Camping World Holdings, Inc. (NYSE:CWH) continues to be a long-term holding, and in my two previous articles here and here I’ve outlined the reasons to own shares. Unfortunately, this position continues to be among my worst performing portfolio positions. Despite such share price weakness, I believe that the underlying fundamentals of the business continue to improve. Since my initial write up on CWH, the following has transpired:
- Revenue has increased by 31% to record levels
- EBITDA has increased by 114% to record levels
- Dividend payout has been increased from $0.68 to $2.50 per share
After having a stellar year, the new dividend payout results in a yield of 8.5% and increased authorization under the buyback program for a total of $200 million to expire at the end of 2025. Spreading that buyback yield over four years would equate to a 2% yield at current prices. Therefore, the capital return yield alone provides investors with a combined 10.5%. And that doesn’t even consider leftover discretionary free cash flow that will likely be used for bolt-on acquisitions to further expand market share, long-term revenue, and EBITDA performance. Management has been utilizing very cheap debt financing to implement its roll-up strategy with secured financing rates of 2.5% (including both borrowings and floor plan debt). It’s hard to argue with this strategy when total net interest expenses are only $61 million annualized while EBIT has surged to $800 million. That’s an interest coverage ratio of 13x, and those costs should be well covered even when the cycle moderates.
So what’s the downside risk? I think there are a few key risks, and sentiment admittedly is bearish and can certainly get worse from here.
After CWH reported FY21 earnings on February 22, closing out a record year, management disclosed they would no longer be issuing annual guidance. The market immediately soured on that news due to concerns over visibility and guidance withdraws are almost always seen as a negative. However, I’m unsure if that’s necessarily the case here with CEO, Marcus Lemonis, stating that removing guidance was due to the fact that they want to be less concerned about near-term results and more focused on generating long-term shareholder value.
Starting in 2022, we are moving away from our approach of giving annual guidance…But as we see with too many public companies, managing the business to deliver an annual metric carries the risk of compromising long-term value creation. We believe each month and each quarter are only as important as the role they serve as markers on our road to continued growth of this company and maximizing value to our shareholders.”
Like some other investors, I’m supportive of this approach. Management and shareholder interests are undoubtedly aligned with the CEO not taking a salary, owning a significant portion of shares outstanding, buying millions worth of shares in the open market, and the company returning capital to shareholders in the form of dividends and buybacks. While financial guidance is nice to have, it’s far from a necessity and if management thinks they are better off without it, I see no reason to keep it.
Double Damage of Inflation
Inflation continues to make headlines as the cost of goods continues to rage higher. On the consumer demand side, higher stables, such as food, gasoline, heating bills, etc. are tightening consumer wallets, leaving less spendable dollars for discretionary purchases. Large purchases such as RVs are one category that could be pressured, especially in an environment with higher gasoline prices as they’re more costly to use ranging from 7-25 mpg. In this environment, consumers might be more willing to look for cheaper alternatives. This not only impacts RV purchases but also the demand for maintenance services that go along with it. So far, management teams and analysts haven’t factored this into their forecasts yet, but it’s something to on the lookout for.
On the supply side, industry competitor Winnebago Industries, Inc. (WGO) addressed in its Q2 2022 earnings press release highlighted a three key headwinds (italics is my emphasis).
- Gross profit margin of 18.6% was equal to the prior year quarter, driven primarily by pricing ahead of known and anticipated cost input inflation, and operating leverage, offset by production inefficiencies related to supply constraints.
- Positioned Winnebago Industries well to take continued pricing actions to offset component and material cost inflation.
- Cash flow from operations was $46.1 million for the first six months of Fiscal 2022, a decrease of $20.8 million from the same period in Fiscal 2021 due to investments in working capital driven by challenges in the supply chain.
Certainly, these issues are not unique to WGO, but rather are industry-wide and clearly impact performance for CWH as well. In fact, the four main RV sellers have all seen major increases in working capital requirements, partially due to high demand, but also higher costs of goods sold which flow through inventory:
Up until this point, all four companies have been able to manage these cost increases with higher prices. Can they maintain it though? Well, WGO posted a flat Q2 gross margin year-over-year, so that’s flattening gross margins for at least one operator. CWH, on the other hand, was still able to post expanding gross margins in Q4 2021.
Regarding EBITDA estimates, we’re essentially looking at flat to down performance over the next two years, and that appears to have more to do with margins than revenue expectations.
While CWH’s financing costs are incredibly cheap, some investors rightfully so are still concerned about the total amount of debt issued and overall financial leverage. As a quick comparison, CWH is the stand out with the most indebtedness, which likely continues to weigh down the equity multiple:
Between Q3 and Q4 2021, CWH’s long-term debt increased from $1.075 billion to $1.378 billion, or an increase of $303 million. That 28% increase quarter-over-quarter ignores floor plan debt. While these concerns are legitimate, I think investors should recall that CWH masterfully sidestepped defaulting on its debt between late 2019 and early 2020. The company still carries a similar amount of book leverage, but EBITDA has improved significantly and liquidity is more than adequate. If circumstances required it, management could also halt capital returns and acquisitions to retain all cash flows.
On the whole, Camping World’s operating performance has been strong. Revenue has grown at a blistering pace and operating leverage has driven significant expansion in TTM EBIT to a record $795 million:
In terms of cash flow performance, free cash flow is artificially low for two reasons. The first is that inventory requirements have been high due to strong customer demand, so that’s more of a good thing. The second is that capital expenditures appear pushing record highs. In FY21, management acquired 12 new dealerships for approximately $100 million. On page 77 of the Form 10-K, management further disclosed that they anticipate spending between $250 million to $350 million on store construction, expansions, and acquisitions. In 2022, CWH has already made two acquisitions through Big Daddy RVs in Kentucky and Bowling RVs in Iowa.
If we free cash flow with working capital and growth capex adjustments, then normalized TTM free cash flow would be in the range of $500 million to $550 million. That makes the stock look incredibly cheap.
The other underlying risk, however, is that CWH management could theoretically have the wrong capital allocation strategy to continue issuing debt and spending the proceeds on expansion. Why? In the event of a severe and protracted economic downturn, RV and ancillary service demand would decline and these fixed operating costs and added financing expenses would put significant pressure on the bottom line. When the industry was in shambles in late 2019 and early 2020, CWH reported multiple impairment charges that eventually resulted in negative book value:
I believe there’s a growing risk of recession due to a variety of macro factors, such as the flattening yield curve, high crude oil prices, weak consumer sentiment, among other factors. A recession would be damaging to CWH, but I think the company has the financial wherewithal and long-term vision to execute over the long term.
Weak Investor Sentiment
Crestview Partners has been a heavy seller of CWH shares. That’s been one of the major pressures on the share price. However, another major factor is that short seller activity has picked up significantly here in 2022. Whenever shares sold short increases, those shares are essentially being borrowed from another investor or brokerage firm with inventory and sold now. Eventually, short sellers will close out their positions, which results in buying back of the sold shares that need to be returned to the lender, thus creating upward pressure on the stock price. How much of an impact are short sellers having?
In the past year, the percentage of the share float that is short has increased from the mid-teens to 34% today. The most significant increase occurred in 2022 by more than 8%, while the stock price collapsed from $40 to $29. So I’d argue they are probably contributing somewhat here.
The problem for bears now, however, is that their cost of carry is 8.5% per year. Shares are already down nearly 30% year-to-date. Granted I think volatility will persist given industry headwinds, as a bear, you have to assume CWH will keep carving out new lows. Absent a recession, the stock is already inexpensive at ~6x forward earnings, so the bear thesis could be getting long in the tooth.
CWH had a solid FY21 but 2022 could prove challenging. In my second article, I outlined that the stock had an intrinsic value of $49/per share. Due to higher gasoline prices, potential earnings pressure from higher supply chain costs, and rising recession risks, I’m cutting my expectations on reaching that target, at least in the near term. Nonetheless, I continue to hold CWH given its strong management team, long-term earnings trajectory, and robust capital return program. I would purchase additional shares but I’ve reached a fully allocated position in my portfolio. What do you think CWH will perform? Let me know in the comments section below. As always, thank you for reading.
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