Travel + Leisure Co. (TNL) Earnings Call Transcript & Summary

Good afternoon, everybody. Next up for our fireside chat session is the team from Travel + Leisure. I feel like every time I say the word travel -- words travel and leisure, I have to add to it formerly known as Wyndham Destinations. Soon enough, we won't be able to do that because it's further along in terms of morphing into a full travel and leisure company. With me on the stage today is Michael Brown, Chief Executive Officer; and to his left is Mike Hug, the Chief Financial Officer of TNL. And in the front row is Chris Agnew, who quarterbacks Investor Relations. Maybe you could start with a big picture question for you in terms of what maybe for, both of you, what your strategic priorities are and then we can maybe talk about your core business and demand trends and love to maybe get any updates on the Vacation Club's business, the Travel Club's business. So we'll start with that.

Yes, it's broad, but -- so let me start broad -- is -- for many of you who followed us or not, we had an Investor Day last September, where we laid out an overarching goal over the next 4 years to double our growth rate from mid-single digits to upper single-digit growth rates. And in order to do that, our objective was to begin to reposition ourselves to grow incrementally on top of 2 great core businesses being timeshare, Vacation Ownership and Vacation Exchange. Ultimately, with the net effect of generating upwards of 60, slightly higher free cash flow as conversion EBITDA. That's the output of the operational side of the business, which is to continue to grow at historical rates our core 2 businesses of Vacation Ownership and Exchange being Wyndham Destinations and RCI, and to launch into some non-timeshare businesses, 2 of which we've already launched to begin to fuel some of that growth incrementally, not cannibalistically or not in replacement of but simply incrementally to what we're already doing.

Great. The -- maybe we can just talk about this because it's been sort of a topic, whether it's a traditional lodging company, whether it's the U.S. or Las Vegas trip-centric gaming company. What's been the historical relationship between steep increases in gas and commodity prices relative to demand or tour flow or propensity to transact for timeshare?

Well, I think in the last 25 years between 9/11 and great financial crisis, COVID, you pick up not only commodity issues, but you pick up just macro trends and you see priorities of the consumer. And what we saw, and I think this directly ties to your question as it relates to commodity prices, is that the consumer beyond economic security and personal health, their personal free time is what matters most to them. So I would expect what we will see for the remainder of this year is you might see vacation behaviors change from maybe fly to, to drive to. But you're still going to see that propensity for people to go on vacation, and I'll just share maybe 2 anecdotes with you. The first is that at the beginning of COVID, pre-COVID, 72% of our arrivals were by car. As we got into COVID, people want to stay closer to home. That number went to 92%, 93%. And as of early February, before the recent events in Europe, that number had dropped already back to 72%. I think oil prices, gas prices starting to go up, 80% of our owners are fully paid for their vacation already. I think you'll see people stay a little closer to home, more drive-to markets, and they'll see a huge value with inflation and commodity prices in the value of their ownership.

Great. And when you're in periods of inflation, does that make it actually easier to sell a timeshare? And I mean no one's showing up at a timeshare pitch with an HP 12C calculator and trying to do the net present value. But there is a positive net present value. And in an environment like we're in now with significantly higher increasing hotel room rates, in that kind of environment, is there a way the consumer to be sold or to be told to perceive the value of a timeshare?

Well, there's no question, without using the calculators, we actually do show you -- showing them the value of ownership. And Florida, there's probably no better example than Florida right now, whether it's South Florida, sort of the high season in the Miami, Boca, Fort Lauderdale area, or Spring Break in Orlando, where it's not about the price. You just can't find a room. And when you sit with an owner who has fully paid off their ownership and are therefore maybe $800 of maintenance fee or $1,000 of maintenance fee, and they know that they could have just gone on Expedia for a 2-bedroom and paid $700 a night or $800 a night, value creation and explaining that is super clear and easy, and people see the value of that. So the inflationary component for us really does not come into play unless we were in the construction cycle of where we are. And we're in exactly the opposite. With COVID, our balance sheet is sufficient to support the number of sales that we'll be doing for years to come. So we don't have cost of goods pressure whatsoever, and we're able to very clearly demonstrate at the sales table the value of ownership compared to renting on a nightly basis.

And is there a consumer sensitivity or elasticity to maybe to TNL pushing up the APR on the financing?

I think there's always a little bit of sensitivity, but we see the greater value as an organization of acquiring more customers. So the lifetime value of someone who purchases today is -- they're going to buy $2.68. For every dollar they paid today, they're going to pay $2.6 more in the future. So getting the extra $1,000 today is far less valuable than getting that incremental owner. If I can just translate that, that means for every person that we have come to the sales gallery, we would rather sell them at 13% out of every 100 than 10% out of every 100 because we are laying the groundwork for future sales that we know will come with 25 years of experience.

And just coming back to a period of inflation and hotel pricing strong. Have you seen in that environment in the past closing rates improve?

We've not only seen that in the past, we're seeing it now. On a pre-COVID level, our close rates were hovered around 10%. And in this environment, we're seeing them in excess of 12%. So 2 basis points, that's -- they're 200 basis points. That's not too much. You do that over the course of 600,000, 700,000 tours. That's a lot of incremental sales. That's a lot of incremental revenue. And that $2.68 for every $1 we sell, that's just on sales. That doesn't include management fees, financing fees and all the rest. So we're seeing a noticeable increase in our close percentages since pre-COVID levels.

You and others talked about in January, the impact of Omicron. Can you talk about what you've seen since that quarter-to-date? And has there been anything noticeable in terms of inflection points in different markets, different regions or different geographies?

It's amazing despite the spike in January, which was far greater than the Delta spike or the original COVID surge, how quickly this rebounded. It literally felt like the impacts of Omicron went away overnight or within a week. As we shared on our earnings call, February flipped from being negative net bookings to being positive net bookings versus 2019. And we all know Omicron sort of began to go away right at the end of January. And we've seen the strength that we talked about in February on our earnings call in the 23rd continue to move at the same rate, if not better, since that point. And it just shows where that -- we talked all through COVID about pent-up demand. It's clearly playing through. And absent bigger news that, that expands, I just think it's going to be an extremely strong leisure travel year, and we are 100% leisure dedicated as a company.

When we think about your core timeshare business, and you always kind of start with modeling or thinking about tours, how do you think about the recoveries in tours by different sourcing of tours?

Right. And we're probably a little different than some of those in our space in that we made a decision during COVID to elevate our FICO's level from basically 600 to 640. And what that did is that took out about 150,000 to 200,000 tours of our 900,000. So we view that as our new baseline because we see the opportunity going forward is to raise our volume per guest on every tour significantly and have really strong impacts on to our portfolio. What we've seen very early on, and I'll just mention VPGs for a second, and I'll ask Mike to talk about the portfolio, is that pre-COVID, our volume per guest was 2,300, 2,400, and it has been consistently above 3,000. So for those of you not familiar, every guest that walks through our door buys, on average, over $3,000 of product. And so that's up anywhere from 30% to 50% depending on the period of measurement. And that is a far more efficient way to return to EBITDA than where we were before. Maybe you can talk about the positive impact of the portfolio.

Yes. And one of the reasons that we have been able to generate the significant cash flow that we did this year and even back in 2021, even back in 2020 was because of the good performance of the portfolio. We had originally estimated losses on the portfolio, which was about $4 billion in size, at the end of 2019, would be about $225 million. And the losses have actually come in at about $85 million. So the value to the consumer is very clearly demonstrated when you see they continue to pay for their product. They use the product. And then as we've moved that minimum FICO from 600 up to 640, we've seen our quarterly provision hovering below 18%. So we couldn't be happier with the way the portfolio performs, great for earnings, great free cash flow. And then obviously, we were able to access the ABS markets even during COVID with great terms. Our last deal was under 1.7% interest rate. So I couldn't be happier with where the portfolio performs once again. I think it's a great indication of the fact that our owners do value their product, and they want to keep their ownership and want to take their vacations.

Great. Pre-COVID, one of your focal points was to improve the mix to new owners given what you just said in terms of the lifetime value associated with that. You're targeting around 40% pre-COVID. Can you talk about the past maybe getting back there or whatever you think that new optimal mix or threshold would be?

Yes. So we -- I joined the company in 2017, and we were about 32%, 33% new owner mix of total sales. We gave a very aggressive target to get above 40% from 2017 onwards, we had progressed by about 200 basis points every year. We were up to about 38%, 39%, which is just, for a point of reference, exactly in the middle of our 2 peers. One is slightly higher. One is slightly lower. And as I said on my call, I think all 3 of us are in a great place. So you could say mid-30s, early 40s, you're in a very good place to keep supporting your long-term top line growth. I expected that we would be around 25% during COVID because its owners coming back. You don't have scale. We ended up the year, I think, at 28%, 29%. We will work ourselves back to the upper 30s. We're in no rush because we've got a very strong base, and we want to do it efficiently because there is some cost headwinds. But I would expect us to be in the upper 30s within a few years.

Can you get to the upper 30s and still maintain VPG at around $3,000? Or is that just mathematically not possible?

Well, it's definitely mathematically possible. If you just take that -- let's just take the 2,400 and I said plus $3000, just take 30, 100, halfway -- we think about half of that's due to mix. So halfway there is about [ 2050 ].

Mix being...

Mix being owners and new owners. So we think about half of our VPG lift is due to mix and half is due to just pure performance. And I've been saying that for 6 months, and I will continue to say that. But what I will also say is every time I say that and we keep improving our new owner mix, our VPGs are holding exactly where they've been for the last 6 to 9 months. And I -- at some point, I'm going to have to give our teams credit and say they're just performing extremely well. But I also don't want to get ahead of myself with you all that it has to drop back to [ 2,800 ]. I -- our teams are performing incredibly and it's maintained itself considerably over 3,000.

To what extent has the VPG been positively impacted by going to a consumer or going after a consumer that has a higher FICO score? Is that part of it, whether it's higher close rate or higher average transaction size or...

Believe it or not, almost none of its transaction size. And oddly enough, I think if you dig into everyone's numbers, you're going to find that everyone's transaction size is somewhere between 20,000 and 25,000 no matter what price you're selling. And for us, it has been close rate. It is higher close rate. You're seeing a better consumer in front of you. You've got a stronger sales force because you've downsized during COVID and you've brought back very methodically. And then the programs that you were adding back in, you're adding back in because you know they're going to be profitable from day one. And I think the challenge that leaves us, and it's a challenge that we're already well down the path on is the people that we were touring previously from 600 to 640 are still going on vacation. So we're looking at another avenue to still supply a vacation product for them but maybe not with the same transaction price.

Got it. And the fourth quarter Vacation Ownership EBITDA of $182 million was about 82% of pre-pandemic levels. In the third quarter, that EBITDA was $177 million. That was -- so [indiscernible] here 87% of pre-pandemic levels. Do you think you can get back to 100% of pre-pandemic levels in [ 2002 ] relative to 2019? Or is there some other dynamic? I know that the FICO score change is sort of maybe getting back to 2019 with sort of overstating kind of what you were talking about, sort of the reset. And then also, two, you have maybe the headwinds of a smaller loan portfolio because in COVID, you didn't sell as many, so you don't have receivable income. But are there offsets to that potentially?

Yes. So let me just share, and then I'll ask Mike to really talk about the dynamics of that portfolio. If we equalized our portfolio, our belief is that we'll be back to our pre-pandemic run rate. We've said it in the first half of this year. So we'll see how current events unfold. But really, the -- there are a number of other headwinds, but we have defeated those with sort of the strength of our close rates, our strengthening provision. So we feel really good about getting that back to '19 levels and that our business with its margins and efficiency is definitely going to get back there. The one caveat or the caveat, it's the one piece that we have to work hard on the portfolio. Maybe you can talk about the size and why that's the headwind.

Yes. I mean, as I mentioned earlier, we were at about $3.9 billion at the end of 2019. Now we're about $1 billion less than that. So $2.8 billion, $2.9 billion in our portfolio size, which represents over $100 million in interest when you think about the fact that we lended over 14.5%, and we've been borrowing it under 25. So that's the big headwind. What you'll see us do and what you've heard us talk about is we are very happy with our provision. That's been very strong. We've guided first quarter to around 17% when pre-COVID it was north of 20%. But what we're going to do is work to drive a higher percent of sales finance so we get more of our buyers to take financing to start to get that portfolio growing again. So it's important to understand that when you do see our provision move up throughout the year from the -- around 17% will run in the first quarter, we do expect it to be higher. But it's not a quality issue in terms of us lowering our FICOs and our market standards. It's more, let's work with the sales team so that are asking for less down payments at the table or less cash deals at the table, we get that portfolio growing back again eventually and start to overcome that headwind of the $100 billion -- I'm sorry, that $1 billion in portfolio size that we've lost. So just important to understand, provision is not always a quality issue. In our case, it's a good issue. It's a good quality issue because it is good quality receivables that we're going to be trying to generate at a higher rate.

And what's the EBITDA margin on the $100 million of interest income? Is it...

Yes. So it's -- and that's the point, right? We borrowed...

Is it 100%?

No. Well, you've got the interest expense, say, 2% or 3% and we're borrowing at 14%. So that's kind of where that -- if you think about our portfolio was down about $1 billion. our spreads are about 10% or 11%. So that's where you kind of come up with that $110 million in interest that we lost.

Yes. And you sort of touched on it. A really good point there is we've been maintaining our margins despite losing all of that interest income. And it's masking a lot of that close rate level and improved provision, the fact that we're losing really high-margin net interest income yet maintaining our margins.

Maybe you can give us an update on Travel and Leisure Club. Obviously, it's sort of two-pronged, B2B, B2C. You've had some early successes with the National Associates of Realtors, with the NFL Alumni. Can you just talk about trends you're seeing there, trends in activation? I think I'll know the answer to what you're going to respond to this question. But what should be the right penetration rate for like something like that?

So I think it would be disingenuous to say, well, it's exactly as we predicted. We sort of -- we came out with the B2B Travel Club and really believed in it and have learned a lot in the first year. What we're seeing at the moment is an acceleration of what we call Panorama Travel Solutions, which is simply a B2B travel club. And we use the National Association of Realtors, the NFL Alumni Association because their names everyone recognized. We signed 18 contracts and a number as well in Latin America. And what we're seeing is that we've moved from can we contract partnerships, get people interested in it. That's now very clear, and now there's a very clear pipeline, and we're moving on to that activation or penetration percentage of, if you've got 10 million members of an association, 3% penetration would be $300,000. So we think the number is 3% to 4%. And for us to be -- it doesn't sound like a lot. Our -- within 3 to 4 months at already 0.5 percentage point for National Association, we're really pleased it's ahead of schedule. So we will continue to elevate the penetration levels of the contracts we've already signed and then the focus becomes maximizing the actual activation and transactions of the people who become members. So that funnel is really going correctly, which is sign a big enterprise that has 1,000 members or 40 million members, then get them to become part of the club and then get them to transact. And then ultimately, what's your transaction size? I think the transaction size is pretty clean. We're already seeing that that's playing out to be true. We know that we're getting people into the funnel, so it's those middle 2 steps of increasing penetration and increasing activation that our focus is.

On the B2B side, I can sort of understand hunting big elephants with associations with tons of members. How does that differ or contrast to what you're doing on the B2B side in terms of sourcing customers and the investment there to bring that to some level of membership?

The B2C? The B2B versus...

Yes.

Yes, it's -- there's a lot of the same funnel except that it's one at a time. And therefore, it's a lot more awareness, a lot more marketing, a lot more building. I don't want to say just building SEO, but if you can think of SEO, getting it to the top of people's mindset and seeing clear value. So I would say it's a different -- it's a similar funnel but the -- with the B2C, it's more on the acquisition side is where the pinch point is versus on the B2B, where you've got the big elephant, as you say. It's the activation side. So those are the 2 dynamics that we're really focusing on. It's tougher on the B2C, the acquisition side, because it's one at a time. It's tougher on the activation side on the B2B side. But B2C is 6 to 9 months behind when we launched B2B. And the first 3 to 4 months, we were what's going on with B2B. A lot's not happening. And then as we got contracts, began to roll. It's, as I mentioned, sort of hockey sticked in the way of performance KPIs, all the rest.

Maybe we can pivot to the exchange business. How can RCI grow top line? How can you improve margins from here? I mean if you look at it as it's not been sort of this growth top line business, but it's a really high-margin business. It's a free cash flow generator. Is there a way to sort of restimulate growth there without necessarily just relying solely on incremental development within the timeshare industry?

Sure. And I think that is the fundamental premise, is when Mike and I sat back 3 years ago, we said the vacation ownership business is consolidating. It's continuing to grow at sort of mid-upper single digits. But the exchange business, no matter what way you cut it, there is an actual headwind of going from external exchange to internal club exchange. So that 0% to 2% growth rate and the top line very modest growth, we didn't see changing fundamentally. So you can either just accept that and cost cut your way to growth, but we don't think that's any way to run a business. So that's why we made the purchase of ARN. You start to stack around pure exchange, other travel benefits, and you could start to blend more value in your exchange business to hold up that 0% to 2% growth and allow yourself to start jumping off into more opportunities that are adjacent to the exchange. So we did not want to accept that we would be a mid-single-digit growth company. We saw Vacation Ownership as being consistently where we've been historically, that sort of 6% to 8%. We saw RCI 0% to 2%, and we wanted these other businesses to stack on top of them incremental growth. And that's how we get from what we -- what has been historical growth to what we think will be our future growth.

Great. Maybe we can talk about capital deployment priorities, balance sheet and capital structure focus. We've always looked at your business as more than self-funding, generating a lot of free cash flow. You obviously paid a dividend throughout COVID, makes you a little bit unique and different within our coverage universe. And then obviously, you've been talking about, more recently in the last couple of quarters, about returning to another activity that your company, your present company were actively engaged in buybacks. I guess maybe you can just talk about your philosophy on buybacks. And is there anything that would be disruptive to buy back activity whatever that amount is? I mean I know you talked about this potential for buyback over the next 5 years at your Analyst Day in September.

Yes. No, first of all, I think the one thing that everybody, I think -- I want to make sure [indiscernible] is we are going to delever. Right now we're at just under 4x levered as of the end of the year, but that deleverage is not going to come through paying down debt. But as we grow our EBITDA, we will naturally delever. So excess cash will be available to us for growing the business or return of capital to shareholders. And in the last 2 quarters, we've increased our dividend by $0.10 in total, so about 33% in the last 2 quarters. And then we did restart share repurchases in the fourth quarter of last year. So when we look at where we're at today, I think we're similar to pre-COVID, in my view. We have cash available to us. We do expect to be in that EBITDA to free cash flow conversion range of [ 55% to 60% ] again this year and then over time, moving up north of 60% as each -- some of these other businesses that don't require a lot of capital continue to become a bigger portion of the business. But basically, if you look at pre-COVID, the capital allocation must grow the dividend, look at M&A and absent M&A activity, return capital to shareholders through share repurchases. And that's kind of where we're at today, and that's where I view it today. So we're confident in our cash flow. We generated cash flow even during COVID. The reason we couldn't buy back shares during that time was obviously like everybody. We had to go in and amend our revolver because of the rising leverage because of the drop in EBITDA. But where we sit today, strong free cash flow conversion and, I would say, a pre-COVID philosophy as it relates to capital allocation.

And if I could just add, it's more maybe philosophical than it is what our capital return policy is, is that during COVID, when we were being lumped with sort of everything, gaming, lodging, leader -- leisure, highly levered, big capital outlays, in the worst of times, where we closed resorts for 2 months, we cut our tour flow back dramatically. We were so confident on our cash flow that we cut our dividend from $0.50 to $0.30. And I know everyone else got rid of their dividend, and you could argue whether we should or shouldn't have. But in the worst of COVID with the resorts shut, we're still -- we didn't cut it down to $0.01. We barely -- we cut it from $0.50 to $0.30. And that, to me, speaks more firmly about the low beta on the cash flow of this industry and how resilient it truly is. We've talked about it in all our previous crises. But we've not had anything like we had in sort of March to June of 2020. And we just felt that it was an important sign that would distinguish not only us but the industry that cash flow is so reliable in this space. We're happy we did it, and I think that should continue to be a distinguishing factor of our business.

I'm going to share this with you. And I'd love for you to tell me what's sort of wrong or crazy about this scenario. So if I think you guys can do $1.125 billion of EBITDA in 2025, which I think is at the lower end of the range that you gave at the Investor Day of 9/11 of last year, and then I assume that you hold that to a 3.5x leverage ratio, that means I have an implied year-end 25 net leverage of $3.9 billion, which would be about $900 million more than last year's leverage, which could be another $900 million for deployment to capital return. If I then factor in the cumulative amount of cash flow between this year it's [ 725 ], that's $3 billion. The sum of that is $3.9 billion, which is exactly where the market cap is of your stock unfortunately today. So..

It was a [ 2 ] weeks ago.

So what would be the scenario where you don't do that?

Well, your math is correct. Your pegging of the way we think about our business is correct. We value the cash flow and our ability to clearly return shareholder value through share buybacks even more so after landing today from when I took off. And I think the only variant to that or one of the only variance I can think of is if there's M&A opportunities. But I would say to that, number one is they're going to have to prove to us that it's more valuable than in the long run than the share buybacks. And number two is, for you all who have followed this space for the last decade, the big consolidation opportunities are far less likely than they were in 2012 and '13. So with our size, you could arguably say that almost anything we would do would be considered a tuck-in. So...

But you can do a lot of sort of TNL type of acquisitions and buy back a ton of your market cap.

Absolutely. And I don't think you mean it this way, but TNL was a strategic acquisition that was not about just a pure EBITDA financial. It was about the beginning of a repositioning, combined with our ARN acquisition. The tuck-ins that I'm referring to would have to bring with it not only strategic value but financial logic to it. And returns in excess of share buyback.

Any questions from the audience as we're approaching the end of our time slot? I didn't mean to say that in that way to discourage any questions. Great. Thank you, Michael. Thank you, Mike.

Thank you.

Thank you.