Have you recently brought your family overseas for a vacation and found luggage restrictions and long waiting times at the airport affecting your mood ? You might have considered buying a recreation vehicle for family vacation purposes. About one in 10 U.S. household with someone 35 years old and above at the helm owns a recreation vehicle.
Thor Industries , the largest manufacturer of recreation vehicles (RVs) globally, is the best proxy for such a trend. I am also positive on its variable cost structure and management compensation structure. Moreover, Thor Industries is valued at a discount to its peers with a reasonable forward P/E of 13.4, making it a buy in my books.
Proxy for secular growth in RVs
The RV market is increasingly attractive for two major reasons.
Firstly, baby boomers born between 1946 and 1964 are now aged between 49 and 67 years old - the sweet spot for RV purchases. Moreover, RV buyers are getting younger, according to a 2011 University of Michigan survey. The survey shows that more Americans aged between 35 and 54 are owners of RVs, increasing from 9.0% in 2005 to 11.2% in 2011, overtaking those 55 years old and above who now make up 9.3% of the market as the largest age group of buyers. This is indicative of the broad-base appeal of RVs.
Secondly, similar to why home buyers and tenants are choosing manufactured homes over other housing alternatives, RVs are increasingly seen as an affordable family vacation choice. According to research published by the Recreational Vehicle Industry Association, a typical family comprised of two adults and two children will spend between 23% and 59% less on average for RV trips compared with other vacation choices like cruises and airlines. In addition, RV trips offer a combination of home-like comforts with family-bonding outdoor experiences
Limited operating leverage with minimal capital expenditures
Operating leverage cuts both ways and fixed costs could depress margins in bad times. I like Thor Industries for its relatively variable cost structure, which provides flexibility in varying economic conditions. Material and labor costs make up the bulk of its costs, with selling, general and administrative expenses or overheads capped at about 5% of turnover.
RVs are typically produced on a ‘just-in-time’ model, based on orders from dealers. As a result, inventory days are low at an average of around a month. Capital expenditures have historically been below 2% of sales, resulting in a strong free cash flow profile for Thor Industries. It delivered positive free cash flow for every single year in the past decade.
Shareholder-centric management compensation
It is not sufficient to pick a good business, as bad management can easily destroy shareholder value with their actions. Management compensation is a good indicator of how shareholder-centric the management is. According to Thor Industries’ proxy statement, its management personnel is largely compensated with cash, based on GAAP pre-tax earnings. The avoidance of measures easily manipulated such as share price and pro forma earnings are positives.
In addition, Thor Industries did not issue share options in fiscal 2012 and shifted the focus of management compensation from share options to issuing restricted stock with a minimum three-year vesting period. Share options represent asymmetric risk-reward propositions and I try to avoid companies which issue excessive share options.
Thor Industries’ peers include Winnebago Industries and Drew Industries . Thor Industries trades a discount to its peers with a forward P/E of 13.4 compared with its peers Winnebago Industries and Drew Industries, which are valued by the market at 17.1 and 14.3 times forward P/E, respectively.
Among recreational vehicles, Thor Industries has a 38% and 21% share of the U.S. towables and motor-home markets respectively; while Winnebago Industries has a 20% market share in the U.S. motor-home market.
The near-term outlook for Winnebago Industries’ motor-homes business is positive, with motor-home backlog revenue for the second quarter of fiscal 2013, a leading indicator, up 167% in dollar terms year-on-year, according to its most recent 10-Q. Winnebago, the only motor-home manufacturer to be awarded Ford’s “fully meets” classification every year since 1997, should see its quality and brand differentiation drive more sales from both retail customers and dealers going forward.
Despite this healthy trend for motor-homes, I still prefer Thor Industries over Winnebago Industries because of Thor’s greater exposure to towables. Towables typically carry higher margins than motor-homes and are riding on the wave of growth in the sport utility vehicles (SUVs). SUVs are used to tow towables such as travel-trailers and are increasingly popular among the younger generation. Another reason that I am not considering Winnebago is that it does not pay a dividend unlike its peers.