Description

Drew Industries is the largest supplier of structural components (axles, chassis, suspension, doors/windows, etc) to RV/Towables OEMs such as Thor, Winnebago, and Jayco.  After hitting a low of 152 000 shipments in 2009 the towables industry (70% of DW’s mix) will ship a new record level of about 350 00 units in 2016.  In addition, over the past decade DW has done a great job rolling up complimentary suppliers and increasing their content per vehicle from roughly $1500 in 2006 to $3000 in TTM 2016.  The effective acquisition strategy, combined with the above peak unit shipments and all time high margins have resulted in a stock price that is up 86% in the past year to record levels.  The stock is trading at 19x forward earnings, to us this seems incredibly rich for a business that is reliant on very high ticket consumer discretionary products.  We think this represents an attractive entry point on the short side with a price target of $67.00, downside of 33% from the $99.20 where the stock is currently trading.

The short thesis is based on the following:

• The towables business is highly cyclical and is now beyond prior peak levels

  • 2006 was the last peak at 335k units, 2009 marked the low at 150k, and industry will ship about 350k in 2016

  • This has been based on the recovery of consumer confidence and credit availability, notably, the baby boomers have been phasing into retirement over the past decade and they have been in a better financial position to purchase higher ticket discretionary items

  • Industry players pitch the mantra that prior peak to peak levels have grown 20% (although looking below you can see the last “peak to peak” period took from 1976 to 2006), they claim this next leg of growth will be driven by millennials who apparently like to camp, I have no opinion on this but doubt that anybody really could have an accurate view of a whole demographic’s preferences

    

• On top of peak unit sales the company’s margins will be at record levels in 2016, we think raw materials had a significant impact which will begin to revert

  • Gross margins have blown out in 2016, the company’s two largest input costs are steel and aluminum, both commodities sold off hard in 2015 and have seen a sharp bounce thus far in 2016, we believe DW will have to realize higher cost commodities on their COGS line beginning in a few quarters

  • Patrick (PATK), the other publicly traded component player, illustrates this point in that their gross margins will be up a much more modest 50bps in 2016 despite serving the same customer base because they focus on products that consume less in the way of base metals (countertops, wall/ceiling paneling, furniture, etc)

• Their customer base is consolidating

  • #1 player Thor bought #3 Jayco in September, in conversations with management they expressed confidence they could leverage their larger size to extract savings from suppliers

  • #3 player Winnebago acquired a smaller participant Grand Design on Monday

  • These deals won’t be a huge structural shift but they’re a negative at the margin

     

• Their CFO just resigned after barely a year in office

  • David Smith started in September of 2015 and resigned last week, he came from Key Safety Systems, we’re told that it was a mixture of him not liking the relatively hard charging culture of DW and a distaste for Elkhart

  • Not a red flag but its probably light yellow, and again, a negative at the margin, especially for an acquisitive company

     

• Lets say the industry is right on their 20% peak to peak unit target and we throw in another 5% for further content per vehicle gains….

• What multiple would you put on above peak earnings of a high ticket consumer discretionary business?  I would say 12.5x which gets us to $82.00, at the current price the stock is discounting 15x this which seems very rich given the inherent downside to such a rosy scenario

   

• There have been a few negative data points recently

  • July retail sales were -1%, the first negative month since 2012, we will get August figures in about week (retail matters a lot more than the shipment data we get from THO sales and industry surveys)

  • The CEO of the country’s largest towable dealer, Camping World Holdings, mentioned in their IPO roadshow lunch last week that he felt most dealers were heavy on inventory, given he represents 20% of retail sales and nobody else is greater than 2% it might be a decent read

     

• Its owned by a collection of passive managers, never good once the chart becomes tilted

You could also play this via the OEMs (but both have done decent sized deals and will likely extract synergies over the short to intermediate term) or the other component supplier Patrick (but it’s a little cheaper and didn’t get the margin explosion that DW got in 2016).

In terms of valuation we think 15x 2017 EPS of $5.30 is appropriate which gets us to a $67.00 price target.  11-13x would be the right multiple for an OEM with no secular growth  (see HOG/PII/etc) but DW deserves a slight premium to account for the fact that they will undoubtedly continue to increase their content per vehicle through acquisitions.

Catalyst

-monthly retail data

-quarterly reports