Camping World: Another Blow-Out Quarter, Investors Still Disappointed

Summary

• Camping World beat expectations handsomely in Q4.
• Investors lacked enthusiasm likely due to the still leveraged cap structure.
• CWH management continues to execute well, but reduced financial leverage could result in a favorable equity multiple rerating.
• Nonetheless, shares remain attractive at current levels.

Camping World (NYSE:CWH) smashed earnings expectations by delivering Q4 non-GAAP EPS of $0.48 and GAAP EPS of $0.34, well beyond what Wall Street was forecasting. The beat was primarily driven by continued top-line growth running red hot at 17.5% to $1.1 billion, and even greater improvement in gross margins and sustained tight cost controls. While JPMorgan finally switched its rating from neutral to overweight, giving credit where it is due, investors still remained unimpressed by the quarter as shares fell by 15%.

Strong Outlook

CEO Marcus Lemonis provided a healthy outlook regarding the supply demand picture for the industry, as supply constraints continue to limit available RV inventory while demand remains persistently strong, even as pandemic lockdowns are subsiding. Fortunately, that only supports the thesis that Mr. Lemonis outlined in early 2020 that he believes demand will remain strong even after the pandemic due to the structural shift in society of people wanting to balance their lifestyle with more outdoor activities, i.e., secular growth. However, analysts continue to believe that the industry is cyclical, and while that is true, I think the path of RV volumes and pricing will reflect a trend that's akin to the well-known long-term economic cycle, i.e., a staircase that reflects higher highs and higher lows over time, or at least that's what it will be for an industry leader like CWH.

While this is nothing new, Camping World has restructured its business to be inherently more profitable, has strategically made private-market bolt-on acquisitions, and continues to push its Good Sam subscription membership, among many other ancillary service offerings, that continues to be enhanced that will continue to drive long-term revenue and earnings growth over the long term, i.e., 5-10 years. Importantly, management is NOT trying to manage analyst or investor expectations quarter to quarter, but it appears to be gearing everything towards longevity and sustainability to meet the ever-increasing demands of the consumer while also building brand equity by being genuine and giving back to the community.

Rounding out the discussion, Camping World has guided for adjusted EBITDA to land within the range of $640 million to $690 million, which compares favorably against its 2020 adjusted EBITDA of $565 million, or an increase of 17+% YOY. Such a result would consequently produce even greater net earnings and cash flow. So, what's not to like?

Rerating Potential via Cap Structure

Company valuations can remain flat for years before market participants finally decide it's time to reprice, but one thing that Camping World management may not be considering seriously enough is its leveraged capital structure.

Of course, cheap debt financing is a great thing in the world of low interest rates. However, when a material segment of the investor class (both retail and institutional) observes that half of total assets are tied up in debt, even when it's considered "good debt" or "good leverage", they invariably shy away because they recognize the potential ramifications that sustained deflationary pressures could impose on the equity. Put another way, when a capital structure is leveraged, e.g., debt-to-assets, certain market participants will simply pass on the investment, particularly more active investment capital.

Many speculative-grade issuers are inherently avoided because they don't meet investment criteria or underlying mandates, and some of these companies can be mispriced for much longer than what would be considered normal. Of course, many speculative credit issuers can deliver incredibly strong market cap return performance but if the business is considered cyclical, or relatively more vulnerable to economic uncertainty, the market will naturally account for that either actively or passively.

Perhaps CWH has considered a more credit-friendly capital allocation policy many times over already, but a potential solution could be to allocate additional available free cash flow funds to the most expensive debt financing to reduce net leverage ratios sequentially to beef up the balance sheet. At a glance, net interest expenses for 2020 were a total of $73.4 million. Not considering the slight benefit of the tax shield, that figure represents approximately one-fifth (1/5) of total 2020 net income!

Effectively, cutting leverage would not only reduce the company's interest burden, but it would also lead to a stronger interest coverage ratio, lower book leverage, and likely even a credit rating upgrade towards the most sought-out credit classification of "BBB". For example, debt to assets stood at 52% as of Q4 2020, which doesn't even come close to the investment-grade credit rating classification.

That said, a concerted directional shift to reduce leverage to much healthier levels would likely lead to a more significant re-rating of the equity valuation. Of course, there are no guarantees, but essentially market participants will have one less excuse to not buy the stock. In other words, it would turn into a situation where there are only too many good things happening (i.e., sustained demand, great operating performance, and a strong balance sheet) that would ultimately attract a more diverse group of investment capital.

We have to remember that investors drive share prices, not sell-side analysts. So, despite whatever Wall Street analysts argue, if current and/or prospective investors remain cautious about lingering investment risks (including balance sheet quality), and therefore do not provide incremental bids, the stock will on balance take longer to trend up and to the right.

Attractive Valuation

That being said, I still believe CWH remains inherently mispriced given the inherent improvements in operating assets and performance. Of course, recurring and special one-time dividend payments make holding onto the CWH stock much more attractive relative to many alternatives, with the latest total cash dividend coming in at $0.23/share.

And while the stock price has gained some ground from ~$25/share in November towards $31 in February, which is a slightly less attractive entry, the long-term upside is still significant, in my opinion. The continued execution in Q4 further underpins my confidence that the equity is likely worth closer to $49/share, if not more, depending on your investment horizon. In my humble opinion, however, I believe the valuation would trend more favorably if net leverage was reduced more aggressively. Perhaps we'll see that shift in 2021 and beyond.

Bottom Line

The lack of financial deleveraging is disappointing, but hopefully management will adopt the approach of strengthening its balance sheet longer term. Many will argue that such capital allocation is wasteful, or a destruction of shareholder value, but there are numerous investors would who argue just the opposite, particularly for a cyclical RV operator. All that being said, Camping World is an exceptional company valued at an attractive price that should generate investors solid annualized returns. What do you think? Let me know in the comments section below.

As always, thank you for reading.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CWH over 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.