Wolf Hill Capital is Bullish on Hilton Grand Vacations (HGV)

Wolf Hill Capital Management, LP is the management company of the Wolf Hill Partners fund. Insider Monkey has recently published a copy of Wolf Hill Capital’s Q1 2020 investor letter.

A copy of the letter can be downloaded here. Gary Lehrman is the fund’s founder and managing member. For Q1 2020, the fund reported a net return of -10.13%, while the S&P 500 returned -20.94%.

In the said letter, Gary Lehrman highlighted a few stocks and Hilton Grand Vacations Inc. (NYSE:HGV) is one of them. Hilton Grand Vacations is recognized as a leading global timeshare company, which is based in Florida. Year-to-date, HGV stock lost 47.5% and on April 22nd it had a closing price of £17.84.

Its market cap is of £1.5 billion, and HGV is trading at a price-to-earnings ratio of 7.42x. Here is what Gary Lehrman said:

“Hilton Grand Vacations (“HGV”) was spun out of Hilton Worldwide Holdings in early 2017. The company operates in the “vacation ownership” industry, selling deeded timeshare ownership and vacation club membership to customers in the US and Japan. HGV has four distinct revenue streams: developing and selling time-share units, providing consumer financing to new and existing members when purchasing ownership units, managing properties for owners under long-term contracts with the homeowner’s associations (HOA) on a cost-plus basis, and receiving rental income from unsold inventory at its resorts.

Given the industry’s position in the eye of the storm, it’s not altogether surprising that HGV’s stock has sold-off ~50% year to date. However, we believe HGV is a classic example of the “the baby being thrown out with the bathwater,” as the business possesses a number of important attributes that position it well to weather the current storm and thrive in the post-virus “new normal.” First and foremost, HGV is a survivor under even our most stressed scenario of a prolonged economic shut-down. HGV’s free-cash-flow generation should prove to be more stable than most other hospitality businesses with almost half of its EBITDA derived from stable and recurring high-margin fee streams.

Specifically, the management fees it receives from its homeownership associations (annual dues of about ~£500 per year to pay for upkeep of the property) as well as fees/interest it receives from its sizeable consumer loan portfolio (average FICO score >700) represent recurring revenue streamsthat should prove to be highly resilient even under the most dire of scenarios. Additionally, HGV benefits from entering the crisis with a conservatively capitalized balance sheet. HGV’s balance sheet is currently levered at slightly above 1-turn of Net Debt/EBITDA while maintaining cash reserves of approximately £700mm.

HGV’s cash position should ensure many years of runway without having to tap the capital markets – in fact, even under our highly stressed scenario, we don’t envision HGV burning through more than £125mm/year. Second, HGV is a compounding machine. Its affiliation with the highly respected Hilton brand and success of its timeshare development program have allowed it to compound “net owner growth”1 for 27 consecutive year at an 8% CAGR – far outperforming other timeshare industry competitors.

A highly satisfied and growing base of “net owners” is an important driver of recurring revenue. Consistent low single digit increases in annual management fees and higher customer utilization of HGV’s resort network and points system has driven consistent growth in annual fees per owner. Clearly, resort usage and corresponding revenue growth will suffer during the shutdown, but we believe there will plenty of pentup demand for unitholders to go on vacation upon the resumption of some level of economic and socialdistancing normalcy.

Given these attributes, it’s not difficult to see why in late 2019 HGV was reportedto have received buyout interest2 (around £40/share per press reports) from the likes of Blackstone, Apollo, and Centerbridge (who coincidently holds a 5% stake). In fact, the “take-out” angle was so pervasive prior the Covid-19 health crisis that the stock attracted a largely short-term focused event-driven and merger-arb shareholder base. The recent shake-out in the event-driven space has likely exacerbated the stock’s recent fall.

Of note, just last week HGV adopted a poison-pill takeover defense. With many tens of billions of dollars of recently raised private equity cash waiting to get deployed and an influx of capital flooding into the High Yield market, a sponsor-led buyout of some sort still appears to be a highly possible outcome. We believe that a private equity owner with a 5-7 year investment horizon could extract highly attractive levered returns from this collection of assets.

An investment in HGV at today’s valuation offers substantial margin of safety with terrific upside optionality to a take-out or eventual re-rating of the stock. For perspective, at a recent price of £19/share, HGV’s valuation is 4.5X pre-COVID run-rate EBITDA relative to its historical 8-10X valuation band. We don’t believe that the Hilton brand is tarnished in any way, nor is the idea of timeshare ownership likely to be impacted by the “new normal” – whatever that may look like.

If you liked your Hilton timeshare prior to the outbreak of COVID-19, chances are you will probably enjoy it after COVID-19. Today’s valuation should in theory, reflect the pre-COVID-19 valuation less the present value of lost/foregone free cash flow caused by the disruption and subsequent economic slowdown – not the capping out of estimated 2020 depressed earnings into perpetuity. Over a medium term investment horizon, we believe that an investment in HGV at today’s discounted valuation offers the potential for 2-3X type return as the market begins to sift through the carnage in this sector with a more discerning eye, and begins to discount an increased likelihood of HGV’s earnings snapping-back relatively quickly post-COVID.”

In Q4 2019, the number of bullish hedge fund positions on HGV stock increased by about 7% from the previous quarter (see the chart here).

Disclosure: None.

This article is originally published at Insider Monkey.

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