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To The Recession: Eat My Dust

There's no tradition more all-American than the cylinder count. Add up your V-8 pickup and motor home, the six-banger sedan and all the two- and four-cylinder toys and tools strewn around the garage, then see how you stack up against your neighbors and friends.

Somewhere in that tally you are bound to find the name Polaris.

Minnesota-based Polaris (NYSE:PII - News) has spent the last couple years gobbling up market share from foreign competitors. A large part of that momentum has come from its groundbreaking Ranger RZR series of high-performance all-terrain vehicles.

But the company has also engineered some interesting strategic turns, spending a total of $28 million for two deals in April.

On April 19, it announced it would buy Minnesota-based Indian Motorcycle, adding the long-struggling U.S. brand to its Victory motorcycle line — an upscale rival to Harley-Davidson (NYSE:HOG - News).

A week later, Polaris snapped up Chrysler's Global Electric Motorcars division, which produces "neighborhood vehicles." Essentially large, luxury golf carts, the battery-driven vehicles have top speeds of 25 miles per hour and generated sales last year of $30 million.

In addition, both Polaris and Harley are reaching to overseas markets, working to capitalize on brand strength in regions with rising incomes.

In August, Polaris launched a sales initiative in New Delhi. It's testing the waters with a 70-vehicle lineup, aiming for $400 million in annual sales within five years.

"You look at the population density (in India), you look at the infatuation people have with good brands and higher-end, aspirational-type purchases," said analyst Scott Hamann of KeyBanc Capital Markets. "Brazil, India and China are markets where there's very low penetration, and where you want to be for long-term growth.

As a group, the makers of powersports vehicles, as they are collectively called, have fueled the remarkably strong recent performance of IBD's Leisure Products industry. The group held a No. 35 ranking among IBD's 197 industry groups on Friday, after rating a top 20 slot since June.

1. Business The Leisure Products group is comparatively small. It includes makers of firearms, golf clubs, pool tables, mountaineering equipment and weightlifting machines.

It is also home to Steinway Musical Instruments (NYSE:LVB - News) and faded photo giant Eastman Kodak (NYSE:EK - News).

But the group's only three stocks with market capitalizations of more than $1 billion are motorsports industry leaders: Polaris, Harley and boat maker Brunswick (NYSE:BC - News).

Leading competitors outside the group include farm-equipment icon Deere & Co. (NYSE:DE - News), and Canada's Bombardier Recreational Products, maker of Ski-Doo snowmobiles, Sea-Doo watercraft and Can-Am roadsters and ATVs.

Pacific Rim competitors are led by Japanese auto titans Honda (NYSE:HMC - News), Suzuki and Yamaha, the latter also being the world leader in musical instruments.

Polaris and its neighbor Arctic Cat (NASDAQ:ACAT - News) started as snowmobile makers but successfully branched out into all-terrain vehicles, or ATVs.

The ATV market grew out of the off-road motorcycle market, one wheel at a time.

The category originally started as ATCs — three-wheeled, all-terrain cycles — that were eventually pulled from the market because they tended to flip in fast turns.

Powersports manufacturers added a fourth wheel, and ATVs moved in to fill the gap. Today, ATVs can be two-wheel, four-wheel and even six-wheel-drive contraptions. Among the fastest-growing categories are the side-by-side ATVs, so called because it seats two people beside one another.

Traditionally, side-by-sides were slower and geared low and used by farmers, groundskeepers and other utility applications. But Polaris struck a massive hit with its Ranger RZR line.

The RZR's lower center of gravity makes it much more stable at higher speeds, allowing the side-by-side to cross over into a more high-performance sport market.

Name of the game: "What seems to determine market share is the innovativeness of the product," said Craig Kennison, an analyst with R.W. Baird. "It might be a bit of an overstatement to compare (Polaris) to Apple (NASDAQ:AAPL - News), but like Apple it has used its innovative wherewithal to develop cool products.

2. Market Recreational items tend to be high-ticket items and extremely sensitive to economic cycles, especially pricier products like motorcycles and boats. Prices for Polaris ATVs start out at $6,200. Harley's entry point is $8,000.

All the vehicle makers got hammered by the recession and, apart from the side-by-sides, most are seeing sales come back only this year. ATV sales actually peaked alongside the housing market in 2006. From that high point, U.S. unit sales fell 63% to 330,000 last year, according to the Motorcycle Industry Council.

Motorcycle sales declined almost as sharply, down 55% to 329,000 in the same period. Boat sales were also halved between 2007 and 2010, Brunswick reported.

This year, sales started to turn. ATV sales were still down in the first half, but motorcycle unit sales rose 3.3% over the first half of 2010. (The ATV data do not include side-by-sides.) Although the industry is labeled leisure, vehicle makers aren't strictly serving recreational markets.

Polaris handles corporate and military contracts. On Sept. 12, it announced three Department of Defense orders for ATVs and side-by-sides, topping $12 million in total.

Other types of motorcycles and small vehicles are used by police, farmers, construction workers and the like. Hamann says a strong agricultural sector, driven by high food prices, has helped boost the commercial side of the off-road market over the last year.

Another leading player in the group, Sturm Ruger (NYSE:RGR - News), scratches that old American, trigger-finger itch to possess firearms. It sells mostly to private individuals. Buyers use them for sport, but also for personal protection. Hamann says that in times of economic hardship and social unrest, gun sales go up, making them a countercyclical play.

But Hamann says gun sales are subject to a different kind of cycle: the election cycle. During the last run-up to a presidential election, in 2008, gun owners stocked up for fear of new legislative restrictions. Now another burst is in progress, with August's FBI background checks — a measure of gun purchases — up 14% over the year earlier.

"This could be the biggest pull-forward of demand in the history of the country," said Hamann.

3. Climate The recession led to a massive de-stocking of inventory among dealers and vehicle makers. Analysts praise Polaris' and Harley-Davidson's inventory management in particular, which kept operating margins positive even when their sales went negative.

"(Polaris) learned several years ago that having too much inventory at the dealer level only put dealers in financial distress, and forced them to discount products," said Kennison. "(For Harley) it hurt dealer profitability, hurt the cachet of the brand, and put pressure on used-bike values.

Kennison's most recent survey of Harley dealers, released in August, found those problems turning around. Inventory was low, new-bike sales were up 11% sequentially and used-bike sales rose 16% during the first half of the third quarter.

Hamann says the market disruption in off-road vehicles actually benefited U.S. companies. Japanese competitors pared back investments in North America. Harley seems to have benefited the same way, as its U.S. market share rose from 46% in 2008 to 55% last year, according to Kennison's data.

Brunswick lost money for three straight years, using the recession as an opportunity to restructure. It sold off its more sluggish brands and hacked back its head count by 46%. Sales turned up again last year, however, and the company is expected to turn a hefty profit this year.

Polaris also made significant structural moves, announcing last year it would close a manufacturing plant in Wisconsin by 2012 and begin manufacturing its ATVs in Mexico this year.

4. Technology After being stalled for many years, designs among side-by-side ATV makers are changing fast, spurred by Polaris' introduction of the Ranger RZR in 2008. The design kicked side-by-sides up into the category formerly owned by the more nimble, single-seat ATVs.

"(The RZR) has terrific suspension, it handles really well off-road, and it's just a tremendous amount of fun," said Kennison.

Arctic Cat recently introduced a competing side-by-side line with its Wildcat, launched in July. It boasts a few features the RZR doesn't have, including electronic power steering and racing shocks with 17 inches of travel.

Polaris' acquisition of Global Electric Motorcars also points to rising competition in the market for on- and off-road electric vehicles. Battery-powered-passenger and goods-delivery side-by-sides will be part of its offering in Indian markets, in an effort to outflank India's Mahindra Reva Electric Vehicle on its own turf.

Bombardier jumped into electric neighborhood vehicles in 2008 and launched its Can-Am model side-by-side ATVs last year. The company now says it is working on an all-electric version of its Can-Am ATV, with a 100-mile range.

5. Outlook Apart from Polaris, which has been on the upswing since early 2010, most of the top companies have just seen their finances turn, hinting at upside potential.

Analysts expect Harley's profit to more than double this year, then grow in the mid-20% range in each of the next two years. Analysts see Brunswick's earnings up 85% next year and 60% in 2013. Polaris and Arctic Cat are both expected to grow in the mid-40s, while Ruger's outlook is in the teens.

Analysts also see potential abroad. Harley, which saw 72% of its revenue from the U.S. last year, is building a new assembly plant in India — only its second outside the U.S. Polaris, which booked 71% of 2010 sales in the U.S., says it is positioning for growth in China and Brazil, as well as India. Analysts say Brazil has been a receptive market for American powersports vehicles, and offers a swelling, brand-conscious middle class.

Upside: Continued economic recovery, cleaned-up operations and growth in emerging markets can all help U.S. leisure brands build market share globally.

Risks: Globalization also means more exposure to foreign troubles, such as those besetting Europe, which prompted Kennison to trim his outlook for Harley recently. It's also a market where whoever comes up with the coolest new product could grab market share, including the Japanese makers who historically have led the field.