By Bernardo Teixeira, Andrew Nikolai, Dan Zatony, Matt DiCenso, and Michael Liamos of the Northeastern University Student Value Fund
For the past couple of months our group of students from Northeastern's Student Value fund analyzed Winnebago Industries (NYSE:WGO) through a deeply fundamental approach. In this article we would like to share what we think are Winnebago's most important catalysts, some of the company's key idiosyncratic risks, and an estimation of the firm's intrinsic price.
Winnebago recent internal improvements
Winnebago has made significant investments in Enterprise Resource Planning, Product Life Cycle management, and strategic outsourcing. Although it will have a current negative impact on their bottom line it should provide long term benefits to WGO's margins.
Winnebago is the most recognized name in the RV industry, partially due to their products being featured in films and TV shows. Additionally, WGO has been an innovation leader in their industry, making yearly product improvements and introducing new products.
Winnebago has recently been directing more attention to the Towables market. Over the past 4 years this revenue stream has increased from 3.4% to 7.3%. Towable net revenue experienced growth of about 23% over the past year. The towable market is significantly larger than the motorized market and represents a large opportunity for growth.
Steep discount opens an opportunity for Value investors
As of yesterday's market close Winnebago Industries was being traded for a steep discount. The company's current forward P/E of just 11x and P/S of 0.5 (far bellow 5 year averages of 22x, 0.61x respectively) opens a very good opportunity for value investors. A ROIC valuation is presented at the end of the article.
1. Hiring constraints
Operations being located in Northern Iowa may create difficulties in hiring enough skilled employees to meet production needs
2. Dependent on large dealer organizations
Two dealer organizations accounted for 17.9% and 15% of FY15 net revenue. Loss of one of these would significantly hurt WGO
Two strategic initiatives were approved at Winnebago's December 2014 Board of Directors meeting. As a result, these projects began in the second quarter of FY2015. These significant investments will contribute to Winnebago's continued success into the future.
- New ERP system
Winnebago has invested in a new ERP system implementation that will replace their currently used, in-house developed, financial and operational systems. Advantages of these new system include: supply chain optimization, lower overall operating costs, and access to more recent and relevant data. Having this data will allow Winnebago management to more quickly react to production and other business changes. It will also increase management's ability to proactively respond to market trends and opportunities.
This project has a 3 year time frame and a cost estimate of $12-16 million. This includes software, external implementation as assistance, and increased internal staffing related to this initiative. Winnebago estimates that 40% of the cost will be expensed throughout the project and 60% will be capitalized. The capitalized cost will then be amortized over a 10 year period. As of FY2015 approximately $3.3 million has been capitalized and $2.5 million expensed. While Winnebago has a huge expense over the next few years, it should allow them to operate more efficiently and benefit their bottom line in the long run.
- Strategic sourcing
Winnebago has also invested in a strategic sourcing project. This goal is to obtain material cost savings through standardizing purchasing processes, optimizing supplier relationships, and improving current sourcing methodologies. Winnebago has hired external support that has deep expertise in this area to help launch the project. Winnebago has incurred $1.6 million in general and administrative expenses and expect to incur an additional $200,000 in FY2016. Project management will be fully transitioned to internal resources in the first quarter. A gross margin expansion of 30 to 50 basis points is expected once all commodity materials have been through the strategic sourcing process.
#1 Name in the RV Industry
- Brand reputation
Winnebago is an industry leader for many reasons, one significant factor being its strong brand. The name Winnebago is known for being synonymous with motorhomes. In fact, according to Statistical Surveys, Inc., Winnebago has been a top selling motorhome brand every year since 1974. The company has seen widespread use in movies and television shows which serves helps improve brand reputation and recognition.
Winnebago's innovation can been seen in how their motorhomes are designed, manufactured, and even tested. One example of this can be seen in Winnebago's use of clay modeling. Skilled modelers create full sized clay mockups which are then electronically scanned to create production molds. While this is standard in the auto industry, no other RV company uses this process.
Winnebago also builds their motorhomes from start to finish, manufacturing many of their own components. This gives Winnebago greater flexibility in design as they can build parts to fit their specific needs. For example, WGO builds their own holding tanks allowing them to maximize space, while some competitors simply use rectangular, off the shelf tanks.
Winnebago's reputation is strengthened by allowing customer input to drive their products. WGO gathers data from surveys, focus groups and market analyses. Feedback from their Sales Managers and Service Managers, who work with dealers and their customers on a daily basis, is also taken into consideration. This gives Winnebago the ability to continually innovate their products based on what the customers want.
- Towables market
Entering new industries usually results in increased revenues and decreased risk. It is especially beneficial when the industry has high growth potential. Winnebago has been doing just that and has already seen results. Back in 2010 Winnebago decided to re-enter the towables market since its departure in 1983. At the end of FY2015 WGO controlled approximately 1% of the North American market share in, according to an RV Industry Association 2014 Industry Profile, a towables market worth $6.7 billion. While this may seem unsubstantial, Winnebago has increased sales of towables units from 769 in FY11 to 2,670 in FY15, an impressive 28.27% CAGR. If the Company is able to improve their market share to a modest 5% of the towables market, this would amount to incremental revenue of over $260 million. Exiting their transit bus and aluminum extrusion businesses has left Winnebago especially poised to reach this goal by putting this freed up capacity towards the higher margin towables market. The progress Winnebago has recently made in this market suggests that this goal is absolutely attainable. According to Statistical Surveys, Inc., this industry experienced growth in travel trailers and fifth wheels of 16.6% through the first eight months of 2015 and 9.6% for the month of August. Winnebago, on the other hand, saw that travel trailer and fifth wheel retail registrations rose 30.2% for the year and 53% during August. This diversification has already been paying off and will continue to act as a high growth opportunity moving forward.
It is also noteworthy how highly management views this opportunity. Chief Financial Officer Sarah Nielson recently commented on the Company's FY2015 results. She stated that Winnebago's strong performance was a product of success in their "class B and C motorized products as well as significantly improved results from the towables group, where both revenue and operating income grew." There is no reason to believe WGO cannot continue their penetration into this market into the future.
We have already discussed what the name Winnebago means in the motorhomes industry. With the towables market being so closely related, this is an enormous asset for the Company when entering this new market. WGO should be able to utilize their innovations, processes, and design and manufacturing procedures to benefit their towables operations. The combination of their proven talent with motorhomes, along with their success the past five years in towables, leads to a safe assumption that WGO is more than capable of leveraging their expertise towards towables in the future.
A final benefit for WGO in moving into the towables market is that these products cost less than the motorhomes. This gives Winnebago the opportunity to target people interested in RVs at a much lower price point. Winnebago has always been able to charge a premium on their products for their commitment to innovation and quality. Based on the FY2015 results, there is a clear shift in sales towards some of their lower cost models. By investing in the towables market, Winnebago is better protected from losing customers who are focused on price. The towable market space allows WGO to expand its sales to a larger group, thus becoming a more robust business as it has proven in the last five years.
While Winnebago is an overall attractive company with good growth prospects, there are a few risks that should be highlighted. We believe that the main risks are: hiring constraints based on WGO's location, large potential liabilities from repurchase agreements, and WGO's dependence on dealer networks. All these risks could have a significantly negative effect on Winnebago's valuation.
- Hiring constraint risks
Winnebago's manufacturing is located in a rural area in Northern Iowa. Additionally, unemployment rates in these areas are currently low. As a result, there could potentially be a shortage of skilled workers that are pivotal to Winnebago's success. These factors decrease Winnebago's ability to rapidly increase production if justified by demand. If there was an unexpected surge in demand, the company could be forced to incur high overtime expenses to meet demand. To minimize this risk, Winnebago has began to expand within the state of Iowa. In FY2014 WGO leased a manufacturing facility in Lake Mills which is now in production. In FY2015 WGO purchased a separate facility in Waverly which should be ready for production by the end of this calendar year. Furthermore, Winnebago's exit of their transit bus and aluminum extrusion operations will allow them to deploy these labor hours to higher margin motorized operations.
It is also crucial that Winnebago is effective at incentivizing and rewarding employees to ensure effective retention of employee talent, and lower training costs. While this is a risk, it is partially mitigated by the fact that Winnebago is so deeply rooted, established, and experienced in its community and operations. The company has been operating in Iowa since 1958, and the average employee has been with the company for about 16 years. In addition, the rural location has allowed them to make a very large manufacturing plant that houses state-of-the art automated manufacturing equipment. This automation and economies of scale should help offset the labor risks involved with a surge in demand.
- Repurchase agreements inherent to the RV industry
Sales are made on cash terms so most dealers borrow all, or substantially all, of the purchase price from a bank or finance company. The loan is collateralized by a security interest in the products purchased. In the RV Industry it is business practice that RV manufacturers, such as Winnebago, enter into repurchase agreements with the lending institutions that finance the dealer's purchase of a product. This means that Winnebago agrees to repurchase the units from the lending institution in the event that the dealer defaulted on their loan. Thus, Winnebago is dependent on the credit worthiness of the dealers it sells through, and there could be potential for adverse effects on Winnebago's costs if unexpected defaults occur. However, the repurchase price in the contract declines over time, and Winnebago is able to resell these repurchased units. In addition, Winnebago incorporates estimates of how much inventory it will have to repurchase when financial reporting. In FY2015, a 10% increase or decrease in the amount of repurchases they allotted for would have only affected net income by about $280,000.
- Dependence on dealer networks
In FY2015, 17.9% of Winnebago's revenue came from one dealer organization, and 15% came from another. As a result, there is potential for a huge loss of revenue if either of these dealers chose to end or reduce their sales of Winnebago RV's. In addition, it exposes Winnebago to strong dependence on the credit worthiness of these dealers due to the repurchase agreements prevalent in the RV industry. It is worth noting that these dealers sell Winnebago RV's in 75 and 11 of their dealership locations respectively. Based on this, and Winnebago's strong brand name, it seems unlikely that it would be in the best interest of these companies to cease or sharply reduce sales of Winnebago products at all of these locations. Rather, such a decline in sales would probably be more gradual, allowing Winnebago time to shift sales strategy to make up any lost revenue. In terms of credit risk, it should be noted that the size of these dealership locations can also be an advantage, as smaller dealerships would have less certain credit worthiness than these large, established dealership networks.
A conservative return on invested capital valuation shows an upside of at least 70%
Source: Prepared by the author using public available information
If the asset growth forecast presented above is roughly correct, it would imply that in order to justify its current valuation, WGO's return on invested capital (NASDAQ:ROIC) would have to decrease significantly from what we have seen in recent years. As you can see in the Market Implied bar of the graph below, the ROIC would have to decrease from close to 7.9% LFY to around 2.63% in 2019. In our view, the market is currently being overly pessimistic about Winnebago' future, as both implied asset growth and ROIC rates are below historical averages and do not seem to fully price in some of the growth opportunities described in our research. In another words, we believe that given the low market expectations (not to be confused with analyst expectations), WGO is likely to outperform in the foreseeable future.
Furthermore if WGO is able to perform as it did in the past couple of years (ROIC ~6-7%) then investors should expect a increase in share price of 70%.
Note: The spreadsheet with our ROIC valuation is attached to the article for Seeking Alpha PRO users.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.