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Summary

  • Motorized RV shipments remain well below 06-07 peak.
  • Market likely underestimating operating leverage.
  • Healthy backlog will offset weather weakness.
  • Price target: $33 (20x Projected FY14 EPS).

Winnebago Industries (NYSE:WGO) is among the premier motorhome brands in the United States. The company is highly cyclical and dependent on macroeconomic performance, but assuming the U.S. economy remains relatively healthy, shares could easily trade to $33 within the next 6 months-upside of 25%. Let's take a look at a few key assumptions driving this long thesis.

Motorized RV Shipments below Peak Years

Though we are not likely to see a year like 2004 again (71,000 motorhome shipments) thanks to higher gas prices and more conservative lending practices, the industry shipped only 38,332 units in CY13. CY06 and CY07 had industry shipments around 55,000 units. Motorhome shipments were historically weak throughout the credit crunch, bottoming out with 13,900 shipments in CY09.

It is not reasonable to assume motorhome shipments will recover to 06/07 levels, particularly given tighter credit markets and home values that have not returned to previous levels, reducing collateral for buyers. Nevertheless, even a 20% increase in shipments would peg total industry volume in CY14 at only 46,000 units. Thor Industries (NYSE:THO) was confident enough to expand its production facilities for motorhomes in light of robust demand. Thor's confidence and industry growth potential lead me to believe that the consensus revenue estimates of 13.6% revenue growth at Winnebago are too low.

The Market Underestimates Operating Leverage

Few industries have as much inherent operating leverage as manufacturing. Ford (NYSE:F) has seen the market consistently underestimate its operating margin, as it grew from the mid-single digits to over 10% in the last year. The same story can be said for Winnebago.

The firm posted an operating margin of 5.5% in FY13 driven by a gross margin of 10.5%. At the moment, Winnebago's factories remain largely underutilized (current run-rate ~ 70%); leaving ample room to further leverage fixed manufacturing costs in the upcoming quarters. Winnebago consistently posted gross margins in excess of 11% from FY04-FY07, and there is considerable room to boost the 10.5% margin from FY13 to 11.7% to 12%, without factoring potential gains from superior technology systems and investments in factory automation.

Further, Winnebago's management has done a fantastic job of maintaining low SG&A costs even as sales ramp quickly. Going forward, Winnebago should be able to keep its SG&A flat, if not leverage G&A slightly more as sales increase. Gross margin is the larger component of operating margins for Winnebago, but strong cost containment will help drive more dollars to the bottom line. Overall, I think Winnebago can post an operating margin of 7.2% in FY14.

Healthy Backlog will offset Weather

Given the slew of bad news from retailers and automakers throughout January and early February, it is reasonable to expect weak dealer sales of motorized homes due to the horrendous weather across the United States. Dealer inventory is at its highest level since 2008, yet demand is also at its highest level since the period prior to the credit crisis, so I see no immediate cause for concern. Winnebago had a unit backlog of 3,534 motorhome units and 151 towable units at the end of Q1. Therefore, even if dealers sell fewer than expected units in Q2, Winnebago's financial performance will not suffer.

Equally as important, a weak Q2 will not materially impact annual results. Consumers looking to purchase a motorhome will do so in Q3 or Q4. Thus, even if backlog growth is modest or even negative in Q2, orders will be strong in the second half of the year.

Risks

Most risk to Winnebago is macro related. The company's performance tends to correlate to the broader housing market, and its core wealthy 35-54 year old consumer has retirement accounts and wealth dependent on capital markets. Any broader capital market swoon could be an incremental negative for Winnebago's stock.

As for housing, data has not been robust thus far in CY14, but much of the weakness is weather related, in my view. If data flow remains bearish for the first half 2014, it is appropriate to completely re-evaluate the Winnebago story.

On a company related basis, there are not many major near-term risks. The company has seen a chassis bottleneck at its Class A gas supplier, but management revealed that it will receive an increase in supply late in Q2, making this issue less of a risk going forward.

Price Target: $33

Given that the market is underestimating Winnebago's margin expansion and is potentially too conservative on broader motorhome growth in CY14, shares look slightly underpriced compared to historical multiples. The stock rarely trades at less than 20x earnings during upswings in the motorhome market. I model the firm earning $1.68 In FY14-higher than the Street. My $33 price target is roughly in-line with the 20x historical multiple and assumes that stronger Q2 results will cause an upward revision in earnings estimates.

Reasons to abandon the long thesis revolve around the broader economy and to a lesser extent, execution. Poor housing market performance and capital markets performance will impact the firm's wealthy consumers as well as credit availability. Additionally, if Winnebago's attempt to grow its fleet sales prevents gross margin expansion, then shares should be sold. A forward PE in excess of 20 is also a sell signal because the company remains highly cyclical and is not immune from broader economic factors. Rarely has the company been able to meet the lofty expectations associated with such a high multiple.

Source: Positive Catalysts Lie Ahead For Winnebago Industries