Description

Investment Summary

I am long Thor Industries (NYSE:THO, “Thor” or “the Company”), which is the one of the largest manufacturers of recreational vehicles (RVs) in the U.S. and Canada. Thor is cheap, currently trading at a 25% discount to its historical 10-year average EBITDA and P/E multiples and a 60% discount to its historical 10-year FCF multiple, despite having solid growth prospects (both organic and acquisitive), high cash generation and a clean balance sheet (no debt). Thor currently trades at 6.5x 2016E consensus EBITDA, 11.6x 2016E consensus EPS and 10.2x LTM FCF. The stock currently trades at $54.32. Assuming the stock trades at 14.0x 2016E EPS (a 10% discount to its historical 10-year average P/E multiple for conservatism to account for the strong growth the industry has seen in the past several years which may not continue at the same rate in the future) results in a fair value of $65.55 per share. Assuming the stock trades at a 15x FCF multiple, which is a 40% discount to its historical 10-year average FCF multiple, results in a fair value of $75.91 per share. Averaging the two methodologies results in a fair value of $70.73 per share, representing 30% upside from current trading levels. Note I’ve assumed forecast earnings in-line with the Street, which assumes mid to high single-digit sales growth and EBITDA margin expansion from 7.8% LTM to ~8.5% in 2016. Earnings growth could be higher if the Company uses part of its $259 million cash balance for either acquisitions or share buybacks. Management has said they want to keep $150 million cash on the balance sheet given the seasonality of the business. Assuming management spends $100 million on an acquisition at 6x EBITDA (management has historically paid attractive multiples for targets, often resulting in little goodwill) results in ~$17 million of incremental EBITDA, which would increase Thor’s EBITDA by 5.5%.

Company Overview

Thor was founded in 1980 and is headquartered in Elkhart, Indiana. The Company manufactures and sells a wide variety of recreational vehicles throughout the United States and Canada, as well as related parts and accessories. Thor has two business segments, towable recreational vehicles (“towables”) and motorized recreational vehicles (“motorized”).

Towables represent about 80% of the Company’s $4 billion sales. Within the towables segment, Thor primarily produces ‘conventional’ and ‘fifth wheel’ travel trailers. Travel trailers are non-motorized vehicles which are designed to be towed by passenger cars, pickup trucks, SUVs or vans. Travel trailers provide comfortable, self-contained living facilities for camping and vacationing. Conventional trailers are towed by a frame hitch attached to the towing vehicle. Fifth wheel trailers, which are meant to be towed by pickup trucks, are built with a raised forward section that is attached to a receiver in the bed area of the pickup truck. Fifth wheel trailers are generally considered to be more stable and easier to tow compared to conventional travel trailers. The Company’s average towable sells for $27,000. In fiscal 2014, Thor sold 100,700 towables.

Within the motorized segment, the Company primarily manufactures motorhomes. A motorhome is a self-powered vehicle built on a motor vehicle chassis. Motorhomes are self-contained with their own lighting, heating, cooking, refrigeration, sewage holding and water storage facilities, so that they can be used without being attached to utilities. As a result, they are more expensive than towables. In many of the Company’s motorhomes, Thor designs, manufactures and installs the living area. The Company’s average motorhome sells for $77,000. In fiscal 2014, Thor sold 10,200 motorhomes.

The Company has a number of subsidiaries which operate independently under a decentralized structure (similar to many of the companies mentioned in “The Outsiders”). Thor’s subsidiaries sell many different brands of RVs, including, but not limited to, Airstream International, Classic Limited, Sport, Flying Cloud, Land Yacht and Eddie Bauer, Cruiser, Rushmore, Zinger, Elevation, ReZerve and Sunset Trail.

Thor sells its RVs to nearly 2,000 independent dealers (as opposed direct to consumers). Thor minimizes inventory by producing RVs based on dealer orders. FreedomRoads, Thor’s largest customer, is the largest RV dealer in North America and represents 17% of the Company’s sales.

The Company has a backlog which increased nicely over the past few years but which dipped in the most recent quarter, causing part of the sell-off in the stock which fell from $62/share to $57/share after earnings were released in early June. Thor’s backlog fell 11% from $820 million at the end of April 2014 to $727 million at the end of April 2015. Management claims the drop was due to quicker turnaround times, which the customer prefers, as opposed to a fundamental weakening of the business. Backlog levels that are too high are actually not a good thing in this business because it generally indicates consumers are having to order and wait to receive their vehicles.

The business is seasonal and has its low point in the winter when people are not spending as much time outdoors. To give an idea of the seasonality, note that while backlog has most recently been $700-800 million in April, in July it is closer to $400-500 million ($538 million at the end of July 2014 and $442 million at the end of July 2013 as examples).

Thor’s principal raw materials are aluminum, lumber, plywood, plastic, fiberglass and steel. The Company has benefitted recently from lower raw material costs.

Management’s capital allocation program is to first allocate capital towards organic and acquisitive growth, then to maintain and grow the regular dividend, and lastly to finance share repurchases and/or special dividends.

Management has made a number of acquisitions in recent years and describes the Company as an “acquirer of choice” per the following CEO commentary on management’s acquisition strategy:

“What we look at in terms of acquisitions…we're certainly going to limit it to our core RV business. We don't expect us to get back into buses or any other kind of extraneous things. It's going to be in RVs. So Bison, which we acquired last fall, they make primarily horse trailers that have RV-style living quarters, which again, we didn't really think about, do we want to get into the horse trailer business. But some of our dealers actually came to us and said hey, you should take a look at this. And we did, and we found a lot of commonality and we found a lot of ways that we could add value to what they were doing, based on our expertise and kind of the living areas and their expertise and building in aluminum construction and for an overall trailer that kind of hold a horses. So there's things like that, opportunities kind of in -- probably in that, call it $50 million to $150 million revenue range for our traditional markets, whether it be towables, or probably less so in motorized. But there are some smaller acquisition opportunities in towables. And we'll continue to look at them. And the good news for us is that we've become somewhat of an acquirer of choice in the industry, so that, when entrepreneurs reach a point, where they can't grow their business any further, they, a lot of times, will base a decision of do they want to recapitalize with the private equity firm or do they want to sell to a private equity firm or do they want to work with a company that's committed to their growth and their success and has the resources to help support that. So a company like K-Z or a company like Livin' Lite that we purchased last fall. They look at that and they see an opportunity to partner with a strong player in the industry that can really help them achieve the growth goals that they have.”

Thor announces full-year fiscal 2015 earnings (July 31st fiscal year end-date) next week. During last quarter’s release, the stock fell upon guidance from management that they could see some challenges to their Q4 (fiscal) results from integration costs from their most recent acquisition, start-up costs of new towable expansions and shifting dealer order and delivery patterns, all of which management feels are short-term factors that should benefit their results over the long term. While these are likely short-term issues, they are nevertheless worth monitoring as they can drive the share price performance in the short term, potentially creating a better entry point.

Industry Overview

The RV industry is highly competitive with about 70 RV manufacturers in the U.S. and Canada. While barriers to entry are not high, they do exist in the form of codes, standards and safety requirements. New entrants also need to establish a strong dealer network to compete effectively. Competition is generally based upon price, design, value, quality and service. The recession saw a number of Thor’s competitors go bankrupt.

Thor’s primary competitors within towables include Forest River and Jayco (both private). The Company’s primary competitors within the motorized segment are Winnebago Industries (public) and Forest River (private). Forest River has been increasing its market share and just recently overtook Thor to become the number one player in the market. It’s worth monitoring this trend to make sure Forest River does not gain share at the expense of Thor in the future (Thor has said it has a disciplined approach to pricing and won’t necessarily drop prices just to maintain market share).

Thor has the second highest overall market share in the RV market with 34%. Thor’s market share within the towable segment is 37% and 26% in the motorized segment. Given Thor operates in a decentralized structure where its subsidiaries make independent decisions, having a strong market share does not necessarily in and of itself afford Thor with significant competitive advantages. That said, by virtue of having a strong market share Thor in turn has several brands, which reduces risk in the event one of the brands goes out of favor, an incident that would more likely happen to a smaller competitor. See below CEO commentary (slightly outdated) discussing market share:

“We're always very competitive, that's just the nature of the industry. And part of it, I know from an investor perspective, you look at Thor having 34% market share, Forest River having 32% market share, together we have 66% market share, there should be an oligopoly, and we should have better control over the price. Well realistically for us, we have 9 subsidiaries. Each of those subsidiaries has a number of independent brands. All the pricing decisions and product decisions and operating decisions are made at the brand level. So if we have 80 brands and Forest River has a very similar model, they have got another 80 brands, realistically, 66% market share is divided up among 160 brands, 160 companies, which starts to look a lot more like a purely competitive market environment, which is really what it is.”

The Recreation Vehicle Industry Association (RVIA) provided good industry data. Below is a summary of RV shipments (in thousands) over the last 10 years provided by the RVIA:

2014: 356.7

2013: 321.1

2012: 285.9

2011: 252.3

2010: 242.3

2009: 165.7

2008: 237.0

2007: 353.4

2006: 390.5

2005: 384.4

Clearly the industry has seen strong growth in recent years. Note 2006’s shipments of 390,500 were the industry’s highest in the past 35 years and suggest that future shipments reaching 400,000 per year would not be out of the question relative to historical trends, implying upside relative to 2014’s shipments of 356,700.

It’s worth noting that RV shipments are not necessarily correlated to auto sales, although it may initially seem that they are. During the 2008-2014 period, RV and auto units sold increased at a 7.1% and 2.6% CAGR, respectively. During the 2009-2014 period, RV and auto units sold increased at a 16.6% and 8.0% CAGR, respectively. The correlation between RV sales and auto sales during this time was a very high 91% due to both having been heavily impacted in the recession and the ensuing post-recession surge in both. However, looking at the 1990-1999 period, RV sales grew at a 7.1% CAGR from 173,000 units in 1990 to 321,000 units in 1999 compared to auto sales during this same period actually decreasing at a negative 0.8% CAGR (9.3 million vehicles in 1990 compared to 8.6 million vehicles in 1999), representing a negative correlation. Therefore, one cannot necessarily analyze the auto market and in turn derive insights about the RV market.

Given Thor sells directly to dealers, it’s useful to monitor the confidence levels of dealers. Recent surveys indicate that 95% of dealers said they had a profitable year in 2014. All dealers reported an average growth of about 15% over the prior year. In addition, 57% said they saw 2015 being better overall than the year 2014. Furthermore, 77% said they planned on adding staff and 46% said they are adding or expanding their facilities to accommodate future growth. Therefore, dealer sentiment is currently quite strong.

There are several reasons why I believe the RV industry will continue to do well. First, there are roughly 40 million active campers in North America but only 23% of them own an RV, representing an opportunity for the overall RV market to grow significantly. Within the current pool of RV consumers, 70% of them plan to buy another RV. In addition, about every 3-5 years, consumers like to trade in their RVs, representing an additional source of growth. Furthermore, many RV consumers today prefer to enjoy the great outdoors while maintaining the level of comfort they have back home. This can translate to sales of higher-priced models with luxury furniture and hot showers, for example.

Second, the aging of the baby boomers should increase RV sales. On January 1, 2011, the oldest members of the baby boomers celebrated their 65th birthday. Going forward, for the next ~15 years, each day 10,000 baby boomers will reach age 65. Given the typical American retires at age 62 (some argue this age could increase going forward), he or she then has more time for leisure and in turn a potential RV purchase. The aging of the baby boomers, who represent 26% of the total U.S. population, will significantly change the country’s demographics. Today, only 13% of Americans are 65 and older. By 2030, when all of the baby boomers have reached that age, 18% of the nation will be at least that age according to industry projections, representing a near 50% increase in the addressable market.

It’s worth mentioning why older people like RVs. Clearly retirement allows seniors to have a lot more time for leisure. There are many activities they can do where they live (divided between activities done at the house like reading, gardening, and exercising to activities done outside the house like getting involved with the community, shopping and eating out). Getting an RV allows seniors to easily travel across the United States, which many have not had an opportunity to properly explore. With an RV trip, there is no pressure to find a time to return like when buying plane tickets (you can always book a return ticket later but it’s more expensive to book two one-way tickets). What may get overlooked is the fact that traveling in an RV allows seniors to maintain a sense of freedom. This is because they are the ones driving the vehicle as opposed to taking a tour on a bus and being driven around (certainly some people prefer this style of travel). In an RV, seniors can choose their destination without a tour guide planning their trip for them (again some people prefer this style of travel). In addition, many seniors feel that being in the outdoors and traveling is a healthy way to spend their retirement years.

Third, more and more young individuals and families are starting to buy RVs. For example, Thor and several others in the industry have seen a decrease in average selling price as more entry-level models are sold to younger families. Nonetheless, the growth in units sold has been great enough to counteract the decrease in ASP so that sales have continued to increase. Looking 10-20 years ahead, it’s a good sign that younger and younger people are buying RVs, even if they are entry-level, because this could mean that when these people get older, assuming they are still into the RV lifestyle, they may upgrade and buy more expensive RVs than the typical first-time senior buyer. See below CEO commentary on the younger generation:

“Well, I think from our perspective, and a lot of things can change over the years, but the positive about it is that there's a lot more RVs getting to the marketplace, hitting price points that are lower so that a lot of younger people and younger families can look at RVs that might've looked away, or not looked at the segment years ago because the entry prices were too high.”

People in their 20s and 30s like RVing for several reasons, many of which overlap with the reasons older individuals like RVing.  RVing gives younger people a sense of freedom. In addition, the younger generation is increasingly valuing a healthy lifestyle which RVs provide (just look at the boom in healthy eating via organic foods that the younger generation has embraced in recent years). While this may be a debated and somewhat anecdotal point, I believe that a lot of the younger generation has been guided to feel like they are each special and deserve the best in the world (without necessarily having to work hard to get there). As a result, many people work a few years out of college, save some money but realize working is not as glorious as they may have thought and that the road to riches is not only more distant than they envisioned but also paved with uncertainties. Subsequently, younger individuals re-evaluate their lives and often leave their jobs to find some way to ‘find’ themselves. RVs are a natural candidate for this purpose given trailers are not very expensive (~$15,000) and can be rented instead of bought. While RV manufacturers would prefer to have people buying RVs rather than renting them, it’s better that people rent them than not use them at all.

Bears argue that the RV industry has been thriving purely due to consumers’ access to cheap credit and low gasoline prices and is bound to slow and/or reverse in the near future. As a result, bears believe that Thor should trade at a multiple below its historical average. I acknowledge that both of these factors have certainly played a role in the industry’s growth but believe its boom has also come from a secular trend towards greater RV use stemming from an aging population and increased use amongst the younger generation.

While interest rates are very low today, financing terms are not as generous as in the past. For example, in the pre-2008 era, people could purchase RVs with no down payments whereas today down payments are often required. While an increase in rates would represent a headwind going forward, most people don’t expect rates to rise dramatically anytime soon. One could even argue that those extra-conservative buyers who were particularly spooked during the 2008-2009 period and who have held out on buying an RV may now do so given we have been in a stable economy for over 5 years now, representing a potential tailwind for the Company via pent-up demand, although the magnitude of this demand is likely not very large.

With respect to low gasoline prices being a major driver of RV sales, note that gas prices have only been low for a year now and therefore cannot explain the rise in RV sales over the last five years. In fact, during much of this time gas prices were actually very high at $4/gallon and yet they did not deter RV sales. This suggests that access to cheap credit is a more important driver of RV sales than low gas prices. With regards to consumer decision making, low gas prices firstly cause people to use their existing RVs more (given RVs consume quite a bit of fuel) and secondly cause people to go out and buy new RVs. In the event people use their RVs more, this could have the effect of causing their RVs to age more quickly, which is actually a good thing for RV manufacturers like Thor. In the event first-time buyers see low gas prices as the moving factor that causes them to buy an RV, this is also positive for the RV manufacturers. People have varying views on oil prices (and therefore gasoline prices), but the consensus seems to be that they are not going to rise dramatically anytime soon.

Thor’s sales from their low point in 2009 of $1.5 billion have grown to $4.0 billion currently, a CAGR of 17%. Bears point out that this growth is too high and is an anomaly so future growth must come down. I counter by noting that 2009’s sales were an exception given the global financial crisis (for example, the Company’s sales had previously been higher than $1.5 billion ever since 2003). Furthermore, in 2006 the Company’s sales were $3.1 billion, representing a sales CAGR of just 3% from 2006-2015. Given the industry’s favorable secular trends, I do not view this growth as overly aggressive and see it as a sign of continued long-term growth.

Ultimately, RV’ing remains a very cost effective form of leisure and travel. The initial purchase and gasoline are the two main costs. Going to a park and camping out is not expensive, especially relative to going on a cruise or traveling by plane to a foreign country. Therefore, I believe the value proposition for RV’ing will remain strong for many years to come.

Valuation

As mentioned in the opening paragraph, I believe Thor’s fair value is $70.73 per share, representing 30% upside from current trading levels. While most stocks (including Thor) have traded down in the past month due to concerns outside of the U.S. (mainly China), I think Thor should experience a positive re-rating of its multiple (and therefore trade back up) given the Company has no exposure to China or Europe. Thor’s operations and sales are exclusively in North America. The U.S. is currently seen as a safe haven for investors given the general stability of its economy and strength of its consumer. The U.S. consumer continues to gain confidence after several years of now stable growth. It’s not easy in this market to find a strong company like Thor with solid growth prospects and leading market share trading at just 10x FCF. Although I would prefer for my thesis to rely less on multiple expansion and more on earnings growth (through an earnings forecast above consensus), Thor is a solid company that is simply trading too cheap.

While there is downside risk here given the business can be cyclical, the Company’s clean balance sheet (no debt and ample cash balance) serves as a mitigant.

Risks

• Interest rates rise and consumers cannot as easily finance RV purchases

• Cyclicality (Thor’s sales declined 40% in 2009 and EBITDA margins fell from 6% to 3%, nevertheless the Company still had positive EPS)

• Canadian dollar weakness represents a headwind for the Company’s sales in Canada (U.S./Canada sales split not broken out in Company's public filings)
  

Catalyst

• Strong earnings release and management commentary next week

• Continued industry growth and positive outlook

• Management announcement of additional accretive acquisitions

• Share repurchases