Performance and Valuation Prime™ Chart
The PVP chart below reflects the real, economic performance and valuation measures of Wyndham Worldwide Corporation (NYSE:WYN) after making many major adjustments to the as-reported financials. This chart, along with all of the charts included in this article, as well as the detail behind the graphics, can be found here.
The four panels explain the company's historical corporate performance and valuation levels plus consensus estimates for forecast years as well as what the market is currently pricing in, in terms of expectations for profitability and growth.
The apostrophe after ROA', Asset', V/A', and V/E' is the symbol for "prime" which means "adjusted." These calculations have been modified with comprehensive adjustments to remove as-reported earnings, asset, liability, and cash flow statement inconsistencies and distortions. To better understand the PVP chart and the following discussion, please refer to our guide here.
The firm had relatively stable ROA' prior to 2009, ranging from 9.2%-9.5% levels, with the exception of 16.3% in 2004 and 13% in 2008. ROA' has marginally improved since 2009, recovering from 7.6% to 12.8% in 2015, while still below peak levels seen prior to the Great Recession. Additionally, the firm has struggled to grow the business efficiently, seeing nearly non-existent Asset' growth since 2009 as the firm tried to focus on profitability improvements.
Performance Drivers - Sales, Margins, and Turns
It can be helpful to break down ROA' into its DuPont formula parts, Earnings' Margin and Asset' Turns, which are the cleaned up margins and turns metrics used to calculate ROA'. The chart below details both Earnings' Margin and Asset' Turns historically, to help us better understand the drivers of the firm's profitability and performance.
Recent trends in ROA' have largely been driven by improving Asset' Turns from trough 0.6x levels in 2009 to 0.9x in 2015, while Earnings' Margin has remained relatively flat, ranging from 12.4%-14.8% levels. However, Asset' Turns are still at levels seen prior to the Great Recession, as the firm has struggled to substantially improve RevPAR since it crashed in 2009-2010 and is only recently seeing returns recover to prior highs. Without further Asset' Turn improvement to historical highs, or Earnings' Margin recovery to pre-recession highs, ROA' is unlikely to see substantial improvement.
Embedded Expectations Analysis
As investors, understanding what the market is embedding in the stock price in terms of expectations is paramount to making good decisions. Without understanding what the market is pricing in, it is impossible to claim that the market is wrong. We derive market expectations for the firm from valuations and historical performance trends, to give a clearer picture into what the market is projecting for the firm.
WYN is trading at a 17.9x V/E', near the higher end of historical averages. At these valuations, the market is pricing in expectations for no material Asset' growth, but with ROA' expansion to historically high 16.5% levels, from 12.8% in 2015.
Analyst and Management Expectations and Alignment
However, analysts have more muted expectations than the market, expecting ROA' to remain around 12% levels, with modest Asset' growth going forward, as they are expecting the firm to continue having trouble improving RevPAR and thus Asset' Turns, while also only maintaining Earnings' Margins at current level.
Furthermore, Valens' qualitative analysis of the Q1 2016 earnings call highlights that management appears concerned about their ability to maintain revenue growth, and about continued RevPAR pressures going forward. Additionally, they appear to have concerns about increases in customer loan defaults and the resulting requirement for increases in their loan loss provisions.
Additionally, Valens' Incentives Dictate Behavior™ analysis highlights that WYN's management compensation framework is negative for equity holders. Long-term compensation is based on EPS growth, which may bias management to use excess cash to buy back stock, boosting compensation, without improving profitability. Moreover, the framework does not punish management for overspending on capex, which could lead to overinvestment in new locations, potentially suppressing Asset' Turns improvements going forward.
Valuation Matrix - ROA' and Asset' Growth as Drivers of Valuation
When valuing a company, it is important to consider more than a singular target price, and instead the potential value of a firm at various levels of performance. The below matrix highlights potential overvalued or undervalued prices for WYN at various levels of profitability (in terms of ROA') and growth (Asset' growth.) Prices that are in excess of 10% equity upside are highlighted in black, and prices representing an excess of 10% equity downside are highlighted in red.
In order to justify current valuations, WYN would need to either see ROA' improve to historically high levels going forward, or begin growing Assets' at a pre-recession pace. Given the firm's struggles related to improving occupancy and ADR, it is unlikely that they will see substantial ROA' improvement in the near-term, and as occupancy rates are nearly a third lower than peer averages, it is unlikely that they begin growing their hotel base materially either. Given historical trends, and management concerns about profitability, current market expectations are unwarranted, and equity downside is likely justified.
Our Chief Investment Strategist, Joel Litman, chairs the Valens Equities and Credit Research Committees, which are responsible for this article along with lead analyst, Cheska Pablico. Professor Litman is regarded around the world for his expertise in forensic accounting and "forensic fundamental" analysis, particularly in corporate performance and valuation.
Disclosure: I am/we are short WYN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: As of the date of this report, officers of Valens Securities and Valens Credit are engaged and have beneficial interest in an investment management company, Kennebec River Capital, which has actively traded, and may trade, in the securities and/or derivatives of the securities of Wyndham Worldwide Corporation (WYN).