Fitch Expects to Rate Wyndham's $350MM Senior Unsecured Notes Issuance 'BBB-'; Outlook Stable
The 10-year notes will rank pari passu with Wyndham's existing unsecured notes and credit facility. Fitch expects the issuance to be completed on a leverage-neutral basis, with the company using the proceeds to paydown its outstanding commercial paper (CP); the company had \\$476 million in CP borrowings as of June 30, 2015.
KEY RATING DRIVERS
The ratings reflect Wyndham's strong free cash flow (FCF) profile, the majority of which is made up of recurring fee income generated by its lodging, vacation exchange and rental and timeshare segments. The ratings also consider management's public commitment to maintain low investment-grade credit metrics.
Elevated leverage for the 'BBB-' category remains Fitch's primary credit concern, in the context of Wyndham's high exposure to the cyclical lodging and timeshare industries and an increase in the company's contractual and contingent off-balance-sheet obligations.
The Stable Outlook reflects Fitch's expectation that WYN will continue to operate within our target adjusted leverage of 3.25x, with a firm cap at 3.5x at the 'BBB-' rating level. Fitch's ratings have limited tolerance for leverage sustaining above 3.5x on an annual and quarterly basis. Fitch would expect the company to swiftly reduce leverage back closer to our 3.25 target for the rating if, for example recent improvements in WYN's loan loss provision and timeshare inventory procurement costs prove unsustainable through the cycle.
STRONG FCF GENERATION
Wyndham has consistently generated strong annual FCF since implementing more efficient capital allocation policies in 2008 in connection with the previous recession. The company generated FCF after dividends of \\$489 million during the trailing 12-months (TTM) ended June 30, 2015, roughly 15.5% of its total core debt balance (unadjusted and excludes securitized debt). Fitch expects FCF/debt will remain above 16% over the next one to three years - a moderately lower rate primarily due to dividend increases.
ASSET-LIGHT/FEE-DRIVEN FOCUS
Fitch expects the company to focus on less capital intensive inventory sources in its timeshare segment (e.g. Wyndham Asset Affiliation Model [WAAM], discounted inventory purchases and management fee revenue) in addition to maintaining its current asset-light, fee-driven lodging and vacation exchange and rentals models. Wyndham generates approximately 60% of its total revenues (and a greater percentage of its profits) from recurring fees associated with its lodging franchise and vacation rentals and exchange businesses, as well as management fees from timeshare communities. Vacation interval shares (e.g. timeshare) make up the majority of the balance. Fitch expects hotel ownership to play a small role in its strategy.
POSITIVE LODGING FUNDAMENTALS
Fitch's rating case assumes that Wyndham's revenue per available room (RevPAR) increases by 4% during 2015. The company's international exposure is holding back its RevPAR growth relative to our 7% expectation for the U.S. lodging industry during the year, primarily due to currency movements and growth in markets with below average RevPAR.
Wyndham's lodging business primarily includes franchising midscale and economy hotel brands in the U.S. (over 75% of its room system at June 30, 2015). U.S. demand trends remain strong, although growth is moderating as the current lodging cycle matures.
Fitch expects 2015 to be another good year for the U.S. lodging industry, with RevPAR growth of 7%, above the 3% long-term industry average. U.S. RevPAR grew 8.4%, 5.4% and 6.8%, and 8.2% in 2014, 2013 and 2012, respectively, according to STR Global.
U.S. hotel supply will likely grow by 1% during 2015 - well below the 2% annual industry average since 1988. Strong occupancy rates and low supply growth are supporting greater pricing power within the U.S. lodging industry, in general.
DIFFERENTIATED SEGMENT: EXCHANGE & RENTALS
Wyndham's vacation rentals segment is an attractive fee-for-service business that compliments its other hospitality businesses and adds diversification. This segment provides stability to the business profile as it had less severe declines during the past recession (8.5%) compared to both the lodging and timeshare segments. In addition, the segment's low fixed costs allow for cost reductions during a downturn.
Fitch expects the company to capitalize on its strong competitive position to source consolidation opportunities in the fragmented rentals industry, primarily through smaller 'bolt-on' acquisitions. Vacation exchange and rentals make up roughly 30% of the company's revenue and EBITDA and is predominantly fee-driven, with the exception of a small portion of owned/leased properties on the rentals side.
The competitive environment in Wyndham's vacation rental business has arguably intensified with the increasing popularity of short-term rental websites, such as HomeAway, Inc., VRBO, Inc. and Airbnb, Inc. However, the value proposition of Wyndham's rentals business extends beyond property marketing. The company offers a turnkey professional management solution for owners that do not wish to actively manage their vacation rental properties. To that end, the company is progressing in its efforts to apply the dynamic revenue management concepts from its lodging and exchange businesses to improve the pricing and margins for Wyndham and the owners of the properties it manages over the cycle.
Scale represents a significant barrier to entry in the vacation exchange industry given the large number of resorts needed to make it an attractive exchange network. The industry structure is essentially a duopoly between Wyndham's vacation exchange business, RCI, and Interval Leisure Group, Inc. RCI is the larger of the two, with over 4,000 vacation ownership resorts in its network compared to Interval's roughly 2,800 resorts.
HIGH EXPOSURE TO TIMESHARE
Fitch generally views the timeshare business less favourably than the lodging business due to greater earnings volatility and capital intensity. Fitch estimates that roughly half of Wyndham's revenues and slightly less than half of its EBITDA comes from timeshare operations (including a small amount of timeshare-related fee revenue).
Excess inventory build leading up to the global financial crisis has kept development spending low for the industry at this point in the cycle. Fitch expects higher development spending associated with inventory replenishment to lead to increased cash flow volatility for timeshare companies during the next three to five years.
Wyndham has modified its timeshare business model in an effort to reduce cash flow volatility. Examples include emphasizing recurring management fees (evidenced by its acquisition of Shell Vacations, which mostly consists of already sold inventory), as well as the company's transition of a portion of its business to the WAAM model. Wyndham created the WAAM model to improve the capital efficiency of its timeshare business. The company has cycled through several iterations of WAAM based on changing market conditions and opportunity sets in the industry.
Fitch expects the company will continue to seek timeshare inventory sourcing opportunities under its asset-light WAAM business model, in addition to modest timeshare inventory spending of roughly \\$150 million annually. Longer term, the ratings incorporate Fitch's assumption that inventory spending will ramp up modestly, resulting in a continued solid FCF profile.
LOWER QUALITY EARNINGS GROWTH
WYN's earnings have been boosted by declining loan loss provisions in its timeshare segment during the last two years that, all else equal, are lower quality relative to earnings growth through higher sales, in Fitch's view. The company's volume per guest (VPG) - a key measure of sales productivity - decreased by roughly 3% between 2012 and 2014 and is down 0.5% for the first six months of 2015. Fitch attributes the decline to the company's shift towards a group presentation format for its sales to existing customers from individual presentations.
Positively, company's VPG improved by 3.2% year-over-year during the second quarter, suggesting the WYN has found the right balance between group and individual presentation. In addition, the lower provisions are based on improving loss curves in its timeshare receivables portfolio, which have benefited from WYN's tighter customer screening requirements that include higher down payments and FICO scores, on average.
Like many of its peers, the company has also increasingly relied on higher margin sales to existing owners and lower cost inventory through fee for service arrangements and discounted inventory purchases that may be difficult to sustain over the cycle. The level of benefit is challenging to quantify based on the company's public disclosure. Approximately two-thirds of the company's timeshare sales during the second quarter of 2015 (2Q15) were upgrades by existing owners.
INCREASED OFF-BALANCE-SHEET LIABILITIES
The ratings contemplate Wyndham's off-balance-sheet liabilities that include contractual and contingent obligations, which have increased during the past several years. Fitch incorporates these items into the ratings by analyzing Wyndham's liquidity position and the potential impact to increased leverage under various liability funding scenarios.
Inventory purchase commitments under its WAAM business model have increased Wyndham's off-balance-sheet contractual obligations. Fitch recognizes the financing elements associated with these transactions, but does not consider them akin to debt.
As with all of its financial obligations, Fitch is monitoring closely Wyndham's total and maximum annual funding requirements related to its timeshare inventory purchase commitments, emphasizing the impact to leverage under weaker economic and industry conditions. Wyndham has adequate flexibility to redirect discretionary capital expenditures (i.e. share repurchases) to pay down debt and reduce leverage in an economic downturn.
The company's contingent obligations have increased in recent years due, in part, to performance guarantees associated with management agreements with FelCor Lodging Trust (FCH) and Hospitality Properties Trust (HPT).
Fitch recognizes that the company may periodically need to enter into management agreements that contain performance guarantees in order to grow its hotel system, thereby increasing its contingent obligations. However, Fitch expects Wyndham to limit its use of performance guarantees going forward - mainly using them to bolster the competitive position of its upscale hotel brands.
EVENT RISK
Fitch believes the company has attributes commonly associated with event risk in the form of shareholder activism and/or a leveraged buyout (LBO), such as a high FCF yield and a diverse and complex set of operating business with varied cash flow profiles and return characteristics. This risk may be heightened in the current accommodative credit environment, as well as the recent trend for lodging C-Corps to exit their timeshare segments, either through a sale or shareholder spin-off.
Several factors mitigate the potential credit risk from an LBO, including change of control provisions in its bond indentures and the limited leveragability for some of its businesses. Fitch also notes that most of Wyndham's publicly traded peers are committed to an investment grade balance sheet strategy.
Wyndham has also stated its interest in expanding its lodging and vacation rentals businesses through strategic (and possibly large, transformative) acquisitions. The company has expressed publicly a willingness to let its credit ratings fall to a high speculative grade rating for an attractive acquisition, provided management sees a path to returning to investment grade over a reasonable time period.
LIQUIDITY PROFILE
At June 30, 2015, Wyndham had cash of \\$410 million, \\$1 billion of availability (less commercial paper [CP] and letters of credit) under its corporate revolving credit facility, and \\$447 million of availability under its two-year vacation ownership conduit facility underpinned the company's ample liquidity position.
Wyndham has a sizable and well-established consumer financing business related to its timeshare business. Term securitization transactions of timeshare receivables provide an additional source of liquidity. Recent transaction terms have been favorable. Moreover, market accessibility was better than Fitch's expectations through the last recession, although transaction terms were less attractive than the current financing environment.
Wyndham has no major debt maturities during the next four years. The company had \\$476 million in CP outstanding as of June 30, 2015.
KEY ASSUMPTIONS
--U.S. lodging industry RevPAR growth increases by 7% during 2015 and decelerates, but remains positive, to the mid-to-low single digit range for the balance of the forecast period.
--Flat to slightly negative results in WYN's vacation exchange and rentals business as low single digit member gains at RCI are offset by a secular decline in average spend per member.
--Modest improvement in the company's timeshare sales revenue driven by improved VPG.
--Continued emphasis on sourcing less capital intensive timeshare inventory through discounted repurchases and its WAAM third-party development funding model.
--WYN returns its excess FCF to shareholders through dividend increases and share repurchases, regulating the latter to maintain at or near Fitch's 3.25x leverage target at the 'BBB-' rating.
--Fitch's ratings do not contemplate that WYN undertakes a 'transformative' acquisition.
RATING SENSITIVITIES
--Fitch has set Wyndham's core lease-adjusted leverage target at 3.25x with a cap of 3.5x for an IDR of 'BBB-'/Outlook Stable. There is only limited tolerance in the current rating/Outlook for leverage at or above 3.5x on both an annual and quarterly basis. Fitch allows for leverage to be slightly above its target level at 'BBB-' due to Wyndham's strong FCF profile. Wyndham's core lease-adjusted leverage (excluding securitized timeshare debt and related financing income) was 3.2x as of June 30, 2015.
--Wyndham's OBS commitments have increased recently and further increases could have a negative impact on the ratings and/or outlook.
--Wyndham's current FCF/debt ratio is 15.1%, which is very strong for the rating category. If the company's FCF/debt deteriorated to below 15% without the company reducing leverage to within 3.25x, there would be negative pressure on the rating/Outlook.
--Negative rating pressure could result if Fitch's outlook for development spending and the capital intensity of the company's businesses were to increase materially.
--Reducing and sustaining leverage at around 2.75x and the adoption of more conservative financial policies could result in upward momentum for Wyndham's ratings/Outlook. Fitch does not expect this to occur.
Fitch currently rates Wyndham as follows:
Wyndham Worldwide Corp.
--Long-term Issuer Default Rating (IDR) 'BBB-';
--Short-term IDR 'F3';
--Senior unsecured credit facility 'BBB-';
--Senior unsecured notes 'BBB-';
--Senior unsecured commercial paper (CP) 'F3'.
Wyndham Global Finance PLC
--Senior unsecured commercial paper (CP) 'F3'.
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