This time share company is forecasted to grow 27.4% this year.
Hilton Grand Vacations Inc. (HGV)
From Small Cap Informer
Hilton Grand Vacations Inc. (HGV) develops, sells, and operates time shares, which it refers to as “vacation ownership intervals” (VOIs). At the end of 2018 approximately 309,000 members owned interests in the company’s 54 properties. Most, 75%, are American owners, but HGV also has a large contingent of Japanese customers representing 20% of the ownership base. About 600 of its 8,600 employees are based in Japan.
The company was spun out of Hilton Worldwide Holdings in 2017. The eponymous parent no longer retains any ownership, although HGV members can use membership points to book rooms in the parent’s system of hotels, for a fee. Hilton Grand Vacations also pays its former parent an annual license fee for the right to continue using the Hilton name.
Demand for time shares goes through peaks and troughs depending on consumer confidence and access to credit. In a downturn, unsold inventories accumulate alongside pent-up consumer demand. When the cycle turns, that pent-up demand gets released. When it exhausts, the cycle slows and turns down.
The industry currently appears to be facing a downturn in demand. HGV’s second quarter results, announced August 1, fell short of expectations and caused a sudden 14% share price decline. Shares are down almost 50% from their all-time highs and currently trade near the lowest prices seen since the 2017 spinoff.
Investors are clearly worried about the cyclical downswing. Developers are always building new inventory ahead of expected demand. When demand suddenly weakens, the economics of new and in-process developments deteriorate. Selling prices and velocity fall. Before recently reducing its full-year guidance, HGV was budgeting about $400 million of new inventory investment per year through 2021. This is an aggressive pace of investment, and we would expect the company to respond to a downturn by slowing its development efforts. It is also worth mentioning that about half of the company’s sales are upgrades for existing customers. An upgrade does not fill unsold inventory if the customer releases their prior VOI in the process.
The industry might not be as cyclical as investors fear. Time shares are expensive for customers to buy and expensive to maintain. Merchants get a big payment upfront, followed by a long tail of recurring fees.
The company estimates that 35%-40% of EBITDA comes from recurring revenue streams: financing, management, and operating fees. Financing fees are typically realized on a 10-year tail after a sale is made, so they are somewhat less recurring than the evergreen management and operating fees. However, another 15%-20% comes from ancillary fees for trading ownership points and renting out unsold properties to non-owner guests. We view these fees as largely recurring as well because they do not depend on converting new customers. This revenue source actually grows when unsold inventory accumulates. Viewed this way, about half of EBITDA looks recurring and dependable even in a less robust economy.
The company carries about $1.7 billion in debt, about equal to the total value of its financing receivables plus the carrying value of unsold inventory assets. This is a conservative balance sheet in our eyes and has allowed HGV to respond to its share price decline by retiring 12% of its outstanding shares since November 2018. If the company can slow the pace of its anticipated growth investments, more capital should be available to repurchase shares.
Note that revenue recognition can be lumpy, depending on when development projects achieve the milestones required to book revenue from presales. Q2’s comparison to the prior-year quarter was severely impacted. On the surface, revenue declined $109 million, or 20%. However, last year’s quarter enjoyed the benefit of booking $91 million of presales, while this year’s quarter faced the headwind of deferring $34 million of presales. The net of $125 million lost compared to last year is greater than the revenue decrease, implying there was actually some underlying growth.
We model 6% revenue growth going forward. Our EPS growth estimate is 9% per year for five years, which could generate EPS of $4.11. That figure, combined with a high P/E of 15.2, generates a high price of 62. For a low price, we apply a 20% discount to the current share price to get 21. On that basis, the upside/downside ratio is 6.8 to 1.
Doug Gerlach, Smallcapinformer.com, 1-877-33-ICLUB, September 2019