Fleetwood: Result 2015

Fleetwood's full year results were both good and bad. Revenue fell 18% to $300m and operating profit declined 12% to $9m, which sounds terrible until you consider that the company has a market capitalistion of just $100m. At the operating profit level, this wasn't a bad outcome.

Impairments of $4.4m and interest costs of $4m, however, helped vaporise net profit, which fell to just $176,000. Not even management was cheeky enough to point out that this was 170% greater than last year. As a return on capital, accounting profits remain woeful which is why the business trades at about half its net tangible asset value.

Yet that is not the full story. Fleetwood's aggregated full-year result was in fact a tale of two businesses. The accommodation division is delivering decent returns but these are lost by growing losses from the recreational vehicles (RV) business. This is not the uniformly lousy business the numbers suggest.

An agreement with Rio Tinto has seen utilisation rates at the Searipple village soar to 57%, a vast improvement on the sub 40% levels reported earlier. There is still scope for utilisation to rise to 60%.

At these levels, Searipple is generating decent cash flow and, with a mild lift, returns could improve further. The village is largely written off and doesn't demand much capital.

Replacing revenue

Work lost in the mining bust is being replaced by high margin revenue from the education and affordable housing sectors. School buildings in Victoria and Queensland have been supplied by Fleetwood and the business is seeking to replicate this success in other states.

In the recreation market, Fleetwood reached an agreement with the largest operator of caravan parks to supply stock which should keep volumes and cash flow up. It is lumpy, but work in the education and housing sectors appears to deliver strong margins; operating margins have risen from 6.9% last year to 8.9% this year.

The accommodation division generated $17m in operating profit for the full year, a rise of 8%, despite lower revenue. That implies a return on assets of over 7%. Not fantastic but not worthy of the mighty discount implied by the share price. Alas, this isn't the only division.

Much of the pain reflected in the share price comes from the struggling RV business where the operating loss widened from $7m last year to $10m this year. Revenues and margins were both lower as competition continues to hurt.

Caravans in park

The RV business was, for decades, a reliable profit engine. As profits from the mining boom swelled, however, RVs became less relevant to Fleetwood and the division was neglected for years. It has delivered awful results ever since even as the resources bust has made it more relevant. Worse, it has offset decent results elsewhere in the business.

We would support the complete sale of the division, which includes a valuable dealer network and two of the best brands in the business – Windsor and Coromal. Doing so and realising book value for the asset would be a boon for Fleetwood which could undoubtedly reinvest cash at better returns that it is earning today.

Yet management has pledged to persist with RVs for now, believing a turnaround is possible. The RV market is growing again – sales now eclipse their pre-GFC peak – and there's a chance of restoring margins on lower volumes by lowering fixed costs, reinvesting in new products and enlarging the distribution network. The company is pursuing all of these changes.

We agree that there is tremendous upside for investors if a turnaround works. Historically, the division has earned 8% operating margins which, even on a lower revenue base, would generate decent profits. Simply eliminating losses – forget about profits – would transform the financials.

A turnaround, however, will take time. With Fleetwood now debt free, we can be patient. If it comes, the upside would be large and, if it doesn't, the RV division should attract attention in a trade sale. It is a low risk strategy.

Worth waiting for

While we wait, the rest of the business continues to generate decent slugs of cash, with operating cash flow of $42m in 2015 and $9m of free cash flow. Why didn't profits reflect cash flow? Partly because of how Fleetwood accounts for the cost of its villages (it capitalises transport and installation costs), which results in high depreciation charges when new projects are completed, and partly because of impairments to the RV business.

Normalising both operating cash flow and depreciation, we expect the business should be able to generate about $15m in free cash flow even without a lift from RVs, implying a free cash flow yield of 15%.

Fleetwood is not a wonderful business but neither is it the basketcase implied by the share price. The 50% discount to net tangible asset value is too wide for a business capable of average returns. The valuation outlined in Fleetwood's share price surge (Hold – $2.10) stands and we're returning the stock to SPECULATIVE BUY. 

Note: Our Growth Portfolio owns shares in Fleetwood.

Disclosure: The author, Gaurav Sodhi, owns shares in Fleetwood.