Description

Wyndham Destinations, Inc. (WYND) is the world’s largest vacation ownership, exchange and rental company, and today trades at a 9.7% EBIT/EV yield, which we think is cheap relative to the overall market, and represents an attractive entry point.

Operating in 110 countries, although 89% of sales are in the US, WYND has 4 million members, ~224 resorts with a timeshare offering, ~4,300 affiliated resorts through its vacation exchange business, and ~9,000 rental properties. It is the largest company of its kind in the world. Wyndam was written up on VIC by Manchu in August of 2018, and we encourage members to review that writeup for additional background.

With growth in the mid-single digits, this is not a growth story. Further, there is no shortage of negative press around the perception that the industry locks customers into complex contracts they don’t understand, not to mention an ongoing industry battle with so-called “timeshare exit companies.” Add the market’s wait-and-see attitude towards the new management team, and you have a recipe for undervaluation.

Yet the company has undergone a significant strategic makeover during the past year. In May of 2018, WYND sold its European vacation rentals business and spun off the Wyndham Hotel business, which has enabled management to better focus on its core business.

Today the firm is represented by two segments: Vacation Ownership and Exchange & Rentals. Excluding consumer finance, Revenues from each of these two segments were approximately equal in 2018. As with many value investments, the two pieces have different characteristics: The former is riskier and offers higher growth, the latter, has less risk but lower growth. Let’s take each in turn.

VACATION OWNERSHIP

WYND operates the world’s largest vacation ownership business. “Vacation ownership” is essentially time sharing, whereby consumers own a fractional interest in a furnished property, or a right to use it for a period of time. This is a Vacation Ownership Interest, or “VOI.” Typically, an owner might be able to use a unit for some specific week at a specific resort, or redeem points for different units at a particular destination. The accommodations tend to be bigger, and with more features than is true for hotels. VOIs usually have a fixed purchase price, and include a yearly maintenance fee. The majority of WYND’s Vacation Ownership revenues derive from timeshare sales.

In the recent quarter, gross VOI sales growth was 4% overall and 5% in North America. In order to sell VOIs, the company offer tours. Thus, another metric used by management is Volume per Guest, or VPG, which is VOI sales divided by tours. The company expects tours be at the lower end of the guided 5%-7% range, which is similar to VOI growth, which you might expect. Management has stated that VPG, a proxy for sales efficiency, is expected to increase modestly.

EXCHANGE & RENTALS

WYND operates the world’s largest vacation exchange network, with approximately 3.8mm members. This segment consists of non-hotel accommodations include ownership resorts, and private homes, apartments and condominiums, which are shared/exchanged among owners. Vacation exchange is a fee-for-service industry, offering services and products to timeshare owners. In this model, a timeshare owner makes a deposit, based on their ownership and/or interval, into the network, and receives the opportunity to use another owner’s ownership and/or interval at a different destination. This approach appeals to owners who want variety in their travel plans and vacations. WYND’s revenues from this segment derive from annual membership dues and fees for facilitating vacation exchange. The exchange business is low growth, with average members increasing modestly, on the order of 2%.

GROWTH

While the exchange business is sleepy, providing low, but predictable growth, the company’s overall growth is driven by VOI sales to new owners, which leads to follow-on upgrade sales.

The company estimates that there are 53 million households that are potential purchasers of VOIs. And WYND is penetrating new segments: the company is growing sales among Gen Xers and Millenials, which made up 62% of the last quarter’s new owner sales. New owner additions over the past few years were as follows:

2016: 33,000

2017: 36,000

2018: 37,000

POSITIONED FOR A DOWNTURN

VOI sales, at 25%, make up the second largest component of revenues, and these sales would be at risk in a downturn. There are a few mitigants. Notably, the company’s EBITDA margins on this segment are higher than was true in 2008. Also, it’s important to highlight that the majority of WYND’s sales are recurring. Below is a breakdown of sales across segments.

New Owner Sales: 26%

Consumer Finance: 12%

Vacation Exchange: 17%

Hospitality Services: 17%

Upgrade Sales: 28%

The consumer loan portfolio is made up of stable fixed interest payments. FICO scores for borrowers is significantly higher than was true prior to the downturn in 2008, and WYND requires higher down payments. Exchange revenues consist of annual dues from high-retention members (85% are retained). Hospitality consists of ongoing management fees, from a user base in which 98% of contracts are retained. Upgrades are steady, having shown remarkable consistency over the past 25 years.

In an economic downturn, VOI sales would certainly be at risk, but we believe margins could cushion effect, and the balance of revenues would be reasonably insulated and more stable.

SCALE ADVANTAGES

WYND’s size and scale offer numerous advantages versus competitors. Scale makes WYND an excellent partner for developers, since its VOI sales volumes allow the company to rapidly sell inventory, and make long-term commitments to projects. The company’s large marketing platform enables WYND to generate and absorb substantial tour volumes, which opens up the potential for strategic marketing alliances with other leisure brands. Additionally, the vacation ownership business is complementary to the exchange business: WYND’s large VOI base offers a source of vacation rental inventory for vacation exchange members. Finally, the company’s multiple brands enable the company to offer products across a huge variety of locations, and thus WYND can address a very broad demographic.

M&A ACTIVITY

Recent M&A activity demonstrates that others recognize the benefits of this type of structure and of scale. M&A activity often signals the shift in an industry towards an optimal structure. In April, 2018, Marriott Vacations Worldwide bought ILG, creating the largest luxury brand for timeshare vacation resorts. Last month, Hilton Grand Vacations (HGV) stock rose by ~25%, on news that Apollo Global Management made an offer, with an eye to combining HGV with Apollo’s Diamond Resorts, which Apollo purchased in 2016. Imitation is the sincerest form of flattery.

In addition to the M&A markets, the debt markets also seem to like the company. In July, WYND upsized a securitization by $50mm due to investor demand. The weighted average coupon of 2.96%, with leverage at ~2.8X, was attractive versus comparable transactions. On a recent earnings call, analysts expressed confusion about the mismatch between the ease with which the company raised debt financing, as compared with its low equity valuation.

RETURNS ON ASSETS AND CAPITAL

WYND generates strong returns on assets and invested capital. We like to use long-term geometric averages to measure a company’s ability to generate returns over time. WYND has a normalized (trailing 8yr) ROA of 7%, and normalized (trailing 8yr) ROC of 17%, which place WYND in the 60^th and 85^th percentile of our tradeable universe (liquid, mid-cap+).

MARGINS

Gross margins are high, in excess of 90%, and are extremely stable. We believe the stability and consistency of WYND’s margins signal that the firm’s underlying business has economic moat-like characteristics, and demonstrate the pricing power it has in its markets. We believe a major contributor in this regard derives from the company’s scale and strong brands.

FREE CASH FLOW

In the last earnings call, WYND’s increased its full-year outlook for adjusted free cash flow by $15mm to a range of $555mm-$575mm. We think a useful measure free cash flow can be obtained by scaling it versus total assets over time. WYND has demonstrated an ongoing ability to generate cash on its investments.

RETURN OF CASH

WYND is also shareholder friendly, returning its free cash flow to shareholders. In 2018, WYND paid out slightly in excess of its (adjusted) $580mm of free cash flow to shareholders, with ~$210 going towards dividends (which were increased this year) and ~$375mm going towards share repurchases. Management shows good discipline. The company has made a number of acquisitions over the years, but today, perhaps consistent with the economic cycle, is selling off non-strategic businesses and returning excess cash to shareholders.

OPERATING MOMENTUM

The company is profitable, having generated a 6.5% ROA, and it has positive free cash flow. FCF/Asset yield has increased over the past year, indicating a more efficient use of the firm’s assets. Liquidity is trending in the right direction, as in the past year WYND has paid down debt, and increased the current ratio from 0.98 a year ago to 1.18 today. As discussed above, the company has been buying back stock. Obviously, considered in isolation, none of these metrics is dispositive, but taken together they paint a favorable profile.

SUMMARY

The industry has grown at 6% CAGR since 2009, offering a nice tailwind, and the company’s growth seems to be broadly reflective of this trend. We expect organic growth in this range. Including the effect of share repurchases the company could grow EPS in the mid-teens range.

WYND has recently spun off and sold assets to sharpen its strategic focus. It enjoys numerous benefits of scale, and has generated strong returns on capital and assets over time. It has high and stable margins, and has generated strong cash flows over a long frame. WYND shows strong operating momentum, with a strong statistical profile, including with respect to profitability, cash flow, and liquidity. The company is shareholder friendly, returning its free cash flow to shareholders via dividends and stock repurchases.

In sum, we think WYND, at a 9.7% EBIT/EV yield, offers a reasonable return profile for the risk incurred.

Catalyst

- Execute on VOI sales

- Share repurchases