THO - THOR Industries Faces A Bumpy Road Ahead

2023-04-04 05:06:30 ET

Summary

• Disastrous latest quarterly earnings shed some light on the RV industry globally.
• The writing was on the wall for a while now that RV sales have been declining over the last year, and OPEC cutting production surprised many, which may bring inflation.
• THOR Industries' guidance for the full year sees over a 30% decline in sales.
• Conservative DCF estimates for the next 10 years suggest the company is overvalued and may see further decreases because of the volatile environment.

Investment Thesis

With the recent Q2 earnings coming in well under the expectations on the street and with forecasts for the full year adjusted to the downside, I had to adjust quite drastically my forecast models that would reflect the slowing demand for RVs in the US and Europe. Coupled with such uncertainty in the economy, THOR Industries ( THO ) will see more headwinds in the next 12-24 months before it could become a viable investment as it does have potential, but for now, it is a hold in my opinion.

Most Recent Earnings- Not Looking Good

The company took a big hit on the day of earnings for Q2, at one point was down 9% on the day. It has not performed better since as the stock price tumbled even more, another 10% or so. What happened to justify such a selloff? The management's guidance for the full year was adjusted down to reflect much tougher economic conditions that will persist for a while, revenues were down a whopping 39% from the quarter prior year, and EPS came in at 50 cents, which was well below analysts' estimates. On top of that, gross margins also contracted quite a bit, 530bps. The management is guiding towards $10.5B -$11.5B revenue for the upcoming full year, which was lower than analysts' estimates. Gross margins will also take a hit in the full-year report.

Outlook

If you would look solely at annual reports, the company seems to be growing at good rates, however, to get a full picture of what is happening currently, quarterly reports give us a great gauge of how the company feels about the current demand for their products, the economic environment and their assumptions for the upcoming quarters. In this case, we can see that it is not looking good for THOR Industries. I had a model of the company's financials completed after the company announced FY2022 results which were sometime in the summer of last year if I remember correctly, my assumptions back then were much more optimistic and the company looked quite under-valued, however, the writing was on the wall, with many articles coming out with sales declines in RV vehicles since then in the range of -30% to -40%. It was only a matter of time before the company was going to take a hit, and a hit it took.

Speaking of the near future, it is not going to get better. We haven't seen a big downturn in the economy yet. The interest rates are still climbing, and the Fed will do whatever it takes to bring down inflation to its 2% long-term target. The most recent surprising announcement by OPEC of cutting production is not going to help increase the demand for THO vehicles in the next year or so. Inflation might pick back up with the said announcement as the Fed may have to tighten further for longer. There is a lot to be pessimistic about in this industry as of right now.

In terms of margins, the company for FY2022 saw a nice increase in gross margins. Well above its average of the last 5 years, however, with the recent 540bps contraction, the margins more or less are back to where they have been previously. The short-lived efficiency did not last a full year, which suggests the margins will be kept at around the historical levels for the foreseeable future, or even trend a little down also.

RV shipments in the two months of '23 show substantial decreases, which may suggest that the trend will continue.

With the increases in gas prices and higher interest rates, I could see people not making such a large purchase right now, as the loans might be too expensive to afford at this moment and may continue being like that for a little while longer.

Financials

The company has a good amount of cash on hand and has been able to generate very good cash flow from operations over the last 5 years. This is good because they do have a lot of debt on their hands also, $1.7B as of the latest quarterly report. The company seems to have added more debt recently after it was paying it off steadily in the previous years. The company does not have a problem in terms of paying off the debt as EBIT more than covers the interest expenses. It would be ideal if the company starts to pay off the debt once again and bring it down as much as it can.

Speaking of liquidity, the current ratio is more than acceptable too, it has been hovering around 1.5 for a while now, meaning the company can cover its short-term obligations without a problem.

In terms of efficiency and profitability, the company has been in an uptrend as of the latest 10K report, however, with the above-mentioned misses on revenues and contracting margins, I wouldn't be surprised if ROIC, ROA, and ROE will show a dip in the next annual report.

The problem with a company that reports their end of year figures in the summer is that it misses the other half of the year, which in this case got more volatile and even more uncertain, and as we saw with the latest quarterly earnings, it has been ugly and might not get any better for quite some time. If I was to look at these figures above without knowing that they are missing half a year of results, I would think the company is in great shape and will continue to perform well. That is not the case as we all know.

Valuation

For the model, I piggy-backed off of the management's outlook for FY23 where they are predicting to make around $10.5B- to $11.5B for the full year. For the base case, I assume the company makes $10.8B in net sales, $10.5B for the conservative case, and $11.5B for the optimistic case. These estimates for the base case show a 33% decrease in net sales, which is quite a big drop y-o-y. For FY24, I assume a further decline in revenues of 10%. The reason is that the summer of '24 is only around 15 months away and I feel we would not be out of the woods yet in terms of a recession, elevated interest rates, and oil prices. After that, I argue the sales would start to pick up but to be conservative, over the next 8 years the company would average 7.3% growth bringing total net sales from $10.76B in '25 to $17.2B by '32.

In terms of margins, we saw the company has lost over 500bps in the most recent quarter, which kind of brings the margins back to the historical levels it saw in the past. The management guided gross margins to be in a range of 13.4% to 14.2%. I would believe the management knows its company and I will take these margins at face value and implement them for the next two years. For the years after, I assume the company managed to improve but only by around 130bps to keep it conservative, with slightly more improvement on the optimistic case and slightly less on the conservative case.

I will also add a much higher margin of safety to the company than I usually like to do, mainly because it is a very volatile time, and the company depends on too many variables. Therefore, I believe a 50% margin of safety is sufficient. I believe these assumptions are reasonable and conservative enough for value-seeking investors. With that said, with the 10-year DCF model with a 50% margin of safety built-in, THOR Industries' intrinsic value is $58.82 per share, implying a 25% downside from current valuations.

Conclusion

The latest quarterly results were just too ugly to be upbeat about the current state of the RV industry. The company is a great long-term investment in the future once we see the demand picking back up, however, there are too many unknowns as of right now. I can see the share price coming back down to the implied intrinsic value above, or even below that too. The RV industry will thrive once again as it did before, I'm just not sure how explosive the growth will be in the future.

I will keep an eye on the next 2 quarter reports and on other RV sales statistics that come out over the next year or so and will re-visit the valuation once I get a clearer idea of where the inflation, interest rates, and gas prices are going. For now, we are not out of the woods yet.

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