Fleetwood to go sans caravans?

Be careful what you wish for. Fleetwood's recreational vehicle (RV) business has been a drag on profits for years, consistently losing about $10m a year, and we've long argued the division should be either cleaned up or sold. We are probably closer to that now happening than at any other time, but it has come at the cost of a downgrade.

Fleetwood warned last week that full-year earnings before interest and tax (EBIT) would now be $5.5m rather than $14.6m. The difference is mostly due to deteriorating performance of RVs, where new designs and new models have failed to turn the business around.

Unit sales just aren't high enough and competition has increased, making a turnaround with current volumes impossible.

RVs in reverse

Only about 30,000 RVs are sold in Australia each year and about 80 different brands compete fiercely for that limited volume. Selling cars looks comparatively breezy, with about 50 brands fighting over 1.1m units a year.

With results well below expectations and little hope of improving without substantially more volume, Fleetwood will almost certainly sell or close the division in quick time.

That will realise a large part of our investment case which noted that the rest of Fleetwood could potentially earn reasonable returns.

What appeared to be a loss-making, lousy business was, in fact, a profitable business with a lousy division. This will soon be clear in the numbers as RV losses are expelled.

In the short term, the prospect of lower profits has hit the share price – but being rid of RVs will undoubtedly be a good thing and makes full-year EBIT rather meaningless. We need to consider what this business would look like without caravans.

Sans caravans

The rest of the business, including accommodation, villages and accessories should be able to make $18m–20m for the full year. Assuming management is able to close down the RV division with zero net cost, it means Fleetwood currently trades on an enterprise value to EBIT multiple of 7–8 times, which isn't far off fair value for a business of this quality.

Yet things aren't as simple as that. Fleetwood's accommodation business involves lumpy revenue; villages is highly cyclical and the accessories business is a prime candidate for sale. We need to break up these divisions, normalise earnings and come to another valuation check, which we do in Table 1.

Assuming the accommodation business can generate about $12m of EBIT across the cycle, which assumes return on assets of just under 10%, we think an EBIT multiple of about 8 is about right, valuing the segment at about $100m.

The villages business is more cyclical and we use an asset-based multiple reasoning that a highly depreciated asset base can still generate a high return on assets. We value the villages business at about 2.5 times tangible assets, or $60m.

The accessories business largely offsets corporate costs and we assume zero value for RVs. That is a strong assumption; RVs could attract a negative value if closure costs blow out, or it could bring in a few million dollars if a competitor acquires the brand.

Totting up our parts brings the enterprise value to about $160m. Adjusting for debt, that gives an equity value of $150m or about $2.50 per share.

Endgame

This is less than our previous valuation of over $3 because the option value of higher RV earnings has been removed. The range of outcomes is now narrower and more certain but the valuation, without a recovery in RVs, must fall.

All this suggests the market has Fleetwood about right. We would require a decent buffer before considering buying and we're therefore lowering our Buy price to $1.70. With some of the upside removed, we're also lowering the Sell price to $2.50.

Despite all the excitement from the market, which swung the price around wildly, there is no need for action. If, as expected, Fleetwood sell RVs cleanly, we should have sight of our sell price. For now, HOLD.

Note: The Growth Portfolio owns shares in Fleetwood. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

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