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

Good day, everyone. Thanks for joining us in Nantucket. And if you're not in Nantucket, we wish you were here and hopefully, we can have you join us next year. I'm David Katz, lodging leisure analyst with Jefferies. And the next discussion we're going to have is with Travel + Leisure, TNL and just a quick word of intro, which is that through my coverage of the timeshare industry over many years, we think that the intrigue, the interesting elements of the timeshare and highly financially productive elements of the timeshare industry are particularly prevalent -- particularly interesting at the current time. The next discussion we're having is, as I said, with TNL, the CEO, Michael Brown; and CFO, Michael Hug, are with us today. Gentlemen, thank you very much for making time for us and joining us.

What I'd like to do, first, if I may, is just start off with the supply and demand discussion, which is always prevalent when it comes to timeshare. What has experience taught us about economic cycles in the industry? And what are you seeing in terms of strength of consumers in the early days of summer so far. And Michael Brown, I think is probably a good place for you to start.

I'm happy to do it. And then as always, it's great to be with you, David, and at the Jefferies conference. I love the introduction. This space has a great economic model and a great business model. What else can you want in these times, and that's definitely playing out as we not only move past the pandemic and into the summer travel season. But it's also great as leisure travel demand has increased. And let me say very clearly, leisure travel demand is at record levels, and we haven't even gotten into the heart of the summer season. So despite the macroeconomic news, leisure travel demand remains extremely strong. Forward bookings for us are back above 2019 levels and the economic performance, which is often measured in our industry through volume per guest is at record highs as well. So I know it's easy to be distracted by what's going on in the macro news. But our industry and specifically, our business is performing in a way that we've not seen it perform in a very, very long time. So leisure travels back, and we're heading into a very, very robust summer season where I expect it would only accelerate as opposed to anything else.

Now at the risk of being repetitive, I just want to double back on VPG levels because it's probably the most important metric. Perhaps just describe the context of VPGs. And I just want to be clear that we're not seeing any softness in VPG levels so far, either whatever you can say about the current quarter or the near term going forward? And as the economic backdrop has evolved, anything showing up in there that is worth noting, this would be a great time to talk about it.

Well, I think the ultimate question here is how was the consumer holding up related to leisure travel. And let me start with volume per guest, and then I'll hand it to Mike, and he can talk about the portfolio. But in our industry, volume per guest, which is the amount of revenue we achieve for every guest that we give a sales presentation too. When we were pre-pandemic, that number was around $2,300 to $2,400. At the end of quarter 1, that number was $3,300 and our commentary is that, that accelerated into April and sustained in May. And we're only a few weeks into June. But until now, the biggest driver of this industry, which is volume per guest, which ultimately drives downstream EBITDA and performance is performing at all-time highs over $1,000 ahead of where we were pre-pandemic. Now we believe that's a combination of a number of factors. We raised our marketing qualifications in the midst of COVID. And Mike will talk about what that's done to our portfolio as far as improvement. But also, along with that, in this inflationary environment where every night average daily rates are moving up on the hotels, the value proposition that we can offer is increasing with every bit of inflation that's occurring today. So whereas most of the world is looking at inflation as a purely negative element in our unique situation, increased inflation provides our opportunity to show greater sales value at the table because, in effect, you've paid for your vacation previously, and you're getting more and more value at the sales table. I can give you an anecdote, but at the risk of not going too long, I'll ask Mike to share the portfolio commentary.

Thanks, Michael. Good morning, David, and everyone. When we look at our portfolio, it's as strong as it's ever been in the 23 years I've been with the company. And the reason I can say that with confidence is twofold. First of all, during the pandemic, we did see the portfolio at a time from $4 billion down to below $3 billion as a result of natural principal reductions. And obviously, our sales volume wasn't as high, so we didn't recover all of the paydowns, which means it's more seasonal than it's ever been in a seasoned portfolio results in fewer losses because the consumer has more equity and it's less likely to pull. In addition, as Michael mentioned, as we reopened our sales and marketing channels coming out of cohort, we moved the minimum FICO up to 640. Previously, it had been 600. And now new originations coming in the portfolio are averaging at 735 FICO, which is the highest FICO we've ever averaged once we -- 22 years I've been with the company. So I would say the portfolio has been tested through the pandemic. And even during the pandemic, once again, we started the end of 2019 with a portfolio of just under $4 billion, and our incremental losses were only $85 million. So one, the portfolio performed very well during the pandemic, has been tested during the pandemic and then the new originations are better than they've ever been. So we're confident in the portfolio going forward, especially with those new originations coming in at the level they are.

Understood. Michael, you can't tease us with an anecdote and then just move on. If it's a quick one, I think this is a great forum for us.

Well, by using it, you came back and asked the question, which is what I really was hopeful for because the anecdote is playing out throughout our industry and on locations. But if you just take Orlando, for example, if you wanted to go to any of the theme parks, you're probably going to pay anywhere from $500 to $700 a night for a hotel room. You multiply that by 7 nights, you're talking $5,000 to $6,000 of just a combination expense to stay in a hotel room, whereas for an annual maintenance fee. And again, this is at our most demanded project here in Orlando within a mile or 2 a Disney. For a 2-bedroom apartment, that's about $1,500 to $1,700 per week. So the value is many thousands of dollars just for one stay. And as ADRs continue to go up when we sit across the table from consumers, that value continues to increase. Just a reminder, and I'll add this one last stat is 80% of our owners have fully paid off their ownership. So literally 80% of our owners are traveling every year for that $1,500 of maintenance fees. So as we get to the fall and people are making the decision whether they want to swipe their credit card for a hotel stay or for a vacation rental, or go on vacation for something that they've already fully paid for. I think that's really going to soften any demand hits if the consumer does weaken in the fall.

Perfect. Look, I do want to move on to the loan loss provision because it is also an important metric that the Street is focused on. And we've seen some improvement from you of late on that. If you could just talk about how that improvement has been driven. And I do have to ask also, how do we think about that in the context of a prospective recession, frankly, that we're all focused on beyond the next couple of quarters.

When we think about the provision, as you all know, prior to COVID, we were running north of 20% on our provision. And as a portfolio has aged, once again, the quality gets better. So we've seen a provision that was under 15% in the first quarter of this year and well below 18% in 2021. And the reason for that is, once again, the agent of the portfolio as well as those new originations come in at 735. Now keep in mind that we have guided to a provision that's going to move up to 17% in the second quarter and 18% in the second half of the year. Not because we're worried about the quality of the portfolio, but we are going to drive our portfolio to grow again. So as a percent of sales, our financing will be going up, which naturally means a provision. So it's important that people understand that as that goes up over the last 2 quarters of the year, it's not because we're seeing a deterioration in quality but because we are getting that portfolio back to growing again and can get that great net interest income that comes at a high margin and a very resilient free cash flow.

Understood. And I think that, that brings to bear the issue about securitizations. And frankly, as an analyst covering the industry for a long time, we do spend a fair amount of time explaining how those securitizations occur. And particularly now in a rising interest rate environment, what that means for your earnings stream, I think, is an important topic to cover. Can you just spend a minute and give the group a sense of how the securitizations work and why it's important and how we're thinking about this rising interest rate environment.

Sure. Be glad to do it. And first of all, as it relates to interest and the increase in rates on the corporate side, 91% of our debt has fixed a little exposure there on the ABS side, the term deals that have already been issued are fixed rate as well. So any exposure is just going to be on future transactions. But to your point, we will accumulate a loan -- pooled loans, let's say, $300 million take them to the ABS market and securitize those at advance rate from 90% to 98%. And that's how we turn that portfolio into cash and that leads to that great EBITDA to free cash flow conversion of 55% to 60%. I mean the current environment, what we're seeing is the ABS market still remains available to us. But as you would expect, rates are going up. So we will pay a higher rate than we've paid over the last couple of years. But for every 50 bps in interest rate increase, if we do $800 million in ABS transactions next year, that's about $4 million in interest -- incremental interest to us. And when we look at what's driving the increase in interest rates, it's been driven by inflation. And when you talk about the value proposition, the anecdote that Michael mentioned, we're seeing nice VPG list because of the value proposition we are pursuing to the consumer. And we only need a VPG lift of about $14 or $15 per VPG per customer in order to cover that $4 million interest expense. So when you look at the overall business, we will run higher interest expense, but that's being driven by inflation, which drives higher VPGs so on a consolidated basis, we come out ahead in an inflationary environment.

Now I may want to just follow on -- double back on one detail, Mike, which is the embedded interest rates in the receivables when they're created does not have the flexibility that the market interest rates do on the securitizations. And this is a question that investors ask, and that's what you've just laid out in terms of the math, which is that sort of $4 million minimal impact. Is that a fair takeaway?

Yes, for every 50 bps, it's going to be $4 million on $800 million issuances, which is probably well will do next year. So we'll see what the interest rates turn out to be. But yes, 50 bps would be to $4 million, which on a company that's making midpoint of this year's guidance at $65, not a future impact. And obviously, once again, those VPGs are stronger than they've ever been. So more than offset that incremental interest.

Understood. Michael, I wanted to just move on to the progress at the B2B and B2C Travel Club. In terms of transactions, new clubs, if you could just give us a quick intro on those business lines and give us a update on those. I think that's a helpful place to start. Given that you introduced a fair amount of information back at your investor for Day, I guess it was last September.

Absolutely. And let me just add one minor piece on to what Michael was saying in relation to rising interest costs. A lot of commentary that I'm hearing in the news is around exposure to supply chain issues. I do want to point out that as it relates to project development, new projects that we need to supply for our sales, we do not have exposure to supply chain simply because the last 2 projects that we are developing and have opened have already done so. And therefore, exposure to cost of product is not an exposure that we're going to undergo in the next 12 months. So I just wanted to point that out. As it relates to our new business extensions, we've launched a travel subscription business, which is to address a non-time share market and offer discounted travel opportunities both on a business to business and a B2C basis. The first is called Panorama Travel Solutions, and we launched it really at the beginning of 2021. The progress we're making against what we laid out at our Investor Day is significant and at if not above our expectations. There's a key -- a few key metrics that we're really looking at, which are the number of clubs that we sign up. We're now over 20 B2B white label travel clubs. And just to pause there when someone signs up, they're going to pay an upfront subscription fee. And then ongoing will pay -- we will receive revenues from the individual transaction. So exactly like the RCI exchange business model. But with that white label B2B business, we are signing up contracts. We're over 20 now. We're starting to see the transactions in the amount of transactions or revenue per transactions really start to hit at our expectation. At this point, David, we're exactly where we wanted to be on the B2B side in the sense that the focus now is just increasing transactions. We have sufficient number of households already within the first year within our ecosystem that would support our 2025 numbers. At this point, though, we need to make sure that we're getting the transaction propensity within the club to make sure we truly deliver on those 25 numbers. On the B2C side, the Travel + Leisure Club, it started about 9 months behind. I would say it's progressing at expectation out of the gate. There were a few questions we had around the actual marketing channels. And we think we've really found and adjusted the right marketing channels to deliver the member expectations there. So again, I would say for 2 new businesses that were extensions to what we were already doing, we could be more pleased with the progress that we have in both those clubs, and we see them as very much aligned to what we laid out in September 2021 -- to in September 21 for our 2025 goals. But within the new business, we've had a lot of new learnings in the key on that as we've adjusted quickly and really started to see traction on the adjustments we've made.

Just to follow up on those businesses, their benefit within the company. And I think this is perhaps an important point is that they are fee-generating platforms, meaning that beyond their sort of setup and maintenance, right, they are generating fees, which should be, in principle, higher value right, than some of the other aspects of the company. And I assume that is a key reason why you are growing into those. But if there are others, we should talk about those too.

Yes, there were several reasons we decided to do this. We have been in the exchange business, which is upfront subscriptions and fee generation for nearly 4 decades. So this is not a new business for us. So the reasons we get it is we wanted to address the non-timeshare market. That's what these travel subscriptions do. The second element is we wanted to be more capital light in our revenue generation and recurring revenue streams like RCI. And that's what both of these businesses do. We've made our capital investment. And other than just ongoing development of the technology platform, there's no onetime big investments that we need to make to grow these businesses. And last and maybe most importantly is we've consistently, over the years has been a mid-single-digit growth company on the EBITDA side. And this allows us to grow into basically double our growth to 8% to 10%. So a lot of things, a lot of reasons strategically. We did it, but ultimately, the bottom line is to deliver double the bottom line that we were delivering before as far as growth rates.

Perfect. And just one final follow-up on the segments. Are there any reasonable prospects for further M&A, tuck-ins or anything like that we should be keeping our eyes out for? And what would be the boundaries around those, if you did?

Well, I think on the new travel subscription businesses, our focus is more on partnerships than it is M&A. Our M&A was done in 2019 when we bought the technology, the fundamental platform that would allow us to launch these 2 new business lines. And accordingly, our objective now is more around customer acquisition than it is actual M&A. So that's what it's on the travel subscription side.

Understood. Look, I think where the rubber meets the road for frankly, all of our companies, but certainly for yours, is free cash flow generation and how that capital gets deployed. How should we think about those range of options and how do we think about, in particular, stock repurchases, which have always been an active aspect, given the market's volatility of late.

Well, let me let Mike answer the capital allocation answer, and then I'd like to just come back after and start looking at that.

Yes. So to your point, David, I mean, our free cash flow is tremendous. One of the other benefits of this -- these subscription-based travel club is we are moving our free cash flow conversion target EBITDA to free cash flow up to 58% to 63% over time. Once again, capitalized very cash flow generative. And what that means is we expect on a cumulative basis between now and 2025 to generate $2.4 billion to $2.6 billion in free cash flow. If we maintain our leverage at 2.9x, it gives us another approximately $500 million. So about $3 billion in free cash flow that we'll generate on a Q2 basis. And we have a great track record of paying dividend, and we'll continue to pay that dividend, and we expect that will use $600 million to $700 million of that free cash flow, which leaves us with approximately $2.5 billion in additional free cash flow, and that's on M&A, we've got a consistent track record of putting that cash to work after dividends with share repurchases. And between the time we spun off the hotel group in June of 2018 until March of '20 when COVID hit, we repurchased 12% of our shares. And as soon as we got out from under the amended revolver that we had during COVID, in November of 2021, we started the share repurchase program again. So we'll delever. We'll get down to that 3x leverage through growing EBITDA. From a debt standpoint, we're in a great spot. We don't have any large debt obligations that we can't cover off through the refinancing or using our revolver. We've got a $1 billion revolver with nothing on it. So excess cash absent M&A has historically gone to share repurchases, and we started doing that again in November of last year.

Just to add to that, and Mike mentioned over $3 billion to return to shareholders. And if you look at your iPhone and look at our market cap, you can see what a great percentage that is as a percent of our total market cap that we have to visibility -- clear visibility to return that to shareholders over the next 2 years. I would also just say that as it relates to the visibility of our business and what I want to keep coming back to is we tend to get lumped into people view our product as a discretionary product buying a $20,000 to $25,000 timeshare. And the reality that we saw after 9/11, after the great financial crisis and what we are seeing today after COVID is that people will do not view this as discretionary because people's travel and their vacations is not discretionary. And with the value proposition that we are offering today, I think one of the most misperceived elements of our business is that it has a higher beta coming out of a recession or going into a recession. And it's just not the case. And if people take the time to just look at our performance over time, you'll see that leisure travel and specifically, our sales performance has returned extremely quick after recession and performed better than everyone expects during a recession because people just won't give up their free time and their vacations, especially when they've already paid for it.

Certainly, true in my household as well. I want to spend just a couple of minutes on valuations, which have always been an active discussion point between us and investors, between you and I, frankly. And certainly, the context for valuation is higher than it was a decade ago. But without arguing for higher value, which the Street reserves the right to do. I do think it's helpful to have your perspective on where valuations are for the group and for your stock and how do you think this should evolve near term and long term?

Well, I think first of all, there's a little bit of context that we all need to be aware of in evaluating value. First of all, it's -- the 3 public companies that are out there today were not public in the great financial crisis. So I would probably argue there's a little bit of industry or sector discovery going on. The model is often viewed as complicated, but it's -- once you dedicate a little bit of time upfront, it's actually a very straightforward model and a very predictable model for everyone in this space. And I think what COVID offered, first of all and what this contemplation of an impending recession, which maybe it is, maybe it's a long way away, who knows, is these are providing quarter-after-quarter proof points that not only will the business performed on the top line, but the business will also and does perform in the bottom line and generate the cash $55 million to $60 million this year, going up to 58% to 63% in the future. So you're right, the market reserves the right to create their own determination on value. I think from my perspective and the reason we attend great conferences like this is we want to help people move up the learning curve and try to dispel any misperceptions about either the beta around recessionary times or the history that may not have been available through the great financial crisis since most of us were private. But when you talk about valuations on companies that generate over 10% free cash flow yield, sorry, free cash flow yield, our conversions, 55%, 60%, high predictability on performance, both in and out of recessions and also paying a dividend, I don't mind putting our story and our business model up and available for people's determination of what that value is really worth.

Understood. And what I would submit as well is 2 things. Number one, my attention to your company during the great financial crisis and its performance through it as a public entity was absolutely a head-turner for me as an analyst. And the second thing more currently is that there are moments of dislocation during moments of market turmoil which have proven to be some of the most attractive moments to buy the stock, most productive moments to buy the stock. So I certainly concur in a couple of those areas. Mike or Michael, I'm happy to give either or both of you the floor for a second before we wrap up and just make sure that we've covered all the points that you had hoped we would during this discussion.

Mike, did you have anything if not all, close?

No, nothing. I think we've pointed out very clearly that we're confident in the performance of the portfolio going forward. The highest VPGs we've ever run because of the value proposition for the consumer and a great free cash flow conversion and our ability to return capital to shareholders. So I think those were a few highlights, and Michael, you can wrap it up.

Yes. I just want to reiterate, David, what I said in my last answer is in these times of dislocation, people are looking for great business models that have a lot of predictability going forward. And as we talked about the free cash flow conversion and our yield and our return to shareholders, I would say 2 things. First of all, with where we are from a share price basis, it makes the hurdle of any other investment at this point an extremely high bar given what we're seeing as current market valuations. And secondly is, I'd encourage everyone through working with our IR team or through Mike and I individually is to continue to, as you're developing the models and really trying to understand the resiliency of this industry. I think a little bit of extra time spent in that area, you'll see that even if we do on a post-summer basis, see an economic downturn, how we will perform differently than a holistic gaming lodging leisure together. I think we're going to have a really strong summer and that should continue to play out for the remainder of 2022 despite what the macroeconomic environment has.

Understood. It's perfect. Let's leave it there. I appreciate you joining us, appreciating those of you that have tuned in and we look forward to spending time over the next few days. Thanks very much, everyone.

Thanks, David.