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

All right. We're going to try to keep this right on schedule. Our next company has been busy over the past year. Travel & Leisure effectively launched, I would say, new business through its membership club, integrated recent acquisitions, drove the core vacation ownership business and returned ample cash flow back to shareholders. It's my pleasure to once again host, Michael Brown and Mike Hug, Chief Executive Officer and Chief Financial Officer of Travel & Leisure. Thanks for being here.

Thanks for naming your conference after us.

Yes, that's right. I mean let's see, marketing is everything, branding.

That's right, that's right.

So I know that you all provided a major strategy update at your Analyst Day in 2021 in September, which in some ways could feel like a long time ago or very short time ago, depending on who we talk to. But how would you grade yourself across your various growth initiatives and your financial targets so far?

Right? So for those of you who aren't aware, in September of 2021, we did an Investor Day, and so all those documents are out there. And basically, we laid out our growth targets of 11% to 14% CAGR in the next few years, and reaffirmed our commitment to our core businesses, which are Vacation Ownership and Vacation Exchange, pre-COVID, which generated about $1 billion of EBITDA. And then we also, in addition to that, identified that we're launching into a travel subscription business. And since that time, needless to say, the Leisure & Travel business has roared back, and we have fully participated in that recovery. And we've incrementally moved toward those targets on the subscription business. So it has been -- yes, it felt like -- it feels like a lifetime ago, September of 2021, but we've made more than ample progress against those targets. We feel very comfortable that we're on our way to achieving what's ultimately a 2025 goal.

Now despite that resurgence, it still seems like investors are now becoming increasingly concerned about what the macro backdrop looks like, whether that's looking at the housing market or even looking at higher interest rates and their impact on demand. I guess to what extent do you look at those indicators, one? And how are you generally seeing the macro evolve as it relates to your business?

So I think there's always this tendency to want to correlate people's personal time and their vacation time with the sort of macroeconomic trends. And if we've learned anything throughout COVID that people don't give up their vacation time. We'll see the University of Michigan study come out this week on consumer sentiment, and it will reaffirm once again that people are going to desire to keep going on vacation, and we're seeing that. So we are a vacation product. We've never and do not sell our product as a real estate product. So you're ultimately asking the consumer is, are you going to continue to go on vacation? And the answer until now in 2022 is yes. We're moving into peak summer season, which means the answer once again is going to be yes. And we've seen our forward bookings, be it 2019 levels through the end of this year. And not only are we seeing it at '19 levels, we're also seeing people's vacation look to be 10% longer than they were in 2019. So that desire to catch up on their free time and enjoy their vacation is very apparent in our business for the remainder of this year.

That's great. Now this is an interesting timeshare business. It's an interesting segment to look at when we look at prior recessions. There's not a lot of pure-play examples to kind of read back to. So if we were to see a slowdown, how do you think the business would fare similar or different to what you've seen in the past given a lot of the structural changes that have occurred?

Do you want to talk just about how we changed.

Yes. No, I think we would see it to continue to perform very well. We saw that back in 2008 and 2009, where the big change we made was really twofold. First of all, pre-2008, we self-developed all our inventory. Since that time, we found partners to develop it for us, which provides very consistent free cash flow generation. Our free cash flow to -- EBITDA to free cash flow conversion is going to be 58% to 63% over the next 3 or 4 years. So that was one big change. The other big change was the quality of the individual that we marketed into. Back in 2008, we didn't have a minimum FICO. We put a minimum FICO of 600 in place at that time and saw the consumer at that level continued to still perform well. And with this downturn from the pandemic, we did the same thing, except we moved that minimum FICO from 600 up to 640. So our average origination for our finance portfolio now is up to 735. The portfolio performance is back to 2015 and '16 levels as far as delinquencies and a provision that's below 18%. So we're very confident in who we're selling to, who we're financing, and our portfolio has always performed well, and it's in as good a shape as it's ever been in my 20 years in the business. So I think we're very confident in our ability to make the right changes. We've already instituted a lot of them as we've come out the pandemic and feel very comfortable with the business overall.

What -- you may be getting to this, I'm not -- not sure where you're going to go with the questions. But the element that we will look toward as we go forward is, I think with real estate and some travel, business travel, you look for this sort of cliffing effect. In our business, we will look for a marginal change in the number of people we sell to out of every 100, and that's really the only impact we will see going forward. And it's so minimal, yes, it will affect our business a little bit, but it's not near as variable. And I would say it's one of the biggest misperceptions about this space is that it's highly discretionary. And if you just frame the question a little differently is, are your vacations discretionary? The answer is usually no, but we might vacation differently, but we're still going to go on our vacation.

So maybe one other follow-up, and this could be a little bit of a leading question, but you also have the ability to pivot between existing versus new. Do you feel like the opportunity is still there as you think about tapping into existing, given we just went through a pandemic where maybe the only person you could sell to is existing?

So just to -- pre-COVID of our annual sales, about 62% were to owners and 38%, obviously, were to new owners. And we are focused on new owner sales in sort of that 35% to 40% range because although they come with a lower margin, they seed the next 10 years of recurring revenue. When times get tough and you're managing your fixed cost, you're recognizing a downturn in the economy, we shifted from that 62% to 70% owner sales. Actually, it was 75% in the worst of COVID. We've already moved that back to 70% and eventually back to 62% because all that is a reflection of is that we are now reinvesting back into our new owner business. And with us heading into summer, what was 25% new owner sales at the worst time during COVID will be back above 30% this summer. And all -- everyone in the room should read from that is that's guaranteed revenue for the next 3 to 5 years as those people come back and then upgrade their ownership even more.

So before I lay off the hook on that one, on the upgrades, how often do people typically upgrade, what percentage typically upgrade?

Yes. So the way to look at it is if someone buys $1 of timeshare today, and think of it if everyone has 28 days -- 4 weeks of vacation, the first time they purchased with us that $1 is 5 to 7 days. And then over the course of their life, they will spend another $2.60 with us on incremental ownership which is nothing more than incremental time. And that's a reflection of satisfaction with their ownership. I have a bigger unit, there's incredible value in ownership, even more so with inflation. And therefore, what this concept that I didn't know much about, I want more of it, and therefore, that $1 today will turn into another $2.60.

On that point of inflation, how do you balance taking price versus trying to drive new owners and conversion?

Yes. Well, for us, our model is really a customer acquisition model because as Michael mentioned, you have those future upgrades. In addition to the future upgrades, if we finance the transaction, we're going to earn interest on that loan at 14.5% or 15%. We're going to get a 10% management fee for managing the property, and then there'll be an RCI member, so we get RCI membership fee as well as a transaction fee. So for us, you won't see us go in and increase prices 10%. It's more about making sure we can demonstrate the value proposition to the consumer, start to get those recurring revenue streams, and then once we've sold on the product, we know they're going to come back again to our properties over and over throughout the years and spend another $2.60. So we love the inflationary environment where we can present the value proposition to the consumer. And we're going to stay focused on being able to demonstrate that affordability and create that future upgrade pipeline.

Do you anticipate that we'll see net owner growth then stay flat, grow? Can it still decline and still grow revenue and free cash flow over time? Or what's the target there?

So over time, you're going to see our owner count grow. I think we're one of the -- we are the most unique company in this space because we've been around for 50 years. So what you've seen over the last decade is someone that's had ownership with us for 30, 40 years, had a lifetime of ownership has ultimately exited their ownership while we've added new owners. So for us, and again, we're sort of unique in a different place in our growth. is we were replacing low revenue-generating owners, although we wanted them to stay with us for very high producing revenue owners. So we were less focused on owner count as opposed to ability to generate revenue for us, which is why, from 2016, we were generating about 31% new owners to pre-COVID, we were generating 38% to 40%, and that was the strategy behind it.

And I think one of the other concerns about timeshare, at least the misconceptions maybe is that younger cohorts, maybe are going to be less interested in timeshare. What are you seeing in terms of the demographics of the new owners? And how are you changing how you market to them or source them?

Yes. so you mentioned one perception, and I'll actually give 2 because I think these are also misperceptions is as you're seeing the average age of the consumer move down dramatically. The average new owner in our businesses is under 50 years old. And the reason is you're starting to see the millennials move into that family stage. So back when I joined Wyndham in '17, that number was under 10% of our new owners or millennials. Now when you look at millennials and Gen Xers, that's 70% of our new owners are in one of those 2 categories. So you're seeing it move down. Why? Because when you travel with a family, you want more space. And whether it be a vacation rental or timeshare, I think the macro trend is very clear that people want more space when they travel. The other misperception, and we get this question a lot between '08 and '09 to today, coming through COVID is how has the industry evolved? Because I've heard the reputation of timeshare? And maybe it was well deserved in the early 2000s where 70% of the industry were independent developers, single site, not a brand, et cetera. From '08 until today 2022, the brands represented 30% of sales in the great financial crisis, great financial crisis basically wipes out most of the independent developers. Today, Wyndham, Hilton, Marriott, Disney, Holiday Inn represent probably 75% to 80% of the business. So you're talking reputation, loyalty programs, flexibility, balance sheets, and the industry has evolved, maybe not the public perception because it's a relatively small industry, but it's completely different than what it was in 2008, 2009.

Maybe to play devil's advocate a little bit here. I -- sometimes I'll hear either if I'm on the radio, you're not listening to the radio that much, maybe podcast whatever else, you might hear every once in a while, exit my timeshare, these third-party players who are trying to get people to sell out of it. So how has that ebbed and flowed because I know that was something that had become a bit of an issue in the space pre-pandemic, where are we now in terms of dealing with the third parties?

Yes. So it's a great question. And I still hear the radio advertisements today. So let's first ground ourselves in a few facts. In our owner base alone, 80% of our owners have fully paid for their timeshare, which means in this inflationary environment when they go to vacation, they've paid $1,000 for their annual maintenance fee where a hotel room is $600 to $700 a night. So the value is there. Of that 80% of our owner base that's fully paid for their ownership, there's a 2% turnover attrition in our owner base, number one. So there's not a line of people looking to get out of their ownership. In our total ownership, it's 4%. So these companies grabbed a narrative and basically look to earn a $500 or $1000 fee, maybe even more to get you "out of your timeshare," when in fact, for the most part, they just needed to call us, and we would do it for free. And we do it every year, about 30,000 to 35,000 people leave their ownership through age, financial situations. It's natural. But this sort of cottage industry jumped up and grabbed a piece of it. Today, though, through a lot of different consumer protection rights and pressing that issue where maybe some of these services weren't real or partially real. That issue has dramatically decreased. And we can really see it, maybe Mike could talk briefly about it is our portfolio performance has increased dramatically.

Yes. No. The big move we made, as I mentioned earlier, was as we reopened sales and marketing locations, we moved that minimum FICO from 600 up to 640. Our new originations now are coming in at 735 FICO, which is higher than they've ever been in the 20 years I've been with the company. And then you know well, Stephen, that at one time, we were running a provision that was in the 20% range, maybe even a little bit higher than that. And over the last several quarters, we've been below 18%, and we expect it to stay below 18%. So I couldn't be happier with the quality of the portfolio, obviously gives us great access to the ABS market, which we were even able to access during COVID, which helps generate that great free cash flow that we have.

So I've got 2 follow-ups for you, Mike Hug, on that. One is, I think sometimes people also look at, okay, 2% to 4% attrition maybe in the member count, but your provision is stabilizing at 18%. That's a much higher number, right? That you're provisioning for should match over time, I would think your write-offs. So what's the disconnect there? Is that not apples-to-apples? And then the follow-up is -- I'll actually hold off and wait till you answer that one before I follow up. .

Yes. No, I think the 18% is what we're projecting, we've actually been lower than that. If you look at the last quarter, we were at 14%. We've guided below 17% in the second quarter. So the reason it's going to move up is because since COVID hit, our portfolio has been declining in size. As a portfolio seasons, your performance becomes better. We're working now to increase the level of finance that we do to get that portfolio growing again. So as we bring in more new owners, you'll see that portfolio start to grow. And when you have a younger portfolio, your losses are a little bit higher because they [ overgrown ] in their life. So that's really why the increase is. It's not a quality issue, it's more us focused on growing that portfolio so we can get that interest income growing again.

And that number is a gross provision before recoveries?

That's a gross provision before recoveries. That's correct.

How much do you typically recover? .

Normally, we cover about 30% of the outstanding principal balance. And keep in mind on those recoveries, we manage the associations and we make sure the associations have adequate reserve to refresh their units every 5 to 6 years. So it's good quality inventory that we're getting back when we do foreclose, and we can sell for more today than we did 3 or 4 years ago when we made that first purchase. So managing those properties, obviously, comes with a great revenue stream, 10% cost plus arrangements in most cases. But just as importantly, to make sure that we have a good quality asset in those cases where we do foreclose.

So if you -- going back to how the industry has evolved, specifically to our consumer, back before the great financial crisis, our average FICO was 680, 685; pre-COVID, 720, 725; and today, with all the changes we made in our consumer and our marketing efforts, our FICOs is now around 735. So it's a really strong consumer as we talked about Gen X and millennials and average household income of $100,000.

So to follow up there then. As the FICO score goes up, how does that impact the ABS facilities, your access to the securitization market? Because I know that in 2008, 2009, the market stayed kind of open, there were some deals that were to happen, but I think they were at 65% upfront. And so what are you seeing in terms of the securitization market as we've seen a lot of moving parts with interest rates and liquidity?

Yes. I think what we see is ABS markets, they are still available to us. To your point, we did execute transactions in 2009 that were costing a low advance rate. But even during COVID, we were getting a 98% advance and actually borrowing under 2%. Now rates have moved up a little bit. So that's what will happen is as we go to the market with new transactions, because our outstanding transactions are already fixed rate, so it's only new transactions where we'll see that higher rate come into play. But if you look across the industry, 4 of us have already done deals this year. The market remains very strong. We might pay a little bit higher interest rate. But let's say, a 50 bp increase in interest rate represents about $4 million in additional interest expense on our new issuances on an annual basis. And keep in mind that, that higher interest rate is due to rising inflation, which gets back to the value proposition we can present to the consumer, which is driving up that volume per guest. And so when we're able to demonstrate to the consumer how you can purchase accommodations through timeshare that are much more affordable than hotels, we get that VPG lift. And we need about a $14 VPG lift to cover that $4 million in incremental interest. And as you know, our VPGs are $3,300 higher than they've ever been. So we've got more than plenty of room to cover that incremental interest expense.

That's great. One of the things that you also referenced was this change in how the inventory was being developed before. Do you feel like there's any places where you're overpenetrated or underpenetrated as you think about the inventory that you have? And is there any way to give us a sense for how much is recycled?

So we have 250 resorts around the world. We're concentrated about 90% in the U.S., brands are known, great regulation, et cetera, et cetera. When you have 250 resorts, realistically, the next dot doesn't move the needle really. . With that said, we've consistently entered markets that we feel the macro trends are going, including urban destinations. We just opened our latest resort in Atlanta, our first timeshare resort in Atlanta, first one for us. It's a combination of Margaritaville and Club Wyndham overlooking Centennial Park. And we've seen that's on the heels of Austin, Texas, Nashville, Portland, Oregon. And those are all -- people say, well, I'm not going to go vacation in Atlanta. Well, you'd say that for downtown Portland, and it's always full; Austin, always full; Nashville, packed. So Atlanta is a great gateway for us into sort of the Hilton Head and Myrtle Beach, Panama City area, Orlando. So we're really excited about that. I will say, though, because we have the dots, we have sufficient inventory on our balance sheet, we do not expect to be in the development mode for at least 3 years because we have the inventory and that cash can be either used to return to shareholders or invest back in the business. And that's what we plan to do about it. And then -- sorry, you had a question on recycle inventory or...

Yes. What percentage of your inventory comes from recycled inventory? How do you generally think about that?

Yes. We'll foreclose on about $100 million worth of inventory. You used the word recycled. Keep in mind, as I mentioned earlier, right? That we're managing those properties. So it's good quality inventory that we can put back on the sales floor and sell right away. But on an annual basis, you're looking at about $100 million in inventory that we'll foreclose on and basically resell right away.

So let me move on to the Travel and Membership segment, which we haven't spent as much time on. I guess what -- can you just remind us of what the different moving parts are within that segment? Because I know that we get a lot of questions on what's changed? What was the exchange business before? What's going on now? What was the impetus to the situation.

Sure, sure. So let's just take our existing businesses, Vacation Ownership and Exchange and completely put them on the shelf. There are some nuances, but completely put them on the shelf. The reason we made the change to our name and the direction we've had it is we're a leisure company. But pre-COVID, we were -- we had narrowly defined ourselves as a timeshare company affiliated with a singular name. We are as committed as ever to growing the Wyndham Timeshare business, and we're committed as ever to the timeshare because pre-COVID, it was $1 billion of EBITDA, and it's highly predictable, mid-single-digits growth. We said if we're great at this exchange business and we're in the leisure business, why not open the purview of what we can do. And one of the ways to do that is you do need to reposition yourself to open those doors up to you. Therefore, the name changed to Travel & Leisure, number one, so that we can talk to more opportunities than we would have pre-COVID under a singular brand name. The second objective is we're very clearly valued as a mid-single-digits growth company. With the launching of the new business I've shared with you, we're looking to double our growth rate in the next 3 years to be 11% to 14% CAGR as opposed to mid-single digits, of which there's probably 2% to 3% that's COVID recovery. So we're looking at stabilized growth in that high single digits in effect, truly doubling our growth rate. The subscription business is simply the timeshare industry is 10 million households, the U.S. travel market is [ 90 ]. We weren't participating in those other 80-or-other million households. And therefore, we launched a travel subscription business. Shorter duration, shorter -- lower entry price point to simply address a travel market that exists today that we weren't participating in. So it's opened ourselves up to brand partnerships as well as start accessing a greater addressable market that we weren't pre-COVID.

And how do you think about the cyclicality of that business? And then also the return profile of that business relative to what was kind of already there?

So I think 2 things are super clear. The first is that people are going to continue to travel regardless of cyclicality, it may ebb and flow a bit, but as we're seeing, people are going to travel even during COVID and the great financial crisis. For us, though, this is clearly incremental growth. We are a mid-single-digits growth company, and this is to allow us to double that. So we're not looking to manage our cyclicality. We're looking to grow into a business. And we have 5 to 10 years to grow into a sizable position before we have to candidly worry about how is our subscription business going up and down. We started at 0, and we're already well above that. So...

Great. And what are the implications for margins then, both within that segment, do you think that there's the opportunity for that to grow? Or as you have this mix shift, is it going to first go down? And then is that enough for the overall business to see margins come down before they maybe go up?

Yes. The existing business that you referenced, RCI, runs about a 40% margin. To your point, the subscription-based business is going to run margins more in the 10% to 15% range because we have to run the cost of the hotels or the accommodations, the airfare, whatever through our financial statements. So you'll definitely see, even though it represents a nice EBITDA growth, some margin compression in that segment. And we've also projected that for the consolidated business where historically, we've been running 25% margins, we'll be in the low 20s. Keep in mind, though, it helps with that free cash flow conversion because we don't require big capital investments to run that subscription business, which is why we've moved our long-term guidance for free cash flow conversion from 55% to 60% now up to 58% to 63% of EBITDA. So we'll tighten margins, but it provides absolute EBITDA growth and helps with that free cash flow conversion.

So on free cash flow and really thinking about capital allocation, I mentioned that you've been active in terms of thinking about dividend, buyback. You've also alluded to M&A. Can you just remind us of what those priorities are? And if you are looking at M&A, what does that look like from here?

Do you want to take the capital allocation. I'll take M&A.

Yes, I think the -- first of all, from a capital allocation standpoint, we'll continue to pay the dividend and grow the dividend as we grow the business. And keep in mind, we did pay dividend during COVID. So very confident in our free cash flow generation. We'll look at M&A, and absent M&A, we've always put the money into share repurchases. So Mike can talk a little bit about the M&A opportunities. But as soon as we got out from under our amended revolver back in November of last year, we started that repurchase program and have demonstrated even pre-CO with a very consistent repurchase program for the use of excess cash.

And as it relates to M&A, I think, first and foremost, is we laid out an Investor Day model with that CAGR that didn't require any M&A. So we, first and foremost, believe in our organic strategy that we're pursuing. We think there are remaining some consolidation opportunities more in the VO space than this new travel subscription space. But pretty much not all, but most of the transactions that could occur would in the grand scheme of things, be considered tuck-ins for us. So we'll look, we'll evaluate. I've been with the company since '17. We've been public since '18, and we've not done vacation ownership. And my answer was the same in '18 is we're going to continue to look. And if it's accretive or strategic, we won't hesitate to act, but we really like our organic strategy. And candidly, where our price is today, it's a pretty high hurdle to make an M&A work versus a share buyback.

Yes. we've got time for maybe a question from the audience. Otherwise, I'm happy to keep going here. Looks like we've got one right there.

On the property management side, have any of the big brands that have been displaced or replaced? Or is that virtually impossible?

It's -- I wouldn't say it's impossible, but it doesn't make sense for the HOA to do that because when you're managing 220 resorts, we get great prices on insurance, great prices on mattresses. So we can bring in the most efficiencies to those HOAs, which helps keep the maintenance fee down. So it's, one, it is difficult. But secondly, financially, it probably doesn't make sense because of the value we bring from a purchasing power standpoint.

One other theme, I guess, that we keep hearing about across the space, which I think is a little bit less relevant to you, but I'll still throw it out there is just around labor inflation. We've obviously seen a big spike. How does that impact your business? And are you seeing, for example, salespeople say, you got to change my commission structure?

Well, in general, we're no different. We have -- labor remains a challenge, and we definitely are seeing labor inflation. Keep in mind, because it's -- we don't have daily cleans, it's self-service apartment, maybe those demands aren't quite as high. On the sales specific one, I'm laughing because the great thing about inflation for hotel rates where the hotels are passing along their cost, our salespeople are passing along every day when they're comparing ownership to hotels, they're passing along value. And therefore, they're selling more. Our close rates are up 250 to 300 basis points, which means our volume per guest is up noticeably. And because they are commissioned associates, they're earning more on every single sale as well. So they're getting commission inflation naturally just by the great performance of the business.

That's awesome.

And on the labor associated with operating a resorts, that's paid for by the HOAs and those cost-plus arrangements we have. So the majority of the labor that you'll see come in through our financial statements is really borne by the HOAs, not by us.

Right. I think that's a good place to wrap it up. Michael Brown, Mike Hug, thank you so much from Travel & Leisure. Next up, we will have Penn. Thank you.

Thank you.

Thanks.