Description

We think WGO is an attractive short here. We cannot think of a worse macroeconomic backdrop to be selling a gas guzzling, high-ticket, highly discretionary good. The RV industry is in the eye of the storm of 1) higher gasoline prices 2) higher rates 3) and a weakening consumer. Layering in the massive demand pull-forward that happened during COVID, we think the near-term prospects for the industry are bleak.

The stock price has rallied since June on the back of upbeat management commentary that we don’t think is grounded in reality. Consensus forecast numbers also remain in La La Land. We think both are about to be brought down to earth. Dealers are closing out a dismal summer selling season and we expect a sharp pullback in new orders in the coming weeks/months. At the same time, used inventory is flooding the market and could create a prolonged overhang. Things could get quite ugly from here. We think the risk/reward skews heavily to the downside.

We like WGO as a short over THO for a few reasons, although we think both should work.

• WGO is vertically integrated with higher fixed costs. WGO makes the majority of components that go into the RV including flooring, cabinets, doors, windows, upholstery, and mattresses. WGO’s operation is incredibly complex and difficult to rightsize in a downturn. This contributes to larger swings in margins. During the GFC, gross margins went from 11% to -15% as lower volumes meant lower utilization and lower fixed cost absorption.
  
  

•  WGO has a higher reliance on motorhomes, which account for ~45% of revenues. Selling $200k+ ASP motorhomes into a recession is difficult. Motorhomes typically experience more exacerbated peak to trough swings than towables. During the GFC, Motorhome sales fell 82% peak to trough (vs. 54% for towables). WGO also has no aftermarket parts business to dampen cyclicality.
  
  

• WGO towables are at a higher price point than competitors. WGO towables have an ASP of $42k, vs $27k for THO. Forest River is even lower. We think WGO experienced outsized market share gains during COVID when demand outstripped supply and consumers were price insensitive. We expect share gains to reverse in a weaker economy (and it’s already starting to).
  
  

The extreme cyclicality of the RV industry is generally well understood. RV shorts (THO/WGO) have been written up a number of times on VIC, so I will focus on dynamics at play in the current cycle. 

The pandemic drove a surge in demand for RVs as consumers looked for safer ways to vacation. Increased interest, combined with a strong consumer and attractive financing terms drove record RV demand that greatly outstripped supply. Consumers were buying RVs at prices 20-30% higher than MSRP for an item that normally sells at a 20-30% discount. After initial COVID shutdowns, OEMs spent much of 2020 and 2021 catching up on production, investing heavily to expand production capacity. The RV industry saw a record 600k deliveries in 2021 as OEMs delivered RVs to dealers as fast as they could produce them. With inventories finally replenished to healthy levels, the industry headed into 2022 expecting another blockbuster year. RVIA forecasted 2022 shipments of 614k, up 2% from 2021.

Demand has not shown up. Retail trends are deteriorating fast. SSI data shows retail sales down -18% in January, -18% in February, and -20% in March. The latest read shows the number down -28% in April (10% below 2019 levels) which is especially alarming because the bulk of RVs are sold between April and July. Our checks suggest dealers have not seen a notable uptick in May and June despite favorable weather and heavier discounting. WGO’s dealers went into selling season with the heaviest inventory levels in years. Deliveries have not slowed down in May/June and many dealers now believe they have over-ordered. Most of the dealers we spoke to are preparing for tough times ahead, and do not plan on taking new inventory in the near term. Rising rates are further pressuring dealer margins. Dealer inventory is typically financed using a floor plan facility. For a mom and pop dealer carrying a couple million dollars of inventory, a 2% increase in rates is significant to the bottom line. With softening retail demand and dealer margins under pressure, we think WGO is about to experience a sharp pullback in new orders.

Meanwhile, management remains far too optimistic in their outlook. In the March earnings call, against a worsening macro backdrop, CEO stated that he believed “retail sales will be down mid-to-high single digits”. This struck us as wishful thinking. In June, he revised the outlook down to “negative 17% versus calendar 2021”. We think this is just more wishful thinking considering YTD April retails sales are already down -22%, with no obvious upcoming positive demand catalysts. We’ve heard in July that WGO has started offering bonuses to dealers to move inventory, so perhaps management is finally seeing the problem. We expect large downward revisions in forward numbers in the coming quarters.

On the supply side, all signs are pointing to another overshoot in production that will inevitably lead to another margin-crushing destocking cycle. One structural reason why OEMs experience such dramatic boom/bust cycles is poor visibility into backlog. Lead times for an RV is typically ~3 months. Dealers place orders on spec, with the expectation of receiving delivery in the next quarter. Due to the short term nature of backlog, OEMs plan production levels based on forecasted demand, which in boom times almost always ends up being overly optimistic. Incentives also favor keeping production levels elevated. When gross margins are healthy, it is better to overproduce and offer discounts, than under produce and risk losing unfilled orders (and market share) to competitors. The end result is that the industry is always left with a glut of inventory when the cycle inevitably turns, which then leads to a painful rationalization process that can take years. We think this coming down cycle could be quite prolonged given how elevated current production levels are, combined with how sudden demand has dropped off. OEMs have all added significant capacity over the past 12 months. As late as May, WGO was ribbon cutting on a new facility. Capex is also still running at over 2x normalized levels.

To make matters worse, used inventory is starting to flood the market. Used listings are up 40% in May. The industry saw an influx of new buyers over the past two years, and we believe many are now looking to exit the industry. Many of these new RV owners paid 50-60% above normal retail prices and are now stuck with a unit with negative equity and no trade-in value. Dealers are reporting a sharp uptick in inquiries from new RV owners looking to sell their recently purchased units. Depending on the magnitude of this “pent-up supply”, which we think could be quite large, used inventory could be a multi-year overhang for OEMs.

The increase in used inventory is particularly problematic for OEMs because the price gap between new and used RVs continues to widen. For the consumer, the relative value of buying a used RV has never been better. Dealers are indicating that used RV pricing is down more than 20% yoy. OEM pricing, on the other hand, has continued to increase as OEMs try to offset inflationary pressures. WGO’s towable ASP is up 18% yoy, and is now at 30% above pre-COVID prices. Dealers were able to absorb price increases last year when RVs were selling for full sticker price. But with lower demand and increased promotional activity, several dealers we spoke to said they are now selling units at cost in order to clear the floor. Current prices are simply misaligned with the demand picture and need to come down. OEMs have never cut pricing in past downturns, but we think market condition will force their hand this time. Lower prices will eat into margins.

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So how bad could this cycle get? In addition to the above dynamics that are unique to this COVID-driven RV cycle, WGO still needs to contend with a slew of macroeconomic headwinds: record gasoline prices, higher rates, a weakening middle-income consumer and cost inflation that isn’t abating. We think the current backdrop more resembles the 70s (-76% drawdown in shipments) or GFC (-58%) than the Dotcom bust (-20%) or 2018 (-20%).

What is fair value?

In a normalized environment in which shipments return to its long term trendline (430k), we think WGO does $190mm in EBITDA. Using a 7.5x mid-cycle multiple gets us to a share price of ~$34, or 41% down from here.

In reality, these things usually overshoot to the downside. We think the setup here is attractive given how high estimates remain as we head into an onslaught of bad news. In a trough scenario with 350k shipments in 2024 (-42% drawdown), we have WGO doing ~$70mm in EBITDA, assuming strong execution in reducing costs. In past cycles, WGO/THO have bottomed at 6-7x near-trough EBITDA.

Catalyst

Monthly Data

Earnings the next few quarters