Is Playing a Cyclical Upturn Safe?
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Thor Industries, Inc. (NYSE: THO) is a company that sells RVs, buses, and ambulances. It has experienced a run up of 12% over the past month (see stock price chart below). The reason for this run up is probably that investors are finally recognizing the improving fundamentals of this company since the last recession. Revenue has grown 35% per annum between 2009 and 2011. Revenue has grown 11% for the nine months ending Apr. 30. Free cash flow grew 34% per annum between 2009 and 2011. It was cash flow positive for the nine months ending Apr. 30 whereas it was cash flow negative this time last year. However, there are four reasons why I think buying this company is not a good idea.
The Fundamentals of this Company are Cyclical
Thor Industries has experienced top and bottom line growth since the recession; however, the story is different once you get into the recession. As you can see from the chart below, the company’s revenue and that of its competitors such as Winnebago (NYSE: WGO) and Oshkosh Corporation (NYSE: OSK) are closely correlated with the state of the economy. In other words, when unemployment rises and consumer sentiment heads south Thor and its competitor’s fortunes (along with their stock prices) head south. RVs and campers are a luxury that people are going to forgo during hard times.
THO Revenue TTM data by YCharts
Thor’s business model entails selling RVs and buses to a dealer. The dealer then finances the purchase, but if the dealer can’t clear the inventory then the bank repossesses the RVs and buses. Thor has to repurchase the repossessed items from the lender, usually at a lower price than what the dealer paid for it. The loss due to repurchases was at its highest in the last three years in 2009 at $5.2 million, declining to $853 thousand in 2011. This is further indication of the cyclical nature of this business.
Determining a Reasonable Price Becomes Harder
In a non-cyclical company something from the media will typically spook investors, and the sell-off usually causes the P/E ratio to sink, indicating to the investor that the company is cheap. Trying to determine a reasonable entry point becomes more difficult with a company such as Thor Industries. Usually the earnings drop more sharply than the stock price during a downturn, which means the P/E ratio actually expands. If investors don’t do their research they are going to think that a cyclical company is an overvalued growth play when in fact the fundamentals are degrading. Right now the P/E ratio of Thor is around 15, but if the earnings of this company go south then the P/E ratio will expand without an expansion in stock price.
To really determine a reasonable entry point to a cyclical company, one has to “take a pulse” of the macro economy by guessing where consumer sentiment is heading, how the GDP is performing, and how other metrics like consumer spending are changing. I think trying to predict the direction of the macro economy is too daunting of a task for some individual investors. It is certainly too daunting for me, which is why I try to stick with companies that sell things that people need.
In addition, I don’t like buying a stock simply because the price is going up. The cyclical elements listed above will most likely reverse short-term gains.
Intense Competition and Government Spending
In 2011 Thor Industries’ bus segment suffered a great deal from price competition from competitors, such as Oshkosh and Supreme Industries, Inc. (NYSEMKT: STS), and lower spending due to fiscal restraints from government customers. Oshkosh and Supreme Industries make buses and compete for government contracts. Thor Industries’ bus segment declined 3% in 2011 from 2010 but recovered in 2012; however, price pressures still exist.
In the RV segment, Thor Industries has to compete with strong traditional brand names, such as Winnebago and privately held Forest River, as well as approximately 70 other RV manufacturers in the U.S. and Canada.
Large Chunk of Sales Comes from Two Dealers
According to Thor’s 2011 annual report, 17% of their bus sales and another dealer comprised 14% of the recreation vehicles sales and 12% of the consolidated sales total. The fortunes of this large publicly traded company hinge on two dealers; this gives me reason for concern.
Conclusion
The cyclical nature of Thor Industries makes earnings predictability difficult, thus skewing normal price metrics such as the price to earnings ratio. This also tells me their products are something people can do without in difficult times. The competition is intense, adding to the underlying fundamental volatility. The huge reliance on two dealers for a huge chunk of sales causes concern about a lack of diversity in revenue streams, which means little things, such as relationships with these dealers going sour, can put a huge crimp in revenue and earnings. I think I am going to stay away from this company; cyclical companies are not my cup of tea.
stockdissector has no positions in the stocks mentioned above. The Motley Fool owns shares of Winnebago Industries. Motley Fool newsletter services recommend Thor Industries. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
