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Thor Industries: Pro Forma Maths

Founded in 1980 by the late Wade Thompson and current executive chairman Peter Orthwein — who still owns 3.6% of equity capital — Thor Industries grew by successive acquisitions to become the largest manufacturer of recreational vehicles in North America, with a market share of about 50%.

It operates as a near duopoly with Berkshire Hathaway-owned Forest River, which sports a 30% market share. Oddly enough, both companies are headquartered in Elkhart, Indiana.

Thor’s blueprint is one of remarkable expansion, capital efficiency, counter-cyclical investments and financial standing — a direct result of the founders’ aversion to debt. Revenues, cash-flows, profits and dividends all grew at an impressive clip over the past fifteen years.

Thompson and Orthwein got their start in the recreational vehicles business as complete outsiders when, in the 1970s, the industry fell out of favor due to high gas prices. A few years later, the pair formed Thor to purchase the venerable but money-losing trailer brand Airstream.

They turned it around and then undertook to consolidate the market, in addition of venturing into the bus and ambulance manufacturing businesses — before reversing course: these two divisions were sold six years ago in order to focus on recreational vehicles.

Mr. Thompson passed in 2009. The company subsequently repurchased his stock from the family estate in a private transaction that valued the shares at $29. Eight years later, following the two massive acquisitions of supplier Postle Aluminum and trailer manufacturer Jayco, shares traded north of $130.

Thor’s decentralized business model is surprisingly undemanding in capital. Manufacturing is outsourced — the company just handles the assembling part — and capacity quick and inexpensive to adjust, for 90% of workforce is contracted.

Production of new units starts on dealer order to avoid carrying inventories and the company does not finance dealer purchases. As a consequence, free cash-flow is plentiful and allow for a balanced mix of dividends, share buybacks — when appropriate — and acquisitions.

This is where the wonderful story comes to a tipping point, for a few months ago Thor announced the purchase of German recreational vehicles manufacturer Erwin Hymer, the leader in Europe with a 30% market share. The combined company should do $10-$11bn in revenue and, per management’s comments, provide for substantial synergies in technology and cost-cutting.

In addition, Erwin Hymer will open the doors of China — where it already operates through its joint-venture with Lingyu — to the now global, undisputed industry leader.

Alas, the transformative deal is occurring against a troubled backdrop. Shipments leveled off for the first time since 2009 and Thor’s revenue declined by almost 30% in the first six months of fiscal 2019. Meanwhile, a massive fraud was uncovered at Erwin Hymer’s North American subsidiary, leading to its exclusion from the scope of acquisition.

Because substantial leverage has been required to finance the purchase — up to $1.7bn of debt now burdens the balance sheet — the market fears an ill-inspired move at the peak of the cycle. This perfect storm sent the shares down from $150 to $50 in a matter of twelve months.

At the current price of $60 per share, or $5bn in enterprise value, assuming a 5% operating margin and $10bn in sales worldwide, Thor now trades at x10 forward earnings before tax and interest. Assuming an 8% operating margin — in line with its historical average — and $12bn in sales — a pro forma figure — the EV/EBIT multiple would come down to only 5x.

On a market capitalization basis, excluding cost of debt and assuming no synergies or additional revenue from the acquisition, the combined company trades at x10 Thor’s average earnings over the past three years — a valuation that may heavily discount a leading market position and the growth prospects of the combined enterprise.

Management, by the way, has addressed investor’s concerns in a pleasingly candid fashion. In a recent information form, to the question “Are you concerned that you may have purchased Erwin Hymer at the top of the cycle and potentially overpaid?“, they replied: “We are keenly aware of the timing of the acquisition, but we evaluated the latter with a long-term view. An opportunity to acquire the well-established European market leader may not present itself more than once in a lifetime. Our investors know that we are debt adverse and, rest assured, we remain so, but the long-term opportunity value demanded that we pursue the acquisition.

It is also worth noting that management’s variable compensation plan is based upon pre-tax profitability, hence the buyout had likely not been motivated by a misguided set of incentives. Besides, and for the anecdote, there’s no trace of EBITDA or any kind of adjusted figures in Thor Industries’ annual reports.

The recreational vehicles industry thrives in good times but plunges during economic downturns. In the short run, prospects of the combined enterprise may be less bright than advertised by management. In the long run, however, the leeway for value creation could be substantial.

(No position.)

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