THO - THOR Industries: Strong Competitive Advantage And Trading Well Below Historical Book Value

2023-07-25 10:19:47 ET

Summary

• Thor Industries faces tough macroeconomic conditions, yet is most attractive as an investment during downturns.
• Its variable cost structure and efficiency strategies enable it to manage costs and maintain profitability and navigate industry cycles effectively.
• THOR Industries is the world's largest RV manufacturer, holding a dominant market share in North America and a substantial share in Europe.
• The stock likely offers a 14.5% annual return over the next 5 years.

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Investment Thesis

I believe THOR Industries, Inc. (THO) stock is a buy, given its strong market position, robust financial performance, and promising growth prospects. The company's dominant market share in the RV industry, both in North America and Europe, coupled with its book value appreciation, underpin its investment appeal. Furthermore, the projected compound annual growth rate ((CAGR)) of 14.5% over the next five years presents a compelling growth story for investors. In the following sections, I will present the evidence supporting this bullish thesis, including an in-depth analysis of the current recreational market conditions, THOR's competitive advantage and market position, the financials, market position, and valuation.

Company Overview

THOR Industries is a leading manufacturer of recreational vehicles (RVs) in the U.S. and Europe. The company's well-known brands include Airstream, Heartland RV, Jayco, and Keystone RV among others. The company has operations in three different business segments with two in North America being the Towable Recreational Vehicles and Motorized Recreational Vehicles. As well as one in Europe being Recreational Vehicles. They manufacture and sell a wide range of RVs, from smaller travel trailers to larger motorhomes.

Current Recreational Vehicle Market Conditions

THOR Industries experienced a significant surge in demand for its recreational vehicles during the COVID-19 pandemic, as people have sought out travel methods that allow for social distancing. I also believe the surge in demand was also fueled by macro factors such as government stimulus, multi-decade low interest rates and multi-decade low unemployment. We saw this led to robust sales and earnings growth for the company, where in the quarter ended January 31, 2023, THOR reported net sales of $3.2 billion, a 33.3% increase year-over-year, and net income of $133.7 million, a 45.1% increase year-over-year. CEO Robert W. Martin attributed this growth to "unprecedented demand" and the company's ability to navigate supply chain challenges. However, it's crucial to consider that these trends may not persist as the pandemic situation changes.

As a manufacturer of recreational vehicles, THOR Industries operates in a cyclical industry that is sensitive to changes in the broader economy. In the past six months (coming out of the pandemic), THOR Industries has been navigating a challenging macroeconomic landscape marked by rising interest rates and high inflation. In periods of economic downturn or uncertainty, demand for RVs historically decline as consumers cut back on discretionary spending, particularly when it comes to big ticket items. Rising interest rates can increase the cost of borrowing for both the company and its customers, this can mean higher costs for financing its operations and servicing debt. For the consumer, higher interest rates make financing purchases of THOR's recreational vehicles more expensive.

Typically, cyclical businesses such as THOR Industries are best purchased during these cyclical downturns, hence why I have written this article.

How THOR Industries Leverages Its Variable Cost Structure For Profitability In Downturns

THOR Industries operates with a variable cost structure. This structure means that a significant portion of the company's costs, such as direct labor, and certain overheads, change in direct proportion to the demand for RVs.

This cost structure allows THOR Industries to flexibly manage its costs in response to market conditions. In periods of high demand, costs increase as production is ramped up. Conversely, during cyclical downturns when demand decreases, the company can scale back production, reducing its variable costs. This was notably demonstrated during the Global Financial Crisis ((GFC)), when THOR Industries remained profitable despite the challenging economic environment.

THOR Industries' focus on efficiency improvements and cost management strategies further enhances its profitability. The company can negotiate volume discounts with suppliers, optimize production processes to reduce waste and increase productivity, and manage inventory closely to align with demand, minimizing holding costs. These strategies can help lower per-unit costs, improving profit margins even when sales volumes are lower during a downturn.

The ability to maintain profitability during economic downturns, as evidenced during the GFC, provides THOR Industries with a significant competitive advantage. It demonstrates the company's resilience and its ability to effectively navigate the cyclical nature of the RV industry.

THOR Industries Hold A Dominant Market Position

THOR Industries is the world's largest manufacturer of recreational vehicles, with a large presence in North America and Europe. Its products are mostly sold to independent, non-franchise dealers throughout these regions.

In North America, it holds a dominant market share being the first largest player. According to Statistical Surveys, Inc. , for the three months ended March 31, 2023, THOR's combined U.S. and Canadian market share was approximately 42.2% for travel trailers and fifth wheels combined, and approximately 47.7% for motorhomes. This position in the North American market highlights the company's competitive strength.

In Europe, THOR Industries also holds a substantial market share being the second largest player. According to the European Caravan Federation , based on unit registrations for Europe's original equipment manufacturer reporting countries, THOR's European market share for the three months ended March 31, 2023 was approximately 19.9% for motor caravans and campervans combined, and approximately 18.0% for caravans.

Experienced Leadership, Shareholder Alignment, and Prudent Capital Allocation

THOR Industries' management team is led by CEO Bob Martin, a seasoned leader with 29 years of experience in the industry and a 21-year tenure with THO. Martin's extensive experience and long-standing commitment to the company have been instrumental in guiding its growth and stability.

The founder of THOR Industries, Peter B. Orthwein, continues to play an active role in the company as a member of the Board of Directors and currently owns 3.5% of the outstanding shares.

Management alignment with shareholders is evident in the significant insider ownership of approximately 4.1% of the company's stock. The company has a strong history of returning capital to shareholders through dividends and share buybacks, with plans to return approximately $875 million over the next three years. This commitment is further demonstrated by 12 years of consecutive dividend hikes and plans to purchase approximately 14% of outstanding shares. Furthermore, the management team actively pays back debt with the goal of keeping their long-term net leverage ratio below 1.

Financial Analysis

Over the past five years, the company has demonstrated strong financial performance. Its revenue has shown a steady growth, increasing from $8.32 billion in 2018 to $12.2 billion in the last 12 months in 2023, representing a compound annual growth rate ((CAGR)) of approximately 8%. The earnings per share ((EPS)), has been volatile, peaking at $20.59 in 2022 before dropping to $10.45 in the last 12 months, though we should keep in mind that 2022 was an exceptional year for THOR Industries and was almost certainly a cyclical high. The book value per share has seen a consistent upward trend, growing from $36.77 in 2018 to $73.01 in the last 12 months, indicating a CAGR of approximately 14.7%. This suggests that the company has been successful in increasing its intrinsic value over the period. THOR's management team projects that by Fiscal Year 2027, the company will reach $20 billion in net sales and $27 per share in EPS. This projection however depends on the macro environment looking forward (which will dictate RV units sold in the industry as a whole) and will also depend on the management's ability to maintain market share and expand margins in their European segment.

As of the most recent quarter, the company reported cash and cash equivalents of $353 million. The company's total debt stands at $1.71 billion. While the company does have a significant amount of debt, it's important to consider this in the context of its overall financial health and its ability to service that debt. The company's current ratio, a measure of its ability to cover short-term liabilities with short-term assets, is 1.6, which is generally considered healthy. THOR's management team in the past have been prudent in actively repaying debt and much of the debt not maturing until 2026 as seen in the image below.

I expect THOR's upcoming quarterly earnings results to be volatile given where we are currently at in terms of the natural cyclically of the RV industry and the tough current macroeconomic environment. For at least the next 12 months, I expect revenue growth to be slower as a result of suppressed RV demand due to higher interest rates. I anticipate margins will remain stable during the upcoming quarters as a result of the company's variable cost structure.

Looking beyond the next 12 months, assuming a return to more favorable macroeconomic conditions, the company should return to strong growth and I fully expect the company to deliver on their 2027 guidance as the management team has proven in the past that they are consistently meeting or exceeding their outlined goals as we saw when they exceeded their 2025 financial targets as also seen below.

Valuation

THOR Industries' current book value per share stands at $73.01. Since 2007, the company's book value has grown at a median rate of 17.9% per year. Looking ahead, I conservatively estimate that the book value should grow at a rate of 8% per year over the next five years to account for the poor macro outlook. This would result in an estimated book value per share of $107 by Q4 2027. Historically, since 2007, the median price-to-book ratio for THOR Industries has been 2.58. However, I anticipate that by Q4 2027, the price-to-book ratio will re-rate to 2 (to be conservative). This would imply a Q4 2027 price target of $214 per share. From today's share price of $109 per share, this would represent a compound annual growth rate ((CAGR)) of 14.5%.

As seen below, when conducting a peer comparison of long-term book value trends between THOR Industries and Winnebago ( WGO ), a smaller competitor in the RV industry, it is clear that valuation of both businesses are depressed and well below historical averages for book value per share. Historically, when book value reaches around 1, there is typically sufficient 'blood in the streets' and usually marks the best time to enter a position like THOR Industries or Winnebago. While I think both businesses are undervalued, I believe THOR to be a safer long-term investment due to its superior position in the RV market, its ability to protect margins in downturns and its proven management team.

Risks

While THOR Industries will likely offer attractive returns over the coming years, I believe it is imperative to consider the risks associated with the company. The company operates in the recreational vehicle industry within North America and Europe, which are highly competitive and cyclical. This means that THOR Industries performance is closely tied to the ebbs and flows of the economy and consumer demand. Consumer confidence is an important aspect to consider for its business model in my opinion as downturns in consumer sentiment can often correlate to slowing or negative growth and poor price action for THO like what was seen in 2022 when consumer confidence plummeted to multi-decade lows based on the numbers from Consumer Sentiment Index from the University of Michigan. If this low consumer sentiment remains or continues to decline, whether that be the result of a recession or the reacceleration of inflation, then THOR Industries could see its growth hampered as a result.

Another aspect I pay close attention to are the RV Industry Association ((RVIA)) projections. If the RVIA forecasts a downturn in the RV market , this could be a red flag for THO as it may signal a slowdown in growth. This risk played out in 2018 when the RVIA projected slower growth for the industry which left THOR Industries with substantial inventory levels, which they could not easily reduce due to the oversupply of the market, THO stock declined by over 50% as a result. The company's success is heavily dependent on the health and growth of the RV market, so any negative trends here could spell trouble for THO.

Supply chain issues are another major concern. The COVID-19 pandemic put a strain on global supply chains, leading to delays and increased costs. THOR Industries relies on a complex network of suppliers for parts and materials. Many of THO's recent earnings calls contain commentary from THOR Industries' management discussing the challenges they were facing due to supply chain disruptions which severely hampered their ability to construct and distribute RVs and left a considerable backlog. Any further disruptions similar to the ones experienced during 2021 and 2022 could result in production delays and increased costs for THOR, which would likely impact their bottom line.

Conclusion

I'm drawn to THOR Industries for several compelling reasons. Firstly, I'm attracted to its variable cost structure which allows it to adjust costs in response to market demand for RVs which helps maintain the company's profitability during economic downturns, as demonstrated during the Global Financial Crisis. This resilience gives THOR a significant competitive advantage in the cyclical RV industry. Secondly, I'm impressed by the company's leading market position in two major RV markets, which I believe is a testament to its competitive strength. This ability is a significant competitive advantage that speaks volumes about the robustness of THOR Industries' business model. Thirdly, the management team has a proven track record and possess values that align with shareholders which should result in value continuing to be returned to shareholders. Lastly, based on my conservative Book Value Growth Valuation, I believe that the current stock price of THOR Industries offers an exciting return potential, further solidifying my interest in this investment.

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