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Stock Strategist

Arctic Cat Repositions for Growth

Investors could be rewarded if management executes its operational turnaround, but patience is key.

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 Arctic Cat (ACAT) is one of the longest-operating powersports manufacturers. Unlike its closest peers, the firm is at a critical juncture in its life cycle, making an aggressive attempt to rebuild revenue and earnings after clearing bloated inventory levels in the retail channel. The firm has sacrificed price, running promotions to move older units rapidly out of dealer inventory, but has been able to gain share thanks to faster unit sales. While discounts continue to prevail--we believe they will persist through the end of fiscal 2016--Arctic Cat should restore operating profit growth beginning in 2017. Despite the lack of switching costs, we think the company's long-standing brand intangible asset and leading market share position garner competitive returns on invested capital and a narrow economic moat.

We expect unit demand to stem from the delivery of new, innovative products after retail inventory levels are restored to normal, which should help improve the gross margin profile. Management has articulated its willingness to expand in new channels, through bolt-on acquisitions as well as partnerships. We liken this updated strategy to the one Polaris (PII) has implemented in recent years and see acquisitions like Motorfist (parts, garments, and accessories) and partnerships with Toro and Yamaha as integral to scaling faster and becoming more operationally efficient and better diversified. With no debt on the balance sheet and the likelihood of rising free cash flow, Arctic Cat should be able to capitalize on appropriate acquisition opportunities at will.

Jaime M. Katz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.