Winnebago: A quality outdoor recreation game (NYSE: WGO)
Winnebago Industries, Inc. (NYSE: WGO) is a leading North American manufacturer of recreational vehicles (RVs) and marine products for outdoor recreational activities. The stock has recently underperformed the broader market. However, I think there are many love about WGO. Commercial qualities cannot be ignored. I will share some of my thoughts here.
Great growth momentum
WGO has grown rapidly over the past decade. Through organic growth and acquisitions, WGO can grow revenue at a surprising CAGR of 20% over the past ten years. This is no easy task for a company that makes physically constructed products like recreational vehicles and boats. Google (GOOG) (GOOGL) CAGR over the past ten years is only 18%. Based on the graph below, WGO outperformed its peers in terms of revenue and EBITDA. Current sales for the last 12 months are 4.3 billion compared to 0.97 billion for the 2015 financial year. EBITDA increased further from 60 million in 2015 to the current 12-month EBITA of 545 million.
While some of the revenue growth may come from seasonal or macroeconomic tailwinds, WGO actually wins the industry competition. As shown in the chart below, it has increased its 3-month VR share from 2.9% in 2015 to 12.6% currently.
Focus on quality, innovation and service
WGO’s success comes from a long-term investment in its VR expertise and brand heritage, as it is best known in the industry for its quality, innovation and service. All WGO RV brands received the RVDA Quality Circle Award in 2021 (a huge comeback since 2015). According to 2021 10-K, WGO products often commanded a price premium due to their reputation for quality. The United States only made 600K recreational vehicles last year. Compared to mainstream vehicle production (Ford, GM, Toyota), RV manufacturing involves a lot of human labor and lacks the scale needed for automation and standardization. The total number of production units is low, while the total number of components included in an RV is very high. So all RVs will have some issues here and there, quality control is not easy. For WGO, all vehicles must pass shock and resistance tests before being sold. The company runs the largest RV factory in the world and manufactures its own metal, plastic and wooden parts. Many pieces of furniture, seating, and mattresses are made in-house, which provides better quality control. The specially designed steel SuperStructure (pictured below) uses interlocking joints (instead of screwing and gluing) to connect the floor, sidewalls and roof and mount appliances and cabinets.
Margin improvements and brand awareness
In fiscal 2016, WGO invested in its manufacturing and supply chain skills to transform the business into a larger, more balanced and more profitable business. Five years later, the company is in much better shape with the acquisition of Grand Design, Chris Craft, Newmar and Barletta, which bring synergistic benefits on a larger scale. Gross margins improved to 18.59% and overtook VR giant Thor Industries (THO).
The improvement in WGO’s profitability and efficiency is also evident from the trend in ROICs, inventory days remaining, and revenue per employee (chart below).
When it comes to brand awareness, WGO had already encountered branding issues with younger customers during its 2016 assessment. Today, millennials are buying WGO RVs because WGO is seeing record sales Millennials, with around 10% of shoppers aged 30 or younger. The average age of its customers has also fallen significantly.
Sustainability and recession Immunity
RVs are not considered essential to life. RV sales increase when the overall economy is doing well and people have extra money. RV sales decline under recessionary conditions and slow or negative economic growth rates. VR business is always subject to volatility. Current levels of sales and earnings may not be sustained in the future. This explains why WGO and THO have had low PE valuations of around 15X in recent years, even under favorable market sentiment and monetary policy.
From 2022, an inflationary environment is expected to have a negative impact on WGO’s performance. However, CEO Michael Happe is confident about the company’s pricing power:
So we will continue to monitor that. We believe we have pricing power in the market. We will first seek to offset inflationary pressures with cost reduction initiatives or cost avoidance initiatives, and we will continue to price to the extent we need to in order to maintain margin, not only the dollar per unit, but the margin per unit. This has always been our position and it will continue to be.
He believes the current WGO is in a much different position than in 2008 or 2018, as WGO is more disciplined, market-informed and has a more resilient product mix. WGO is expected to maintain double-digit returns plus adjusted EBITDA going forward, regardless of conditions. The good news is that market downturns typically last 6-24 months and industry shipments always return to a new high as seen in the chart below. In the long term, the RV industry will continue to grow. Three big players, WGO, Thor and Forest River, are expected to gain more shares with stronger positions after the ups and downs over time.
Valuation and risks
With 4.3 billion in revenue, 0.34 billion in net revenue, 0.09 billion in free cash flow and 1.2 billion in equity, WGO’s current market capitalization of 1.78 billion is already very cheap. by all traditional valuation metrics (PE, PS, PB, cash flow yield). The remaining 0.15 billion buyback plan also provides security for the share price. We believe the pandemic has brought some unusual tailwinds to WGO, and current earnings may not be sustainable. To be conservative, we use the average current and 2019 TTM revenue of 0.225 billion as a starting point. If we set the future growth rate to follow the overall GDP rate of 3% and a discount rate of 7%, WGO should be able to collect 10-year discounted earnings of 1.83. Given the current market capitalization of 1.78 billion and conservative assumptions, this is a very good return.
If you have a long-term horizon, I think the macro risk is actually low. Yes, hyperinflation and recession may come. But the megatrends of an aging demographic and outdoor living should provide tailwinds for WGO. Additionally, housing shortages will continue for the foreseeable future, which could also benefit RV demands to accommodate outdoor activities. A major concern for me comes from future competition and investment risks. Once built, RVs are subject to significant depreciation (27% after three years). If the company fails to manage inventory levels or builds capacity too quickly, shareholder returns will be compromised.
Overall, WGO offers great value to investors. Although there are short-term headwinds, the long-term risks are very limited. Human beings have an innate need to explore nature and the physical world. Visits from the United States to state and national parks continue to increase. There is no doubt that the future demand for outdoor living will continue, and WGO will play an important role in this.