Friday, 8 July 2016

Whistler Blackcomb Holdings Inc. Only Game in Town Rhetoric is Getting Old

They are the only game in town. And at 10x 2015 EV/EBITDA, and 17x 2015 EV/EBIT for a consumer cylical (ttm), this story gets tiresome real fast (update, July 9th, realized I grabbed EV/EBIT at 17x, not EV/EBITDA - correction made).

Here's a typical example of the conventional rhetoric surrounding the thesis for owning the shares, courtesy of Baskin Wealth, link here:

The author has some interesting points, but this analysis hinges on one aspect of the investment thesis; pricing power.  Here are my thoughts after my own analysis:

  • Attendance has averaged 2,482 total visits between 2011 & 2016 (ttm).  Total attendance has been flat to lower every year since 2012, with a sizeable bounce back in the preceding ttm period due to the weakness in CAD/USD, which carried through to Q2 2016.

  • The business model seems to be predicated on maximizing and sustaining the formula, "price per visit" x "# of visitors".  If # of visitors falls, either due to overall economic sensitivity or "eventual" elasticity to price increases, can you really argue that a business has absolute pricing power?  Maybe, maybe not
  • A function of the business success has been the recent depreciation of CAD/USD. Therefore, there is a FX differential angle here.  US visitors have flocked to Canada rather than pay up to go to Vail. Similarly Canadian visitors have not visited Vail and have stay-cationed at Whistler. If price increases to the point of making US and/or Canadian visitors indifferent between Vail and Whistler, any FX differential angle will diminish, negating the pricing power argument.
  • A cursory look at the 2015 financials yields that the company earned $.53 per share, putting the P/E at 45x.  While I don't like looking at P/E in a vaccum (I prefer looking at P/E over a series of years), the P/E has been above 30 every year since 2012 (see morningstar graphic below). I interpret this to mean that investors have paid a premium for the the company being the only game in town since 2012. Translation, at 45x, there is little margin for error.  The company had better continue exceeding expectations.
  • I'm ignoring the forward P/E of 24x, why? Because it's misleading.  It captures ttm #'s without reflecting second 1/2 results which include summer months, and which historically, have shown losses. 
  • The author tries to make the case for a 7% free cash flow yield, 50% of which is paid out in dividends.  This argument is predicated on a sustainable dividend, more on this shortly.
  • The author closes with the comment, "we think this is a high quality company, with a long runway of growth, trading at a reasonable price".  My retail nobody question, since when is 17x EV/EBIT, 10x EV/EBITDA (July 10th correction) and an average P/E of 40x over the last 4 years "reasonable"?  

In the author's defense, I offer the following observation.  Looking beyond the historical average multiple of 40x, the author "may" be onto something.  The following is an excerpt from the Q2 2016 MD&A 

  • Per the above, the company is planning on a $345M additional investment over the next five to seven years in order to expand the park & build additional summer attractions.  Here's a link to the press release.
  • The expected impact and project phases can be found via the following link, courtesy of the company.

A few excerpts from the company regarding project renaissance, which is supposed to be transformational.

Key takeaways:

  • Renaissance will include building an all season adventure centre, independent of weather, an indoor sports complex, new outdoor non-skiing attractions, upgrades to existing facilities, and a new six-star luxury hotel
  • Renaissance will also include monetization of real estate by virtue of build out of a luxury townhouse development
So my retail nobody question of the day is twofold.  a) At 45x earnings, is any of this priced in yet? and b) How is the company going to fund a $345M development.

I can't definitively answer a), but I'll take a stab at b) as follows:

On the subject of free cash flows which the author alluded to above, here are the cash flows from the most recent MD&A for the year ended September 30, 2015:

And here is the cash flow statement:

Observations as follows:

  • Unless I'm mistaken, the company appeared to pay out almost 100% of free cash flow as dividends (not 50% per the author's insight).  Per above, CF ops was $70M.  They spent $30M on capx, leaving around $40M for dividends + debt service.  Dividends alone were $37M, which doesn't leave much room for debt service, unless dividends are cut, or capx is cut, or CF ops increases significantly (due to increases in pricing per the author's thesis I suppose).
  • With no change to dividend policy, the $.97 dividend with no growth (fair assumption as the dividend hasn't grown much if at all since inception), valued at 6%, 8%, or 10% perpetually is worth between $10 and $16 per share.  Ordinarily, I argue strongly against using DDM because DDM only values the discretionary portion of free cash flow as opposed to 100% of free cash flow, but as free cash flow seems to be almost equivalent to dividends paid, I feel DDM makes sense here.  Caveat, if a large %ge of capx is non-recurring in 2015 & 2014, then yes, free cash flow should be higher.
  • The company is planning on spending $345M to build-out the new features.  With a current credit facility of $300M, on which $127M + $75M was available as at March 31, 2016, they will either have to issue new equity or debt to fund the expansion.  See below:

  • Given that incremental positive cash flows from the build-out won't likely start rolling in until +5 to 7 years from project inception (and it's my understanding that all approvals have not yet been obtained), I'd hazard a guess that the company may need to revisit it's current dividend policy while stretching existing visitor cash flows in order to service additional debt (if additional debt is taken on to fund the expansion), or to pay additional dividends (if equity is issued), on the further presumption that visitor cash flows stay level throughout construction and construction does not interfere with visitor experiences
  • The valuation issue therefore becomes a function of attempting to PV the expected incremental cash flows attributable to the build out, and comparing this PV to the expected cost.  If this NPV + the existing operations' discounted FCF's exceed current EV, then the author is correct and 45x eps is not 45x eps (and valuation is reasonable).  
  • I'm not sure how to even start attempting to PV the expected incremental cash flows attributable to the build out, but I'm assuming there are some very smart managers running the company who have probably budgeted this all out.  They wouldn't take on a $345M project if it wasn't expected to yield a great IRR.  Here's my rudimentary attempt at determining a range of possible valuations attributable to Renaissance per share using EVA:

To start, I attempted to determine actual ROIC of existing operations, using normalized NOPAT / invested capital.  I note that historical ROIC has averaged around 5%.

In order to determine expected incremental cash flows from Renaissance, I used a range of expected perpetual incremental cash flows between 10% and 15%, less avg weighted avg cost of capital of 6.67%, discounted at a range of WACC's betweem 6% and 8%.  I then took the average of my perpetual incremental cash flows divided by # of shares o/s, in order to estimate a possible range of values reflected in today's price per share.  My estimates ranged from between $4 and $10.

As historical ROIC has averaged around 5%, I'm not comfortable blindly concluding that EVA/sh is around $10.  It just seems far fetched.  I'm leaning more towards the lowest estimate of $3.92 per share, and even here, I'm taking a leap of faith that ROIC will end up being double historical.

At $3.92 per share attributable to Renaissance, current pps of $24 attributes $21 to existing operations, and at $.53 per share, my P/E for existing ops drops to 39.6x earnings from 45x at $24. Not even close to reasonable.

(July 10th update, my discounted EVA analysis is overly simplistic.  It assume incremental cash flows start at year 1 and are discounted perpetually.  This is obviously not the case.)

Concluding Thoughts

To me, relying on the only game in town rhetoric as principle justification for owning the stock is dangerous, and at 40x earnings, buying the stock here is an exercise in ignoring risk.  Now, I am interested in the stock, but only at the right price, and only if an event unfolds which would serve to unsettle the existing shareholder base.  What type of event might achieve this result?  A dividend cut in an attempt to preserve cash flows during construction.  If such an event were to unfold, I'd be happy to buy shares as existing buy and holders rush for the exits, and only if I can buy the shares at less than 20x earnings.  Until then, I'm happy to stay on the sidelines and observe events unfold.  I may miss out on a consolidator event unfold (i.e., Vail or Intrawest does a deal with the company), but I'm not deviating from my principles and exposing myself to unnecessary valuation risk in order to ride on the coat-tails of every other shareholder who seems to share the same only game in town thesis as justification for sticking with the story.


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