Description

Overview

Magundun beat us to the shorting RV industry punch earlier this week with a great write-up on Winnebago.  We agree with the pitch and wanted to add another short in the value chain.  After a 40% run over the past three months, we’ve recently initiated a short in LCII.

We prefer shorting LCII as it is:

Tied to the same over-earning, highly discretionary end markets

Levered at nearly 2x a TTM EBITDA number that they likely won’t hit again anytime soon

Tapped out on multi-year M+A strategy

Not as crowded a short as the OEMs

We also think the “aftermarket” catch-all business unit will be more correlated to new sales than a traditional aftermarket business, and thus is lower quality and doesn’t deserve a high multiple.

                LCII should report blow-out earnings next week as the industry has been running all-out producing at record high levels through the first half of the year, but we expect that will be the peak and earnings estimates will come down, leverage will increase and the roll-up strategy will be on hold.

Business Overview

LCII is the leading component manufacturer for the RV industry, and in recent years has diversified via acquisition into marine, manufactured housing, international and aftermarket businesses.

The company reports 2 segments – OEM and Aftermarket (which we think is going to be highly correlated to OEM).

LCII successfully rolled up the RV component space, and the stock was a huge winner from 2000-2017.  The company tapped out most of the RV OEM opportunities, and under a new CEO appointed in 2013, began to diversify into marine and aftermarket businesses.   The legacy business is part of a consolidated that sells into a consolidated industry (THO, BRK, WGO).

The company acquired 50+ businesses over the past two decades, but the majority of those acquired in recent years are outside of the North American OEM RV industry.

State of the business

RVs, camping, boating and outdoor activities were clear COVID beneficiaries, and many of these business units benefitted from record low interest rates and stimulus payments.  RVs benefitted from remote work and city dwellers looking to escape into nature at the depths of the pandemic.

https://www.rvia.org/historical-rv-data

Wholesale RV sales hit a record of 600K in 2021, and the industry was likely running at that level through the first half of the year.  LCII was running at 620K in the first quarter.  OEM producers extrapolated the 1x demand boom and were confident in multiyear growth projections based upon “backlogs”.  Bulls thought we’d be in deficit through the middle of 2023, and expectations were for growth on top of the record setting 2021 for years to come.

After a poor April that management teams blamed on bad weather, the summer selling season has not picked up and dealer inventories are rising into a slow seasonal period.

June was the first year/year drop in OEM shipments on the heals of a May in which retail sales were down 30%.

Thor recently announced two plant closures, which signals one of the largest players in the market has reversed course on its intermediate term outlook for RVs.

We’re seemingly at a point where everyone who wants an RV has one, and many people who have one don’t want one.  From the North American Camping Report 2022:

77% of people who traveled in an RV last year did so in one they owned, up from 62% in 2019.  The huge surge in sales appears to have come close to tapping out to tapping out the buyer pool, and that was before rates jumped and the economy (maybe depending on your definition?) entered a recession.

On the flip side, half of new RVers are considering selling their RV this year.

Pre-COVID state of the business

https://s24.q4cdn.com/983662463/files/doc_presentations/2022/06/LCII-IR-Full-Deck-Q122-(2).pdf

Slide 20 sums up the business quality pretty well.

From 2016-2020 (end points roughly equivalent for number wholesale RV shipments, business hadn’t diversified as much as today) the business showed pretty moderate growth in EBITDA and Earnings – and that is with more than $750 million worth of acquisitions included.  The content per RV was pretty flat during that 5 year time period, and really only ramped in the past two years due to commodity price increases they passed on to the OEMs.

Clearly the 2021 numbers were astronomical, and that might continue through the first half of this year, but they will prove to be complete outlier years and we’ll head back to a significantly lower normalized earnings number on a significantly more levered balance sheet.

The sell-side is growing the business in 2022 off of the record 2021 and has 2023 in the ballpark of 2022.  We think the business has already deteriorated and is well on the way to a normalized figure in 2023.

Another issue this cycle that was not present in past down cycles is the emergence of Peer-to-Peer RV rentals.  RVshare, Outdoorsy, RVezy, Camping World’s offering, etc. have all seen tremendous growth over the past few years.  RV’s are large expenditures and typically only used 2-4 weeks per year making them perfect for Peer-Peer rentals.  Millennials, the largest camping set, are used to using products like AirBNB and Uber.  Online reviews for Outdoorsy are overwhelmingly positive and we expect this market to continue its upward trajectory.

We’d expect the Peer-Peer rental market to have at least some impact on new RV sales over the coming years.  One last point is that as part of the side hustle economy, people were buying RVs or fleets of RVs to rent out on the new rental apps.  As we have seen with some AirBNB type properties, the spreadsheet math of full occupancy at high rates while understating maintenance CapEx can reverse quickly.  Many of these buyers are likely out of the new RV market for good.

The extra RV usage should be good for aftermarket sales, but LCII’s Aftermarket is a grab-bag of true aftermarket, products that correlate with new OEM sales, lifetime warrantied products and pure discretionary goods.  This isn’t a TransDigm quality level of FAA mandated replacement cycle aftermarket products.

Aftermarket

The Aftermarket Segment, which accounted for 19 percent, 22 percent, and 12 percent of consolidated net sales for each of the years ended December 31, 2021, 2020, and 2019, respectively, supplies engineered components to the related aftermarket channels of the recreation and transportation product markets, primarily to retail dealers, wholesale distributors, and service centers, as well as direct to retail customers via the Internet. The Aftermarket Segment also includes biminis, covers, buoys, fenders to the marine industry, towing products, truck accessories, appliances, air conditioners, televisions, sound systems, and the sale of replacement glass and awnings to fulfill insurance claims.

More than half of the revenue in this segment comes from large acquisitions made in the past three years.

The largest acquisition in company history came in December of 2019 when LCII acquired CURT for $336.6 million.

CURT manufactures and supplies a complete line of towing products to equip nearly every vehicle on the road today for safe, successful towing. The CURT towing and hitches line of products offers the broadest selection of receiver hitches, 5th wheels, weight distribution and gooseneck hitches, as well as tow bars, electrical components, cargo carriers, bike racks and more. For everything from passenger cars and vans to full-size pickups and SUVs, CURT is 'The First Name in Towing Products.'

The timing on the CURT acquisition worked well as the RV market took off and there were many first-time RV buyers in the market needing hitches before hitting the open road.  We would expect hitch sales to be correlated with new RV sales.

Many CURT products come with warranties ranging from 10 years to lifetime, so these are not true wear and tear recurring revenue aftermarket revenues.

                LCII’s second largest acquisition came at the top of the leisure market late last year.

In September 2021, the Company acquired 100 percent of the share capital of Furrion, a leading distributor of a large range of appliances and other products to OEMs and aftermarket customers in the RV, specialty vehicle, utility trailer, horse trailer, marine, transit bus, and school bus industries. The total fair value of consideration, net of cash acquired, was approximately $146.7 million.

Furrion sells a wide range of air conditioners, water heaters, stoves, fireplaces, outdoor TVs.

Other Aftermarket LCII Products include $2,000 outdoor tvs, ebikes and premium mattresses.

https://furrion.com/products/furrion-aurora%C2%AE-full-sun-smart-4k-uhd-led-outdoor-tv?view=base

https://store.lci1.com/lippert-li-series-gladiator-mountain-ebike-2021014621

https://store.lci1.com/thomas-payne-premium-mattress-tp-foam-matt

These products all look great and have strong reviews, but they are highly discretionary products that aren’t true aftermarket revenue.

Analysts are also excited by the prospects for LCII in the used RV market:

“Furthermore, many folks that are entering the RV market look to go the used route very often; when buying these pre-owned RVs, many will look to freshen them up by way of getting new mattresses and furniture, which are both higher-content products that are right in LCII’s aftermarket wheelhouse.”

We’re not sure how acyclical selling furniture and mattresses into the used RV will prove to be.

The end result of the debt fueled M&A spree is that LCII is above the 1-1.5x leverage target with the denominator at an all time high.  As once in a lifetime levels of profitability roll out of the TTM EBITDA figures, LCII will be heavily levered and unable to continue the acquisition levels of the previous few years.  Many overearning companies / sectors have used the COVID / stimulus boom to de-lever and should be in reasonable shape in the event the economy slumps further.  LCII has gone in the opposite direction and was top-ticking cyclical acquisition targets at the top.

Following 18 months of producing at record highs we’re expecting a sharp retreat in the RV market.  Neither the OEM or the Aftermarket segments have any backlog so the wheels can fall off in an instant.  We think the stock is worth 10-12x a normalized EPS figure in the $6.50-$7 range, plus excess profits they will report in the coming quarter.

Risks

Inside buying earlier in the year at $100 – end markets have worsened since the purchases while the stock is up significantly; given management is running a levered M+A playbook not surprising they have confidence in the outlook

RV’ing is a megatrend and not a COVID beneficiary

Aftermarket segment provides more countercyclicality to the business than we anticipate

Economy improves and / or rates come down

If a lot of fundamentals go against us the leverage on the business will amplify returns

Part of many short squeeze baskets of COVID beneficiaries, consumer discretionary, high correlation to oil prices

Catalyst

Decline in OEM production

Aftermarket sales correlate more closely to OEM sales than bulls expect

Leverage blows out with sales decline

Balance sheet in 2023 prevents LCII from additional M+A