The RV Industry
Over the last 37 years, unit growth of RVs has averaged around 4% per year with trend-line growth of approximately 2.5%. Over the same period, retail value growth has averaged around 7% with trend-line growth of approximately 5%. That implies pricing growth of around 2.5-3%, which makes sense considering inflation over that time. Market research (whatever that’s worth) forecasts 7% revenue growth will continue through 2024.
RV sales are expected to maintain this trend because Millennials have embraced RVing at a rate equal to or greater than prior generations. Added to this, RVs are a popular alternative to camping in a tent or staying in a hotel, and are increasingly being used as accommodations at major events like concerts, festivals, and sports and racing venues. 77 million households camped in 2017, a trend that’s up 2.7% annually since 2014. Campers are doing so more frequently each year, too, showing underlying demand strength. One-fourth of campers use an RV, but only 44% of those were owned versus borrowed or rented, showing long-term penetration could expand.
RVs come in two flavors: towables (trailers) and motorized (motorhomes). Trailers can be further broken down into travel trailers, fifth-wheels and specialty trailers (camping, truck campers, horse trailers). In contrast, motorhomes have their own propulsion and the category is segmented into Class A (looks like a bus, built on medium-duty truck chassis from Ford, Freightliner, Spartan), and Class C and B (built with Ford, GM, Mercedes Benz chassis, Class B looks like a big van, Class C has a van/pick-up front end and a big, boxy backend usually with a sleeping space over the cab). Unsurprisingly, seasonal demand for RVs is highest during summer and lowest during winter.
Thor’s place in the firmament
In North America, Thor is the leading manufacturer of RVs with around 49% market share in trailers and 40% in motorhomes. Thor’s total market share, with the mix skewed to trailers, is 48%. Forest River (owned by Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B)) is second with over 33% market share and Winnebago (WGO) is third with over 8%. Several much smaller players make up the balance. Thor holds a strong position in terms of industry volumes.
Over 70% of Thor’s sales are towables, with the rest motorized and other. Thor’s market share in towables has been shrinking marginally from 51.3% in 2014 to 48.7% in 2018. Market share in Class A/C has moved up from 31% to 42.7%, and share in Class B has moved down from 21.9% to 9.8%. Thor’s brands include: Airstream, Bison Coach, CrossRoads, Cruiser, DRV, Dutchmen, Entegra Coach, Heartland, Highland Ridge, Jayco, Keystone, K-Z, Redwood, Starcraft, Thor Motor Coach and Venture. Many of these brands were purchased in Thor’s roll-up strategy.
Thor’s products are sold through 2,300 independent dealers, only one of which is significant: accounting for 20% of sales and 26% of accounts receivable. RVs are generally produced to dealer order, and Thor doesn’t finance inventory, but does have repurchase agreements with floorplan lenders.
The major inputs to production are aluminum, lumber, plywood, plastic, fiberglass and steel. Chassis manufacturers are a pinch point in that Thor has one major supplier, and even if it didn’t there aren’t many alternatives. Added to this, half the cost of a motorhome is the chassis.
Thor is in a choice position in an industry that grows faster than the economy, but with cyclical swings that can turn investors off in a hurry. Although this may seem like a downside, I think it’s an opportunity for value-oriented investors willing to buy down and sell up. That’s no easy feat to pull off, but I think can be managed (addressed in the valuation section below).
Thor has a joint venture with Tourism Holdings (the world’s largest RV rental operation) dubbed TH2. The idea is to offer additional products and services focused on enhancing RV ownership with innovative solutions. This includes trip planning, service and maintenance support, checklists, how-to videos, remote monitoring, theft tracking, peer-to-peer RV and campsite rentals. This comes in the form of websites and apps like Togo, Cosmos, Roadtrippers, Mighway, CamperMate, Tomo, and Telematics. The idea is to improve the RV experience while also generating additional revenue from subscriptions, advertisements and commissions.
Thor’s big European adventure
Thor recently bought Erwin Hymer Group (EHG, deal closed 2/1/19), the leading European RV manufacturer based in Germany. Thor is getting a strong business with 2.5 billion euros in sales. EHG operates through 1,200 independent dealerships in 35 countries. There’s been less dealer consolidation in Europe than in the U.S., so those dealers have less buying power with respect to the RV manufacturers than currently exist in the U.S. EHG’s production is in Germany, England, Italy and Canada. It manufacturers lightweight trailers to high-end motorhomes. Two thirds of its products are caravans, like Class A and C in the U.S., 17% campervans like Class B, and 17% trailers.
Roads are generally narrower in Europe, and hauling capacity isn’t as prevalent as in the U.S., so smaller motorhomes are the European paradigm more than trailers in the U.S. EHG has 29% market share in Europe and a small North American presence with the Roadtrek brand. 3% of its revenues are accessories and services and 3% is an RV rental business with 2,600 units. There is only one other large player in Europe, Trigano, and the rest of the industry is highly fragmented. EHG is further ahead than Thor in developing autonomous vehicles and alternative power trains. That, along with its rental fleet, shows part of the reason why Thor had an interest.
Thor paid 2.1 billion euros for EHG with cash ($95 million), debt ($2.1 billion from 2 tranches of term loans, and $100 million from a senior secured asset based loan), and equity (2.3 million shares of Thor). It looks like EHG posted 235 million euros of EBITDA in 2018 and is expected to post 300 million euros in 2019 (Thor’s projection). That means Thor paid 7x to 9x EV/EBITDA. That’s not exactly a bargain price, but the business Thor is buying is good and the underlying growth looks like it could mirror Thor’s 7% base-rate. If that’s what happens over time, the multiple paid will prove a good deal.
Thor’s interpretation was that the family privately owning EHG wanted to turn over the business over to good hands, and desired keeping its name out front, too, so price was less of a focus than trusteeship of the family legacy. If that was indeed the case, then like Berkshire, Markel (MKL) and Fairfax (OTCPK:FRFHF), the deal may turn out to have been on favorable terms.
As you would expect, the press releases and conference calls have gushed about future synergies and sharing best practices, which makes me cringe (it’s what managers say when they rationalize a bad acquisition). Thor claims it will be accretive to earnings in the first year, but that yardstick is frequently flawed. Thor also expects to pay down leverage fast to get to 1x debt to EBITDA by 2021. It would be best to do so, especially in a highly cyclical industry.
Post-acquisition, Thor is 76% North America, 23% Europe and 1% rest of world, and product mix is 58% towable, 38% motorized and 4% other. This gives Thor more geographic and product diversification, but I’m not certain this is good for Thor’s shareholders, unless it can really squeeze efficiencies out of the business either in terms of lowering costs or increasing revenues in some way that the two independent companies couldn’t have otherwise done on their own. I think the margins are better in trailers than motorhomes, so the mix shifting toward motorized seems like downside. Thor has its execution work cut out to prove it didn’t make a mistake.
Thor’s CEO came aboard in 2001 when Keystone RV was purchased by Thor, and he has since worked his way up the organization. The CFO came to Thor in 2011 from Coachman Industries, an RV and manufactured housing company. Thor’s management incentive plan is an annual one based on percentage of net income before taxes, 1.5% for the CEO, 0.25% for the chairman of the board, 0.21% for the CFO, and 0.17% and 0.1% for two other executives.
Thor’s long-term incentive plan is restricted stock vesting in three equal installments based on 0.195% to 0.75% of net income before taxes (the CEO gets 0.75% trending down from there to lower executives). There are no additional benefits and perquisites that aren’t also available to other employees. There’s also no executive retirement plan aside from the same deferred compensation plan available to full-time employees not eligible for the company’s 401(k) plan.
I like the simplicity of Thor’s plan, but it’s questionable whether the CEO deserves that much of pretax profit. The plan also doesn’t take into account RV cyclicality, or how the company and its stock perform relative to the market, other industry players, or even comparably sized companies. There’s a lot to be said for simplicity, though, and this is one of the more straightforward plans I’ve seen at a company as large as Thor. Stock ownership for executives is supposed to be 5x base salary for the CEO, 3x for other executives, and 2x annual retainer for board members. The CEO owns $5.6 million in shares, which is only 37% of 2018 annual pay, and the CFO owns $1.1 million, which is only 30% of 2018 pay. Ownership requirements structured to meager base pay multiples means executives look more like hired hands than owner-operators.
The board of directors consists of a consultant, the CEO of Philips Lighting Americas, the CEO of Fortune Brands Home & Security, the co-founder of Thor, the CEO of Oshkosh Corp, a CPA, the CEO of Thor, and the former CEO of Harley Davidson. Board members are paid around $300k per year. The chairman of the board owns $135 million in shares or 3.8% of the company, which means he’s more of an owner than the rest of the board who own a mere $0 to $1 million in shares - weak compared to $300k annual salaries. Their loyalty is likely more toward keeping their jobs than protecting shareholders. Of course, I’d like to see more ownership and more investor-oriented members on the board instead of fellow executives likely to sympathize with managers, but you seldom get to have it all.
Valuing a cyclical business is tricky. Current earnings should not be the focus of long-term shareholders. Instead, they should target mid-cycle earnings with a careful eye on how low price can get in an industry trough and examine how low price has gotten to trough earnings in the past. Valuing Thor has the additional complication in that it just bought a sizeable European operation where the data isn’t fully reflected in reported figures, yet.
Looking at Thor’s long-term sales back to 1984, I think normalized 2019 sales are around $7 billion a year. EHG is expected to generate 2.5 billion euros of sales in 2019, which translates to $2.8 billion at $1.12 to the euro. Thor’s fully diluted shares are 53.132 million (52.807 million plus 0.325 in share equivalents) and they issued 2.3 million in shares to buy EHG, bringing the total fully diluted shares to 55.432 million.
Putting together sales and shares, that’s $177 in sales per share for the combined company projected for 2019. I expect sales to grow at a base rate of 7% plus or minus 5% which has been the five-year (smoothing out the cycle) band around median growth since 1984. Historically, Thor has grown sales 7-13% per year over prior cycles, but that included acquisitions that either won’t happen in the future or, if they do, won’t move the meter like in the past.
Normalized profit margins for Thor are around 4.3%, again at the mid-point of the cycle. Those margins have grown over the years as Thor has scaled up. Margins are lower at EHG (higher gross margins than Thor, but lower operating margins, showing there is fat to be trimmed in SG&A). I think Thor can reduce costs (interest cost being first in line, followed by EHG’s overhead). Putting these elements together, I’m forecasting 4% net profit margins over the cycle. I think that margins over the next five years could decline 3.4% a year to grow 2.1% a year depending on the cycle and how efficiently Thor can run operations.
Thor has not been a big buyer of its own shares, but it did buy back shares in early 2008, a good chunk in late 2009/early 2010, then again in late 2011/early 2012 and mid-2015. It has been an opportunistic buyer of shares when they had cash and the price was low. Thor has already promised to buy back shares after issuing 2.3 million to acquire EHG. With that in mind, I expect buybacks of 1.6% a year if the stock goes down to increases of 0.2% a year if its price goes up.
Putting all the above together, I foresee normalized EPS of $7.57 that could decline 1.6% per year to grow 15.7% per year based on the above assumptions. If I hang a low end multiple - low part of the cycle - of 6.6x and it looks like $50 per share. That’s not as low as it can get - it was down to 5.5x mid-cycle earnings per share in 2009 - but it’s a not unreasonable benchmark. Hang a high end multiple - high part of the cycle - of 20x and I come up with over $150 per share. That’s not as high as it’s gotten in the past, but gives you a flavor of the upside. At a current price of $62, that’s 19% downside and 2.4x upside.
I know that’s a wide valuation band, but makes sense considering Thor is a cyclical business with good underlying growth.
At around $62 and 55.432 million fully diluted shares outstanding, Thor has $3.44 billion in equity value. Thor’s pro forma debt looks like around $2.39 billion. Enterprise value then is $5.83 billion. Thor’s normalized EBITDA margin is around 8-10%, so $560 to $700 million per year mid-cycle. I forecast EHG’s EBITDA to be around 235 to 300 million euros using the unoriginal base of 2018 and Thor’s claim for 2019, which is $263 to $336 million (at $1.12/euro). Combine the two and I come up with $823 to $1,036 million EBITDA.
Using a share price of around $62, that puts EV/EBITDA at around 5.6x to 7.1x right now. For a company with trend growth of 7%, that seems low, but perhaps understandable for a cyclical business. Historically, Thor has traded around 6.1x to 10.8x, so it’s at the low end of the range but not down at the cyclical low of around 4x.
Thor looks like it is at the cheap end of historical and justifiable valuations right now, but not down at a cyclical bottom which could still be an unpleasant drop from here. I think Thor looks interesting at $62 and would look much more alluring at even lower prices, especially if it got down closer to $50 per share, which would be closer to past cyclical bottoms.
If you haven’t guessed from my comments above, I see the cycle as Thor’s biggest risk, especially if the economic background darkens. At the peak end of the RV cycle, supply and inventory get too high, leading to price cuts to keep floorplan financing from clobbering retailers, thus cutting profit margins and resulting in big cuts to manufacturing production. Even after supply and demand return to balance, fixed costs remain high, hitting RV manufacturers’ profit margins additionally. If you buy Thor expecting peak earnings to continue, you’ll get crushed. Even if you buy at a cheap price to mid-cycle earnings, your commitment can still turn out badly because the down cycle causes financial markets to get the dry-heaves. Like a lot of cyclical businesses, it’s best to buy at very low prices to mid-cycle earnings or a reasonable multiple to trough earnings. Easier said than done.
Another risk to be considered is end demand shifts. Although it’s easy to assume RV industry growth of 7%, that doesn’t make it a given. End market demand could shift if retirees or millennials change their minds about RVing, or if renting or a shared RV model takes over. I think most RVs sit idle a great deal of the time, so if you suppose someone figures out a way to share those idle RVs, it’s possible that end demand could permanently shift down. The same fear exists with ride-sharing, time-shares and other mostly idle goods, but it still remains to be seen if people are as willing and comfortable sharing their RVs the way they share condos. Color me unconvinced, but it’s possible and could be damaging to long term RV demand if enough people make that shift.
Competition is always a concern, even with Thor’s strong market share and rational competitors. It’s hard to imagine an RV manufacturer coming up with some new feature that couldn’t be imitated, but I suppose it’s possible. More likely, a lack of differentiation could lead to greater competitive intensity over time, which seems more likely if end market growth slows or stays in a downturn for longer than historically. Competition always hurts profitability, and sometimes in surprising ways.
Thor’s European push is both a capital allocation and operational risk. Although it looks like Thor made the acquisition at a reasonable multiple and expectations for modest cost-cutting seem legitimate, it’s hard to see how this is the best use of shareholder capital. Thor claims it shares some suppliers with EHG, but I’d guess the bargaining power there is pretty weak with European and U.S. suppliers feeling little pressure from a marginally bigger buyer in two distant markets. Thor was clearly casting about for something to do with its cash - always a bad sign - and share buybacks or a bigger dividend may have been a better idea than buying another business. Whether this turns out to be a good or poor use of capital will hinge on execution and that dreaded phrase: potential synergies. I’m a skeptic for now.
Dealer weakness is another threat to be considered. RVs are sold through dealers, which is not a thriving industry. They feel the cycle even more keenly than manufacturers, and have the additional burden of inventory and floorplan lending, both of which can wash back on to Thor with repurchase agreements from floorplan financers. Collecting receivables can become another problem for RV manufacturers if dealers run into enough financial trouble. Dealers are a weak link in the chain, which is good for Thor in that it doesn’t have the lower returns of that business on its books, but it can also hurt when the cycle turns, and it always does.
Supplier concentration is the last risk I want to highlight. Thor holds a stronger hand on the trailer side of the business than with motorhomes, and a key reason is the concentration of chassis suppliers. At half the cost of a motorized RV, this is a pinch point. Added to this, Thor just increased its motorized market share with the purchase of EHG, so it has weakened its control over input costs as a percentage of its business. Perhaps being a bigger buyer will help Thor pressure suppliers, but it seems just as likely chassis manufacturers have enough other buyers that Thor’s slightly bigger volume won’t matter much at negotiation time. We’ll see.
Thor is a cyclical business with good end demand and dominant market share. It’s facing both a down cycle and the purchase of a significant European operation at the same time and by choice. Management isn’t great and neither is the board, but they seem to have performed well over time. Thor’s price looks cheap based on mid-cycle results, but not super-cheap on trough results. This might make it an interesting small position with the potential for buying down if the cycle continues lower. Thor isn’t without risks: cycles and potential end demand shifts being my biggest concerns. I don’t think such risks are overbearing, but a good thing to monitor if you make this investment.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in THO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: © Copyright 2019 Athena Capital Management Corp. All rights reserved. Permission is hereby granted to electronically link, forward, or store this document in its entirety or to quote passages as long as source is attributed to “Michael Rivers, CFA, Athena Capital Management.” Nothing in this letter should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this letter has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.