless, DOOO expects around 15% growth in EBITDA from the OPEX side, with cost control efforts.
DOOO is the industry champion as far as we are concerned. They are making their foray into e-bikes and continuing to innovate in marine as well. While there were some acquisitions this quarter that might have been worth discussing and they achieve some vertical integration, we are primarily concerned about consumer discretionary trends.
A common corporate theme right now is that Europe is a weak spot in terms of consumer confidence and retail demand. Indeed, BRP notes a shift in the mix towards the United States, which is more resilient at the moment, and management considers Europe, which represents around 15% of sales, as a worrying market. We think a similar force could eventually take hold in the US as well, especially as rates continue to rise. Right now the availability of credit isn’t the issue in financing purchases, or the destruction of demand due to gas inflation or something like that, but at some point when the backlog of Renovation orders are liquidated and pent-up demand from more effervescent previous seasons pre-orders are being released, we might see some issues with demand. As Howard Marks says, everything comes in cycles, in particular discretionary consumption. Believing that we are in a new normal for motorsports is a mistake. It is a macro lever.
The company is still trading low at 6x EV/EBITDA, but on an LTM basis. LTM numbers in all markets are likely to be higher than forecast numbers, particularly in consumer discretionary, and particularly for DOOO, which relies on negligible scale advantages and leverage operational. We think we could see the benefits of pent-up demand right now and not necessarily a reflection of failing consumer trends, while already bad in Europe, are also visible in many markets, especially consumer tech, in the States -United. Consumer confidence is low. We just don’t think DOOO is a particularly safe place in the market, especially when it’s still within the trading range of its highs. Great company but pass until the cycle paints a better picture.