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Polaris Amends Credit Agreement, Maintains Dividend, and Expresses Optimism for Recovery

Polaris had good news for dividend investors yesterday when the company announced its regular quarterly payout and shared a brief business update.

Earlier this month, we cited concerns about Polaris' leverage ratio (total debt to EBITDA) rising as cash flow declined due to closed dealerships, supply chain disruptions, and high unemployment crimping demand for the firm's products.

The immediate concern for the maker of off-road vehicles is rising leverage as cash flow experiences a major shock. Polaris may be at risk of breaching certain financial covenants with lenders, which could threaten the dividend.

Moreover, management may opt to be especially conservative with cash as unemployment reaches record highs, crimping demand for the company's high-price products (ATVs, snowmobiles, boats, and motorcycles).

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In fact, management expects wholesale demand to drop 25-30% during the current quarter as dealers work down existing inventory and place fewer orders, even in spite of the promising start to April.

Meanwhile, supply chain disruptions may impede the company's ability to deliver on orders that do come in.

In April, Polaris negotiated an amendment to the firm's credit agreement with lenders that permitted leverage to increase to 4x for a brief period.

Despite the new threshold, Polaris was still at risk of breaching its debt covenants because of the extreme shock to cash flow and poor economic backdrop.

Another round of negotiations with lenders was an option on the table, but the implications for the dividend were unclear.

Fortunately, Polaris revealed yesterday a favorable amendment to the firm's credit agreement that permits leverage to rise to 4.75x through March of 2021.

Moreover, lenders didn't require dividend payments to cease.

With the additional buffer, we estimate Polaris' EBITDA can fall up to 35% in 2020 compared to 2019 before hitting the covenant's threshold.

Analysts currently forecast that Polaris will generate roughly $570 million of EBITDA in 2020, down 20% from 2019 levels of $718 million.

Previously, Polaris' EBITDA could have fallen only 25% this year before an event of default was triggered. The new covenant provides a lot more cushion.

Just as important, CEO Scott Wine noted that sales are exceeding expectations as people seek outdoor adventure during the pandemic:

"I am extremely proud of the resiliency and dedication of our Polaris team, as their agility has enabled our response to the unexpectedly sharp recovery we are seeing, which in many cases has meant unprecedented demand for our brands and vehicles.

"The influx of new customers to our dealerships is very encouraging, as people seeking fun family activities while social distancing recognize that our vehicles and “Think Outside” tagline resonate with their desires."

However, Polaris isn't out of the woods yet. It remains to be seen how much of a drag record-high unemployment and reduced consumer confidence will be on sales in the months ahead, especially if stimulus measures wane.

It's also possible that some of the uptick in interest may be the result of pent-up demand that's fleeting.

At this point, though, a dividend cut would be a surprise. The worst looks to be behind Polaris, and management appears intent on maintaining the dividend.

Nevertheless, we are maintaining our Borderline Safe Dividend Safety Score on Polaris until demand stabilizes and there's a clear path to reducing leverage.

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