Marriott Vacations Worldwide Stock: Consumer Credit Concerns Remain A Headwind (NYSE:VAC)

ClaudineVM/iStock Editorial via Getty Images Shares of Marriott Vacations Worldwide (NYSE:VAC) have been a poor performer over the past year, losing about one-third of their value. Losses related to the Hawaii fires last year and increasing consumer credit delinquencies have weighed on results. I last covered VAC in November, rating shares a “sell,” given my concerns about consumer credit and discretionary spending. Since then, shares have returned just 2%, missing out on the market’s 29% gain. Given this dramatic underperformance, a “sell” rating was justified, but now is a good time to see if the underperformance has created a more compelling relative value opportunity. Seeking Alpha In the company’s first quarter reported on May 6th, Marriott Vacations earned $1.80 in adjusted EPS, beating consensus by $0.07. Revenue rose by 2.6% to $1.2 billion. EPS fell by 29% from last year. Ownership sales declined 1% to $428 million, due to a 4% headwind from Maui. However, the island continues to recover from last year’s fires. The company targets 6-9% contract sales growth, as Maui is “close to” pre-wildfire travel levels. While I do expect sales growth from Maui to improve, aided by much easier comps in the second half of the year, I am cautious as to whether we see this level of acceleration. Looking further into results, adjusted EBITDA fell 8% to $187 million even as VAC reduced G&A costs by $5 million to $63 million. Given higher rates, corporate interest expense increased $6 million to $40 million. As you can see below, Marriott Vacations has well-laddered corporate debt maturities, and as such I do not expect significant further increases in interest expense. I would note this is corporate debt; VAC also has significant non-recourse securitized debt, which I will discuss further below. Marriott Vacations Time share purchases are a discretionary, cyclical item, and this is one reason I am cautious on seeing much acceleration from Q1’s pace. While I do not expect a recession, I also do not anticipate a material acceleration in economic activity either. I would also note that Marriott Vacations is seeing its existing owners spend less on site. VAC owns 120 resorts with about 700,000 timeshare customers, and its volume per guest was down 5% to $4,129. This is partially due to a mix shift away from Maui, which is a relatively pricey property. Vacations ownership margins fell 3% to 25%, given a $23 million drop in sales, and more cautious spending environment. Partially offsetting this, management fees did rise $7 million to $52 million, given a growing customer count and fee inflation. Net sales declined more than gross sales because VAC had to take $46 million of sales reserves vs $38 million last year. These reserves protect against those consumers who make a purchase of a vacation ownership, take out a loan, but may default on the loan. This is the core point. While Marriott Vacations has dozens of resorts, it has more in common with a credit card company than a hotel company because it derives so much of its profitability from financing margins, not based on money spent by guests on management fees and at the resorts while on their vacation. As the economic cycle has aged, we have seen increased delinquencies on its unsecured loans, just as credit card issuers have seen. As a consequence, in Q3 2023, it took a $59 million charge to build reserves. Because of increased loss assumptions, it now is taking more reserves against sales. Overall, VAC has $2.22 billion of vacation ownership notes receivable. It primarily places these in debt securitization variable interest entities. There are $2.18 billion of securitizations. Now unlike corporate debt, VAC does not have to repay these securitizations if defaults rose dramatically. It can walk away from them; they are legally non-recourse. However, they are significant sources of cash flow as the interest they generate exceeds the borrowing cost of the structure, though interest margins have been squeezed somewhat. Financing revenues rose by $5 million to $83 million, but financing expenses rose by $8 million to $34 million, for a $3 million net narrowing. Now, as you can see, management is guiding to about $780 million of EBITDA, up about 2.5% from last year, and $400-$450 million of free cash flow. Now, I see about ~3% of risk to sales revenue if we do not see the sequential acceleration management is looking for, which could pressure free cash flow by about $30 million. That would point to free cash flow in the $370-$420 million range. However, its free cash flow forecast assumes it will net about $220 million from its securitization program. Its securitizations provide the majority of its cash flow, which is why it has such sensitivity to consumer credit trends. In Q1, VAC extracted $238 million of cash flow from its securitizations and warehouse facilities Marriott Vacations Now as noted in Q3 last year, VAC took $59 million in charges to offset higher than forecast delinquencies. With two more quarters of data, I am not sure it has taken enough. On its last earnings call, VAC noted “Delinquencies and defaults continue to run higher than history would suggest.” Management believes they have sufficient reserves, but VAC does “need to see loan performance improve.” In other words, its reserves are sufficient assuming we see an improvement in delinquencies, but if delinquencies stay at Q1 levels, more reserves will be needed. Now, in late Q1 and April, it has seen some improvement in delinquencies. However, I would note that unsecured lenders typically see Q1 credit improvement. This is because during Q1 consumers receive tax refunds, which they can use to catch up on debt payments they have fallen behind on. I have noted this trend in my coverage of other consumer lenders like Ally (ALLY). I would hesitate to extrapolate a Q1 trend, given there tends to be unique seasonal factors. Now, employment remains buoyant, and VAC’s consumer has a solid credit profile. Its average customer has about a 735 FICO score and $125,000 of annual income. Barring a recession, I would not expect delinquencies to get materially worse. However, with consumer debt still rising and employment already about as good as it can get, I do not see a material improvement in delinquencies likely either. As a consequence, I see risks skewed to VAC having to take additional charges later this year to compensate for ongoing delinquencies. I see about a $60-70 million risk to cash flow from defaults persisting at current levels, which leaves me expecting about $300-330 million in free cash flow this year. This is more than enough to covers its 3.6% dividend, and some buybacks like its $24 million of Q1 repurchases. Assuming a stable default environment, I see VAC earning about $6.80-$7.1 in EPS, leaving shares about 12x earnings. Given its marginal dollar of earnings comes from its securitizations, I would rather own a company like Ally, which already has sufficient reserves in my view, at 10x forward earnings. Now after missing out on a near-30% stock market rise, VAC does not look overly expensive, especially as I do think, barring a recession, this should be the last reserve charge it needs. As such, I do not see a need to still sell shares. Even with my lower cash flow forecast, VAC can return 8-10% to shareholders, making shares a “hold.” After its prolonged underperformance, I do not yet see scope for outperformance but do see it being broadly a market performer. That said, I do prefer other consumer credit names like ALLY to VAC.

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