A Bullish Case for Winnebago and Thor Industries

The outdoor recreation industry is massive. Last year, consumers spent a whopping $887 billion on outdoor recreation alone, and a big part of that spending went to recreational vehicles, or RVs.

In this episode of Industry Focus: Consumer Goods, Vincent Shen enlists the help of senior Motley Fool contributor Asit Sharma to dissect the RV industry. RV makers have been enjoying significant growth thanks to a strong economy and consumer confidence.

Two leading names in the space include Winnebago (WGO 0.23%) and Thor Industries (THO -0.64%). Find out about the various products they offer, how some demographic trends point to a bright future for these companies, the cyclical risks they face, and more.

A full transcript follows the video.

This video was recorded on Feb. 6, 2018.

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Tuesday, Feb. 6, and I'm your host, Vincent Shen.

Late last year, I mentioned offhand that we'd dedicate at least a few episodes in 2018 for this edition of Industry Focus to looking at the travel and leisure sector. That coverage begins today with two companies that should ring a bell for any Fools who enjoy the open road and long road trips -- Winnebago and Thor Industries, two leading manufacturers of recreational vehicles, or RVs. Both companies, and the industry overall for that matter, have put up strong returns in the last year, outpacing the S&P 500, with a lot of consumers taking advantage of favorable financing and low gas prices.

Joining me today via Skype to take a closer look at these RV companies is senior Fool.com contributor, Asit Sharma. Hey, Asit! Welcome back to IF!

Asit Sharma: Hey Vince! Thanks for having me back! It's been such a cold winter. I can't wait to talk about warmer weather, traveling in an RV. It sounds like a great topic for today.

Shen: Yeah, absolutely. Before we get into the main part of our discussion, I want to take a minute and direct your attention to The Motley Fool's $10,000 College Student Award. For any students who are over the age of 18 and attending a U.S. college, The Motley Fool is sponsoring a contest to encourage and support the next generation of investors. To enter, write a 500 to 1,000-word article on one of the provided topics, and a group of Fools here at HQ will choose the best write-up and award the author $10,000, with an additional 20 runners-up getting $1,000 each. Whether you're a student yourself or you know someone who might be interested, pass the word along. The competition closes April 30, 2018. We look forward to seeing your submissions. Terms and conditions apply. Please visit www.fool.com/competition for more details.

To start our RV discussion, it's important to understand some of the broad industry dynamics, and also the tailwinds that companies in this space have been enjoying since the financial crisis. Asit, can you walk us through some of these basics?

Sharma: Sure. Looking at the Outdoor Industry Association, this is an association which tracks recreation, consumers spent $887 billion in the last year on outdoor recreation. That's an annualized figure. This, to me, is extremely interesting, given the economy has picked up, we see higher GDP growth, if you look at the U.S. economy, it's a $19 trillion economy. So near $1 trillion just on outdoor recreation is a big number.

And sometimes, we overlook companies that can benefit from these trends. The outdoor recreational industry employs about 7.6 million people, so it's a big employer. We're going to talk about RV shipments today, so recreational vehicle, to throw a little bit of lingo at you. These shipments have increased at a compounded annual growth rate of 10% since 2010. 

Shen: Something else behind the RV industry that's important to know is, also, some of the tailwinds that I mentioned in terms of the demographics and the consumer confidence that we're seeing, but this is still, ultimately, a very cyclical business, and I'd like to speak to that a little bit. Total RV wholesale shipments, for example, in North America, are the highest they've been in about 20 years, with an estimated 480,000 units going out in 2017.

But that volume will ebb and flow based on a lot of factors, some that I've mentioned -- gas prices, strengthening economy, consumer confidence. There's also availability of financing. And now, there's also an increasing number of retiring baby boomers. For example, industry shipments fell 20% from 1999 to 2001, coinciding with the dot-com bubble burst. They fell by over 50% from 2007 to 2009, during the worst of the financial crisis. But even then, there are some different dynamics between the product categories that fall within RVs. Those segments are something that's very universal to the industry that investors need to understand. Asit, can you talk about some of the key differences between the two major RV product offerings?

Sharma: Sure. This industry is divided into two segments: motorized and towable. When I think RV -- I've never owned one -- I think of the big motorized vehicles, also known as motorhomes. I think that's what most of our listeners are familiar with. These are large vehicles, often resting on a truck chassis. They can range anywhere from $50,000 on up to close to $1 million, if you have the leisure and the resources to really deck out your RV in style. The second part of the industry is also very interesting. This is the towable segment. Basically, you can hitch an RV to your vehicle and tow it. These vehicles are much cheaper. They average between $15,000 and $30,000. They require less repair and maintenance than a motorized home. 

Two really opposite poles in this industry. Either you're all in for a very expensive vehicle, which you can camp in. Obviously, it's equipped for riding in as you get to your destination. The other pole is this very cheap offering that younger people, which we'll talk about in a second, in terms of demographics, can afford. You can't ride on it on the way to your destination, but once you get there, it's your second home. These are the two basic poles of the industry. There are some types of vehicles that fall in between these. They generally get shoved over to the motorized segment, like van campers, which some of you are familiar with, the smaller vehicles which are an extension of a typical van-type vehicle. But overall, think motorized or towables. This will become relevant to the rest of our conversation in talking about the economics of this industry.

Shen: And going back to the cyclicality, I'll mention that for this industry, even between these two categories, motorhomes vs. towables, they see different effects from a downturn. For example, motorhomes tend to see a harder hit. They fell 30% in the early 2000s, and 75% during the financial crisis. This part of the market has actually yet to fully recover from its highs from about 15 years ago. I attribute that generally to the higher cost. Towables is a larger market in terms of unit volume. They fell 17% in the dot-com period, compared to the 20% across the industry, and then about 49% during the financial crisis. They have since gone on to establish new highs in terms of industry volume. 

Last bit of backdrop, I know you've wanted to speak to this, Asit, before we dive into this company specifically, is some of that demographic stuff. I mentioned the increasing number of baby boomers going into retirement, being interested in acquiring RVs as part of their retirements. But there's also a younger group of customers getting into these products as well, it seems.

Sharma: Yeah. This was surprising to me. I've written a couple of articles this year about this industry. When I was growing up in the 70s and 80s, you associated RVs with retirees. But the industry has really reinvented itself, and it's marketing itself to younger and younger people. The typical RV buyer today is a lot more ethnically diverse, younger than just even a few years ago. In a recent presentation by Thor Industries, who we'll talk about in a moment here, they point out that Latinos, Asians, African Americans, they comprised 39% of new campers in this industry in 2016. And Gen Xers and millennials, if you just look at age groups, generations, comprised 72% of campers in 2016. So it's a whole new wave of potential RV buyers. 

Really briefly, what's so interesting to me is, Vince talked about cyclicality of this industry. If you look at even a bigger cycle, it's the cycle of young buyers who are getting in today in these cheaper towable segment vehicles, and then aspirationally looking up, maybe 10, 20, 30 years, moving into the motorized segment as they acquire more wealth. We'll see how that pans out over the long term, but that's an interesting larger cycle overarching the smaller cycles in this industry.

Shen: Overall, keep in mind that there has been a pretty strong recovery since the financial crisis for this industry. The results for both companies that we're about to talk about have been quite strong, especially in 2017, their stocks have been up. The first one we're going to talk about is Winnebago. Their ticker is WGO. The stock was up over 75% last year, although it's given back some of those gains over the past two weeks. The stock pays a small dividend, yields about 0.9%.

This is a 60 year-old company, and they're best known for their motorhomes. But the business has changed pretty significantly in the past two years under the new CEO Michael Happe. He brought with him a lot of new executives and managers in a push to turn the business around. During the recent investor day that they had in November, they talked about the three strategic initiatives that he was asked to deliver on when he started with the company. They were: 1) to restore the motorhome segment, because Winnebago had been losing lots of market share in that core space; and 2) to become a bigger player in towables because of the strength and growth in that category; and 3) to create a vision for the company's long-term growth. 

As Asit mentioned, within towables and motorhomes, there's additional classes and styles. But in terms of broad investing purposes, you just need to understand that before 2016, Winnebago generated a large majority of its revenue, about 90%, from that motorized segment. And that splits is now much more even. The business diversified with the top line coming in at about 45% towables, 55% motorized. And towables already make up the majority of unit volume for the company, as they do tend to come in at the lower price points. And I think a big reason why the company has been picking up in terms of the growth of its business, it's been much stronger in terms of its stock and its general financials in 2017, was due to an acquisition that it closed in late 2016 for Grand Design. Can you tell us a little bit about the story there, Asit?

Sharma: Grand Design RV was a competitor, a smaller company. It was a towable RV manufacturer. This goes back to the goal that Michael Happe had of not just restoring this motorized segment, but diversifying into what was fastest growing. So Winnebago acquired this competitor in November of 2016 for $500 million.

What's happened is, in the most recent quarter, Vince alluded to the fact that overall in the industry, the motorized segment has yet to recover. The growth trends are positive at Winnebago, so the CEO is gradually affecting that motorized recovery. But if you look at this most recent fiscal quarter, which is their first fiscal quarter of 2018, Winnebago had a revenue increase of 84%. And most of that, or nearly all of it, was due to towables. They had a big boost from acquiring this competitor, which also gives them a fresh new brand which they can exploit. The company has a pretty decent balance sheet, so they have some marketing dollars they can invest in targeting consumers.

Out of this revenue jump, 84% total revenue quarter-over-quarter expansion, about 34% came from the acquisition of Grand Design RV. But interestingly, the rest of it -- 50% -- came from organic growth. So you see how the company's native Winnebago brand is also doing very well in this towables segment. Again, looking over at the motorized side, negative 2.4% growth. So this was obviously a key acquisition for them. And in a moment, when we talk about Thor Industries, they actually had a similar sized acquisition, also in 2016. So in this industry, the bigger players are looking to acquire revenue, especially where it's fast-growing, as in this towables segment.

Shen: Yeah. There's definitely been some ongoing consolidation in the space. Something else I want to point out for the Grand Design acquisition, this company was the smaller but fastest-growing player in the industry prior to the deal. The company was founded in 2012, and by 2017 had already shipped its 40,000th unit, so pretty impressive. It was a pretty big purchase, as you mentioned, $500 million, but it gave Winnebago a brand and operational addition that was enjoying 80% compound annual growth since shipping its first unit in 2012, 2013. So really important to establishing that towables business for the company. Towables in general are generally more profitable, and they're also more popular, again, with consumers thanks to that greater flexibility, the lower cost. That shift in the company's top line has been pretty important. 

Overall, trailing 12-month revenue for Winnebago came in at $1.75 billion, 70% year over year growth, again thanks to that acquisition. Happe began his tenure with some of those key initiatives to restore motorized, grow towables, establish a long-term road map. We've seen the top line really blow up with the Grand Design deal. The operating margins for the company are trending upwards, as well as free cash flow. The company won't report for some time, but the most recent quarterly results for that first fiscal 2018 quarter had been really strong, definitely keeping with the CEO's goals.

I'll just add here, rounding out our discussion of Winnebago, the balance sheet at the company has typically been debt-free, but they took on over $250 million as part of that Grand Design deal. Management, one of their goals is towards reducing that debt load. And this is not the only deal that the management team has in mind. They're still seeking out additional M&A opportunities, whether that gains them exposure to new markets or new products or to increase their scale. The North American RV market is estimated at about $17 to $18 billion, but there's related platforms and products that can add billions, essentially, to the company's target market. Short-term, while they are reducing that debt, the company is still funding spending and investments in its production facilities. Their operational footprint right now is in three states -- Oregon, Iowa, and Indiana -- but they want to be able to feed and maintain that growth that Grand Design is enjoying, as well as the bounce-back for Winnebago's organic growth. 

Last point here from me, longer-term, the company has announced goals of growing their unit market share, right now, from approximately 3% to over 10% by fiscal 2020. They want to grow their operating margin from about 8% to 10%, and they want to have 10% of their revenue come from new businesses that Winnebago is not currently exposed to, again, by 2020. So there's some of that long-term roadmap that Happe was brought in to establish. I think he's done a pretty good job so far. In towables specifically, Winnebago has about a 5% market share, while its two bigger competitors claim about 85% to 90% of the market. So there's a lot of work there still to do. They don't shy away from that fact during the investor day presentation, for example. But they make an interesting point with the Winnebago name being so well-known, they're still only the No. 3 player. The analogy they use, it's like having a name as universal and popular and well-known as Kleenex but being a distant third player in the industry in terms of tissues.

Last point for this company before we move on is, I want to talk about valuation. Given the broad industry growth and latest results, Winnebago's stock is pretty reasonably priced to me. What do you think?

Sharma: Winnebago has, right now, a forward price-to-earnings ratio of about 14x. This is about 3 to 4 percentage points below the total manufacturing industry. It's really about the same or maybe 5 percentage points below the S&P 500's core valuation. Why the valuation of these, despite the stock ascendance of companies in this industry, why they're so low relative to other manufacturing outfits is, the profit margins are quite slim. And this is a risk for investors. In a given year, Winnebago will have net profit of 4% to 5%. And the way it's growing earnings per share and making these huge leaps in net income is through that top line acceleration. You can look at this as the glass half empty or glass half full. If you are an optimist like I am, you can see there's some value here as the company maybe improves margins and expands its manufacturing footprint just a bit, invests in its own capacity, it probably can add 1 or 2 percentage points to its profit margins. And that's good for long-term investors. 

On the other hand, that should give you a little pause, that the P/E ratio is so low. My favorite example is the airline industry. That's a risky industry, also very cyclical, and right now, you can buy a good airline for 9x forward earnings. That doesn't mean you should necessarily leap in. For this industry, though, I think long-term, it is a positive investment. It's worth a little bit of risk in this valuation. And I think these valuations can grow -- bottom line -- for both Winnebago and Thor, who we will talk about here.

Shen: Last point I'll add here is, management says that during the average downturn, motorized will decline about 25%, while their towables category will fall about 15%. That's something that these management teams always keep in mind in terms of any downturns that might happen. They keep their operations flexible, so they can adjust their production and supply when that's necessary. I think management said that 80% to 90% of their cost of goods sold comes from labor and materials. These are variable costs that they can minimize when demand weakens.

After the break, we'll talk about the next company, Thor Industries, the RV industry leader.

Our next company is Thor Industries, ticker THO. This stock also saw a major rally in 2017, up about 50%. Though we're talking about the company second in our discussion, Thor is the undeniable leader in this industry, with over 50% market share for towables and 40% market share for motorhomes. Asit, how much bigger of an operation is Thor, in terms of their revenue and some of these other financial metrics?

Sharma: Thor sells about $7.2 billion worth of products in a year. That's, you set that aside, Winnebago is $1.5 billion in annual sales, and we'll see how much bigger they are. They have a market cap of close to $7 billion vs. Winnebago's $1.4 billion market cap. So it's magnitudes larger than Winnebago, going back to that opportunity that Winnebago has, with its great brand name, to expand in the industry. It owns the celebrated Airstream motorhome brand. One of the ways that it's grown is through acquisition, which again, I'll talk about in a second here.

Shen: Thor is a little different also in its product lineup. Their towables are their biggest segment, with about 71% of revenue, and motorhomes are growing their share from about 22% in 2015 to 27% in 2017. So a bit of a reverse situation for this company compared to Winnebago. They also are on a pretty similar earnings calendar as Winnebago. How did the most recent results for Thor come out? And how does that point to some of the changes in their business with that acquisition that you mentioned, and the state that the industry is in?

Sharma: The most recent quarter for Thor was a knockout quarter. They increased their revenue by 31% to $2.2 billion, and their net income increased 63% to $128 million. The acquisition that I was referring to is a 2016 -- I think this was July 2016 -- acquisition of a company called Jayco.

Jayco is interesting, because, Vince, you talked about the diversity in product that Winnebago wants to explore. To me, Jayco brings all of this to Thor. It's a manufacturer of recreational vehicles but not just the motorized homes. They do conventional travel trailers, so the towables we talked about. They also do pop-up camping trailers. And for you, people who own these, they do fifth wheel travel trailers, not to get too specific here. They have a wide range of products. They're also based in the Midwest, they're based in Indiana, so they're close to the nexus of Thor manufacturing. This was a $576 million acquisition, but it gives you an example of what both of these companies are doing. They want to buy diversity of revenue, and they also want to buy insulation from a potential downturn. This quarter that they just reported, it shows you both through organic growth and acquisition that they are -- and you said at the outset of the show, Vince -- they're riding a tailwind right now. 

I want to go back for a second just to talk about, as we've talked about on the show many times, the difference between discretionary spending and spending on staples. Right now, the economy is growing at between a 2% to 3% rate of the gross domestic product, and that's actually true globally now. Consumers are making the purchases for recreation. We're on a gradual up-curve of global GDP. I don't know if we'll have a recession. For those of you watching the market the last couple of days, maybe there's some signal there. But these kinds of numbers aren't going to last forever. It's the mission of Thor to diversify for when that inevitably slows a bit.

Shen: Last couple of minutes here, overall, I'd say both Thor and Winnebago, they're not the only companies in the outdoor recreation market that are trying to expand their base and their target markets and attach themselves to a greater part of that $800 billion plus industry, with RVs specifically only being about $17 to $18 billion of that. Both of these businesses are based primarily in the U.S. Thor included some pretty eye-opening numbers in their latest earnings presentation. Strong annual growth of 11% expected for the RV industry over the next five years. Also, 34% of RVs sold in 2016 were to first-time buyers, and eight in 10 of the new buyers were under the age of 65. Again, there's some of the demographic tailwinds that they're enjoying. 

I want to give you, Asit, a little bit here to share. Any last thoughts that you had for these companies, any final takeaways for listeners before we close out?

Sharma: Certainly. If you're interested in Thor Industries in particular, one thing that really caught my eye late last year when I was doing some analysis is their backlog. Thor has an order backlog of $3.6 billion. That's a 70% increase over the prior year, and it represents 50% of their annual revenue. The company that this brings to mind is, of course, Boeing. Boeing, the airplane manufacturer, has a huge backlog, and it's able to manage its own revenue by just producing a little faster. It's a great position to be in.

So in a cyclical downturn, Thor itself has some mechanical ability to pump up earnings just a bit by producing faster. And it's taking excess cash flow, it's paying down debt rapidly. It paid down the Jayco acquisition, which was, I think they used about $360 million worth of debt, they've paid that down to about $80 million now. They've also used their cash flow to increase their production capacity. They're looking ahead to that time where sales on the top line might slow, but they can still record great revenue for a quarter, again, by that mechanism of throughput. That's very interesting, about this market leader. Though they're extremely big -- again, if you looked at Boeing's chart in the last year, being big doesn't necessarily mean you can't grow at a pretty fast rate. I think that this company has a lot of potential ahead, as does Winnebago.

My final thought on both of these companies is, they're pretty fairly valued and can grow. There is some risk, recessionary risk, cyclical risk, in these. But if you have a long-term horizon, a Foolish time horizon, you should consider these for your portfolio. And I'll see you out on the road, listeners, at some point in the future.

Shen: Thank you, Asit! That's all the time we have for today. Thank you, Fools, for tuning in. Austin Morgan is the producer for Industry Focus. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Fool on!