LCII - LCI Industries: A Promising Investment Opportunity

2023-05-16 12:25:38 ET

Summary

• LCII has demonstrated a remarkable track record of consistent and substantial revenue growth over the past decade.
• LCII has successfully gained market share and expanded its content per RV.
• Despite a downturn in the RV industry, LCII is still attractively priced based off a DCF analysis.

Opening

LCI Industries ( LCII ) is a company that manufactures and provides components for recreational vehicle (RV) manufacturers and related industries worldwide. It operates in two main segments: Original Equipment Manufacturers (OEM) and Aftermarket.

The OEM segment produces and distributes a wide range of engineered components for RVs, including chassis, axles, suspension solutions, and much more. This segment serves RV manufacturers and other industries such as buses, trailers, boats, and manufactured homes.

The Aftermarket segment supplies components to retail dealers, wholesale distributors, and service centers, offering replacement glass, awnings, and marine products.

In this article, we will conduct a detailed assessment of LCII's financial performance and its prospects for future expansion. Our evaluation includes a thorough analysis of the company's revenue and profitability patterns, its ability to generate free cash flow, and the health of its balance sheet. Additionally, we will employ a discounted cash flow analysis to determine LCII's intrinsic value, providing valuable insights for investors interested in assessing the company as a potential investment opportunity in the present market.

Track Record

Over the past ten years, LCII has shown consistent and substantial revenue growth, with the company reporting $5.21 billion in revenue for the most recent fiscal year, which represents an increase of 415% over the last decade. Additionally, LCII has recognized revenue growth in nine of the past ten years demonstrating the company's remarkable consistency.

LCII has also displayed impressive growth in free cash flow, with the company announcing a free cash flow of $471 million in the latest fiscal year, which reflects an outstanding 823% increase in free cash flow over the past decade. However, the company has been less consistent at producing free cash flow, as evident in 2021 when it lost $210 million in free cash flow.

The reason for the substantially lower free cash flow in 2021 was primarily due to lower cash flow provided from operating activities attributed by increased cash usage related to changes in net assets and liabilities, which included higher inventory levels and receivables driven by efforts to address supply chain challenges and increased demand. I wouldn't worry about this too much since the company bounced back with a record level of free cash flow in 2022.

LCII has also demonstrated impressive profitability, with an average return on equity of over 20% in the last ten years without a single year below 15%. This is an indication that LCII is generating a significant return on the investment made by its shareholders, and it is using its assets effectively to generate profits. This is a positive signal to investors, as it suggests that the company has a strong competitive advantage in its industry.

The company's financial health appears robust, as evidenced by its impressive balance sheet metrics. Its low debt to equity ratio of 0.99 suggests that it relies less on borrowing to fund its operations and is financially stable. Moreover, the high current ratio of 3.13 indicates that the company has adequate current assets to meet its short-term obligations, reflecting its ability to manage its debts in a timely manner.

LCII's investors have not seen exceptional returns despite the company's impressive track record. Over the past five years, the company's total return has underperformed the total return of the S&P 500, with a difference of 22.6% (42.3% compared to 64.9%). This has left investors wondering whether LCII can reverse this trend.

Outlook

In the coming years, analysts anticipate a challenging journey ahead for LCII. The estimated full-year revenue for 2023 is projected to be $4.02 billion, indicating a significant decline of 22.7% compared to the previous year. However, analysts expect a rebound in 2024, with a projected year-over-year increase of 8.75% to $4.38 billion.

Similarly, the earnings outlook for LCII appears mixed over the next few years. The anticipated earnings for 2023 are expected to be $6.14, representing a substantial decline of 60.3% compared to the previous year. Nevertheless, a recovery is predicted in 2024, with earnings projected to reach $9.91, reflecting a year-over-year increase of 61.4%.

These less favorable revenue and earnings projections are a result of the challenging RV environment, characterized by reduced RV production and a decline in wholesale RV shipments. The cyclical nature of the RV industry, influenced by economic factors, seasonal demand, interest rates, and consumer confidence, contributes to these fluctuations over time.

It is worth noting that we are currently experiencing a rising interest rate environment, with the Federal Reserve implementing its tenth consecutive interest rate increase on May 3rd. When interest rates rise, financing options become more constrained, dampening consumer demand and negatively impacting the RV industry as a whole.

To mitigate these challenges, LCII has made significant progress in diversifying its business beyond RVs. According to the company's latest quarterly report, sales from Aftermarket, Marine, International, and other related ventures accounted for a combined 63% of its overall revenue. LCII's President and Chief Executive Officer, Jason Lippert, emphasized the importance of diversification during the company's 2023 Q1 Earnings Call.

Lippert has never been more diversified in downcycle, moving from manufacturing almost only RV products to building content for a wide variety of markets, including Marine, International, automotive, Aftermarket, and mass transportation. I am confident that continued execution on this strategy will keep us on the path of outperformance and consistent profitable growth over the long-term.

Despite the current downturn in the RV industry's business cycle, it's crucial to keep in mind that when the tide turns in favor of the industry, there are significant factors supporting LCII. These include the increasing presence of Generation Z and younger buyers, as well as the expanding popularity of peer-to-peer RV rentals. These trends contribute to attracting fresh consumers to the outdoor lifestyle.

In spite of the current industry downturn, LCII has effectively capitalized on its controllable aspects, particularly by gaining market share. In the most recent quarter, LCII achieved a remarkable 21% expansion in its content per RV, amounting to $5881. Notably, the company's performance in the motor home RV sector was even more impressive, with a 27% growth compared to the previous year, reaching $3985.

LCII faces a challenging path ahead as analysts anticipate a decline in revenue and earnings for 2023. However, there is optimism for a rebound in 2024, with projected increases in both revenue and earnings. LCII can benefit from factors such as the growing presence of younger buyers, and the company has successfully gained market share and expanded its content per RV, demonstrating its ability to navigate through the industry's ups and downs.

Valuation

We will use the discounted cash flow ((DCF)) analysis to evaluate LCII's intrinsic value, a well-known valuation method that assesses an investment's intrinsic value by calculating the present value of its anticipated future cash flows.

Starting with LCII's free cash flow from the previous year, which was $471 million, we will apply growth rates of -60.3% and 61.4% for the two years, based on average analyst earnings estimates for that time. However, it becomes increasingly difficult to predict LCII's free cash flows beyond this period, so we will use a growth rate of 7% for the next eight years, considering the company's strong track record of growth.

To determine the terminal value, we will apply a more conservative perpetual growth rate of 2.5%. Furthermore, using a discount rate of 10%, which takes into account the S&P 500's long-term return rate with dividends reinvested, LCII's intrinsic value can be calculated at $196.55. This suggests that LCII may be substantially undervalued, indicating a potential 84.74% return for investors compared to the current market price.

Closing

LCII has demonstrated a remarkable track record of consistent and substantial revenue growth over the past decade. Despite a challenging RV environment and projected declines in revenue and earnings for 2023, there are factors that support LCII's future prospects, such as the increasing presence of younger buyers. Furthermore, LCII has successfully gained market share and expanded its content per RV, showcasing its ability to navigate industry fluctuations.

Although LCII's recent performance has underperformed the S&P 500, its impressive track record, robust financial health, and ongoing efforts to diversify its business beyond RVs are positive indicators for long-term profitability. Additionally, when applying a discounted cash flow analysis, the company appears to be undervalued, suggesting significant potential for investors.

Considering these factors, I recommend considering LCII as a promising investment opportunity. Despite short-term challenges, LCII's strong track record, diversification efforts, and potential for future growth make it an attractive option for investors seeking long-term returns.

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