Winnebago Industries (NYSE:WHO) has been one of the main beneficiaries of the COVID-19 pandemic due to increased demand for domestic tourism after international borders were closed due to the global lockdown. of the stock is now trading well below the Spring 2021 all-time high, and my valuation analysis suggests it is extremely undervalued. But I prefer to wait on the sidelines as the industry experiences massive cooling after pandemic growth multiplied by the challenging macro environment. A strong history of success and a strong financial position give me high confidence that the WGO will weather the storm. But I expect the headwinds to last for multiple quarters, and I think there will be better entry points for the foreseeable future. Overall, I assign WGO a neutral “Hold” rating.
Winnebago Industries is one of North America’s leading manufacturers of recreational vehicles [RVs] and marine products with a diverse portfolio used primarily in leisure travel and outdoor recreational activities. The company also designs and manufactures advanced battery solutions that provide “home power,” supporting the internal electrical features for the company’s products.
Fiscal year 2023 refers to the fiscal year ending August 26, 2023. The Company operates through three reportable segments: Towable RV, Motorhome RV and Marine. According to latest 10-K reporttwo RV-related segments represented 85% of total sales in FY 2023.
The company’s financial performance over the past decade has been impressive. Revenue grew annually at 15.6%, and profitability metrics expanded as the business grew. The improvement in profitability highlights the company’s operational efficiency gains and increased pricing power. There was an increase in revenue in FY 2021-2022 due to increased demand for RVs during the pandemic, and the company successfully absorbed this massive tailwind. This emphasizes management’s ability to demonstrate flexibility and meet unexpected increases in demand.
Management’s capital allocation approach is moderately shareholder-centric, as the company pays dividends and regularly conducts share buybacks. I like this despite having little free cash flow [FCF] stock-based compensation [ex-SBC] margins, management can balance between keeping shareholders happy and maintaining a healthy financial position. The leverage ratio is relatively low and most of the debt is long-term with a comfortable coverage ratio of over 14. Short-term liquidity metrics are also in excellent shape. Such a solid balance sheet makes the company well positioned to drive further business development and growth.
The latest quarterly earnings were released on October 18, when the company missed consensus revenue estimates. On the other hand, WGO beat expectations from an adjusted EPS standpoint. As RV requires continues to sink following the pandemic surge, so did WGO’s revenue, with a 35% year-over-year drop. So did adjusted EPS, as it almost halved on a year-over-year basis.
As revenue declines, operating margin also declines. The metric narrowed by three percentage points on an annual basis. However, it would be fairer to compare last quarter’s operating margin to the company’s long-term averages to smooth out the effect of pandemic-related growth. The average operating margin between FY 2014 and FY 2019 was 6.7%. That said, last quarter’s operating margin of 7.5% looks like a strong performance. This strikes me as a strong sign of growth as the company navigates the environment of a sharp drop in demand, again underscoring management’s flexibility and proactivity.
The high-quality execution of the management is a great asset for the company, especially in the current circumstances, as the macro environment is still tough for the RV industry. While inventory levels have begun to moderate, levels are still high and much work needs to be done, especially given the current environment of high interest rates, which will likely dampen discretionary spending. Tall last earnings call, management admitted that the dealer network is very cautious and reluctant to add inventory. That said, elevated inventory levels seem like a major short-term problem for management to address.
Earnings for the next quarter are scheduled to be released on December 21. Quarterly revenue was expected by consensus at $731 million, indicating a 23% year-over-year decline. Adjusted EPS is also expected to shrink significantly, from $2.07 to $1.28. There have been six downward EPS revisions over the past 90 days, which is also a red flag for the company’s near-term prospects.
I expect the company to experience massive headwinds due to high inventory levels and softening demand over multiple quarters. Management’s strong track record of success, along with the company’s solid balance sheet, gives me high confidence that WGO is able to weather the storm and overcome all temporary headwinds. However, I expect these negative factors to weigh on the share price until the macro environment starts to show positive trends. It depends a lot on the monetary policy of the Fed and the recent public speeches of Jerome Powell still a hawk, with the door still open for more rate hikes. It’s hard to expect consumers to start spending more on RVs when high interest rates are driving up household costs, as household monthly mortgage and car loan payments rose in the past two years.
However, I think the company is well positioned to demonstrate a strong rebound when the macro environment becomes more favorable for the RV industry. I came to this conclusion by comparing the company’s profitability metrics to a larger player in the RV industry, THOR Industries (THO). Despite having about three times less revenue, WGO outperforms its biggest competitor across the board in terms of profitability ratios. This is a clear indication of WGO’s higher business efficiency and stronger pricing power. The stronger pricing power clearly indicates that customers perceive WGO’s products as superior to THO’s.
The stock demonstrated a 16% year-to-date gain, matching the performance of the broader US market. Alpha Quant research assigns the stock a good rating grade of “B-“. Indeed, the current valuation ratios look very attractive compared to the sector average and the company’s historical averages. That said, from a multiple perspective, the stock looks fundamentally undervalued.
Now, let me continue with discounted cash flow [DCF] the simulation. I use an 11% WACC for discounting. Income consensus estimates are available until FY 2028, and I apply a 10% CAGR for the following years. I use a flat spread of 3.3% FCF ex-SBC, which is the average over the last decade. All the assumptions seem quite conservative to me.
According to my DCF simulation, the fair value of the business is about $3.2 billion. This is more than 70% above the current market level, indicating significant undervaluation. My target price for the stock is $105.
Danger to my cautious statement
While I believe that the overall RV industry will most likely experience headwinds, there is always a chance that the company will make strong strategic moves that could add great optimism to investors and boost the stock price.
The Company may introduce new innovative and in-demand products directly related to RV or other recreational products. This can attract new customers and stimulate sales even in a challenging environment if management finds a new commercially attractive niche under the radar in the industry.
Strategic partnerships or acquisitions are usually announced unexpectedly, and they can also become a strong catalyst for WGO’s share price. Investors may view this positively if such a deal expands the company’s product offerings, market reach or operational efficiency.
To conclude, WGO is a “Hold”. I think strong headwinds are very likely to pressure the stock price over multiple quarters. I have no doubt that the company can overcome all of the challenges I’ve outlined, but multiple quarters of deteriorating financial performance will likely prevent investor sentiment toward the stock from rapidly turning positive.