Posted on the Value Lab 7/25/22
BRP Inc. (NASDAQ: DOOO) is an excellent company from an operational and end-market perspective. ROICs are high and the company benefits from a favorable industrial structure. However, supply chain issues have been a big deal for the company after the initial powersports boom. Volumes fall and profitability takes its consequent decline. The question is now macro. Management believes their end market profile is strong enough to withstand macro headwinds. We think they might be right. But with prices not too far from the highs, we are not constrained by valuations, although fundamentals may remain resilient.
This quarter was a down quarter. While BRP has fared better than most other players in the industry, the drop in products selling this season is on average around 9%. The situation for wholesale sellers fully mirrors the situation where they shift their inventory to retail, almost 1 to 1.
In recent quarters, the company has relied on home improvement sales to satisfy its customers. These renovations will continue from this quarter. Ultimately, demand pushes hard against supply and nothing but unleashing supply chain bottlenecks can solve this problem.
The fall in volumes is indeed the main characteristic of this quarter. Sales remained stable as price increases offset volume declines. But volume declines were unable to smooth out G&A, and gross margin compression due to production inflation still had its effect.
EBITDA fell by more than 25% and gross margin by nearly 20%. Operating leverage is naturally in effect for an industrial company like BRP’s and the hardship falls on the shareholders. Aftermarket revenue has grown quite well by at least 14%, and we expect that 20% of revenue to be a more resilient element as the larger installed base produces more recurring cash flow in this segment.
Assessment and Conclusions
The company produces very high ROICs and, in principle, the valuation is quite low at 5.5x EV/EBITDA. In previous articles, we have used TMA to demonstrate that at least using DCF logic, business is cheap. The problem is that DCF logic generally says companies are cheap. The market reality is that the company is still trading a bit above pre-COVID levels and not too discounted (around 25%) from the highs, roughly in line with the market. Indeed, sales are ahead of 2019 levels by a decent margin, and earnings are also ahead by at least an expected 20-50% margin, so ahead of pre-COVID probably makes sense. In fact, we agree with management that the business should be fairly resilient to macro headwinds.
Craig, to be honest, we’ve had our review with our entire division before, obviously, our quarterly results and we’ve challenged the team, and we’re not seeing any slowdown in demand right now. Their customers and maybe it’s because our customers, our above-average household incomes, they don’t feel that impact.
José Boisjoli, CEO of BRP Inc.
The destruction of demand due to higher prices is of greater concern, also because it slows aftermarket turnover if people are more careful about using their vehicles. But when it comes to macro risk, preorders haven’t dropped yet, and they likely would have if customers anticipated the concerns.
However, the unemployment spiral has yet to begin and the economy could decline much further from these levels.
In some ways, BRP can be thought of a bit like the building products businesses we cover, where releasing bottlenecks might actually be good for business volumes, with higher income end markets. able to sustain spending while the rest of the economy contracts. But such a bet would be optimistic. Although the company has negotiated with the markets, we still believe the supply chain situation will persist for at least a little longer. Being quite influenced by market movements, even though its fundamentals are strong, we would be cautious to invest now. Perfect for the watch list.