Q3 2023 Travel + Leisure Co Earnings Call

Participants

Christopher Agnew; Senior VP of FP&A and IR; Travel + Leisure Co.

Michael A. Hug; CFO; Travel + Leisure Co.

Michael D. Brown; CEO, President & Director; Travel + Leisure Co.

Brandt Antoine Montour; Research Analyst; Barclays Bank PLC, Research Division

Charles Patrick Scholes; MD of Lodging, Gaming and Leisure Equity Research & Analyst; Truist Securities, Inc., Research Division

Chris Jon Woronka; Research Analyst; Deutsche Bank AG, Research Division

Dany Asad; VP & Research Analyst; BofA Securities, Research Division

David Brian Katz; MD and Senior Equity Analyst of Gaming, Lodging & Leisure; Jefferies LLC, Research Division

Isaac Arthur Sellhausen; Research Analyst; Oppenheimer & Co. Inc., Research Division

Joseph Richard Greff; MD; JPMorgan Chase & Co, Research Division

Presentation

Operator

Hello, and welcome to the Travel & Leisure Q3 2023 Earnings Call and Webcast. (Operator Instructions) As a reminder, this conference is being recorded.
It’s now my pleasure to turn the call over to Christopher Agnew Investor Relations. Please go ahead, sir.

Christopher Agnew

Thanks, Kevin, and good morning. Before we begin, we’d like to remind you that our discussions today will include forward-looking statements. Actual results could differ materially from those indicated in the forward-looking statements and the forward-looking statements made today are effective only as of today. We undertake no obligation to publicly update or revise these statements.
The factors that could cause actual results to differ discussed in our SEC filings and in our earnings press release accompanying the earnings call and you can find a reconciliation of the non-GAAP financial measures discussed in today’s call in the earnings press release available on our website at travelandleisureco.com/investors.
This morning, Michael Brown, our President and Chief Executive Officer, will provide an overview of our third quarter results. And Mike Hug, our Chief Financial Officer will then provide greater detail on the quarter, our balance sheet and outlook for the rest of the year. Following our prepared remarks, we will open up the call for questions.
With that, I’m pleased to turn the call over to Michael Brown.

Story continues

Michael D. Brown

Thanks, Chris, and thank you for joining us on our third quarter earnings call.
This morning, we reported adjusted EBITDA of $248 million, a 6% increase over the prior year and adjusted diluted earnings per share of $1.54, a 20% improvement over Q3 2022. Third quarter adjusted EBITDA margin was 25% flat compared to the prior quarter and prior year. Our team delivered solid results against key performance indicators, particularly the vacation ownership business. Sales volume per guest and gross VOI sales were at the top end of expectations. As well, new owner in total tour flow increased 36% and 18% respectively, year-over-year.
In keeping with our commitment to grow our new owner base, the transaction mix increased nearly 200 basis points to 35% of sales. The provision for loan loss came in ahead of expectations at just over 18.5%, re-infirming the improvements in owner credit quality.
Regarding capital allocation, we returned $98 million to shareholders in the third quarter through a combination of dividends and share repurchases, which puts us on track to reduce our outstanding shares by 10% for the full year.
From the start of 2022 until the end of the most recent quarter, we have reduced our share count by 16%. Since spin, we have reduced our share count by 27 million shares or 27% of shares outstanding.
Let me update you on the key performance indicators we monitor to gauge the health of our consumer. Forward resort bookings, sales volume per guest and the performance of our consumer finance portfolio. Regarding forward bookings, Q4 owner nights on the book are 7% ahead of fourth quarter 2019, reflecting a continued strong booking pace. Total owner arrivals are ahead and length of stay is 5% above the fourth quarter of 2019.
Of note, in our post-pay surveys, nearly 1 quarter of respondents were remote while staying at our resorts reinforcing the work from anywhere trend that we believe is one of the factors behind longer length of stay.
Turning to VPG. Our third quarter VPG was $3,108, above the top end of our guidance range. On an absolute basis, VPGs are healthy and reflect the strong value proposition of our product and for the full year, our outlook is improving to $3,100 to $3,150. VPG did decline $42 from the second quarter, but 90% was due to the higher new owner mix. VPG remains well above our long-term guidance range of $2,700 to $3,000.
In 2023, we made a strategic decision to ramp up new owner marketing channels to continue growth of new owner tours. Year-to-date, we have had success with new owner tours, which have increased 35% over the same period in the prior year. Over 70% of this growth have come from open market channels or packaged sales. This investment positions us to achieve our long-term plan for new owner transactions to be 35% to 40% of all sales. We expect this tour pipeline to yield incremental growth over the next 12 months and grow our pipeline of future upgrade sales.
Blue Thread, which is our new owner marketing channel aligned with Wyndham Hotels, continues to exceed expectations with VPG nearly 50% higher than other new owner channels. We expect Blue Thread sales to finish the year at an all-time high over $100 million.
Our third key performance indicator is our consumer finance portfolio, which performed well in the quarter. Delinquencies remained below 2019 levels and our outlook for the full year loan loss provision is unchanged at 18% to 19%. At the end of the third quarter, only 10% of our portfolio had FICO below 640, and year-to-date, the average FICO score for originations is 738.
All in all, our Vacation Ownership segment continues to perform well. The continued strength in our Vacation Ownership business was challenged by headwind to the Travel and Membership segment. This segment continues to lag expectations due to lower exchange propensity and slower-than-anticipated ramp-up of Travel Clubs. Accordingly, we are making structural and operational changes to reduce its cost structure while maintaining focus on driving transactions in both exchange and travel clubs.
These changes will occur prior to year-end, allowing us to enter 2024 more streamlined. Coming into this year, our expectation was that our exchange business would maintain the 2022 transaction propensity levels and that travel clubs would ramp up through the year. Instead, we experienced a decline in exchange propensity throughout the year.
To put it in perspective, our exchange propensity is nearly 20% off pre-COVID levels. Mike will provide more details in a moment, but the lower expectation of Travel and membership in combination with 3Q coming in toward the lower end of our guidance is the reason for our full year reductionn — for a reduction in full year adjusted EBITDA guidance to a range of $900 million to $915 million.
As we look ahead to next year, it is worth reflecting the Travel and Membership over the last 4 quarters, had revenues of $716 million and adjusted EBITDA of $253 million with a healthy 35% adjusted EBITDA margin. The business has low capital requirements, strong returns and cash flow.
We expect that Q4 will mark the trough and revenue momentum for Travel and Membership due to a combination of stabilizing transaction propensity trends and pricing at RCI and growth in our travel clubs.
On the strategic front, we acquired the rights to the Vacation Ownership business of Sports Hospitality Ventures, the hotel and resorts licensee of the Sports Illustrated brand. Our plans, including network of sports teams resorts located in popular college towns and in leisure destinations. We will be launching and managing a Vacation Ownership club under the Sports Illustrated Resorts Brand. Among the strategic goals we shared at our Investor Day was the intention to add incremental vacation ownership revenue streams under the Travel and Leisure brand. We are proud to launch this expansion with Sports Illustrated, the most celebrated name in sports with nearly 70 years of legendary content.
Tuscaloosa, Alabama, home of the University of Alabama has been selected as the first college destination in the Sports Illustrated Resorts portfolio and is projected to open in late 2025. Our goal is to develop Sports Illustrated Vacation ownership inventory in a capital-efficient manner.
We have several additional locations in the pipeline and more consideration after significant inbound inquiries following the Tuscaloosa announcement. We are excited by the initial representation of our strategy to add new brands to our portfolio and we look forward to sharing more with you over the coming quarters.
As a reminder, it’s important to remember that the prepaid nature of timeshare ownership is a key differentiator for our business model within the leisure travel industry. 80% of our owners have fully paid for their timeshare, and therefore, the choice to vacation is less dependent on economic conditions.
As we have seen historically, our healthy mix of recurring and predictable revenues is one of the reasons we expect our business will continue to be resilient as we enter a more challenging economic environment. This resilience in demand among timeshare owners has been proven time and time again, most recently coming out of COVID.
With that and for more detail on our performance, I would now like to hand the call over to Mike Hug.

Michael A. Hug

Thanks, Michael, and good morning to everyone. As well as discussing our third quarter results, I’ll provide more color on our balance sheet and cash flow as well as update our outlook for the remainder of the year. All my comments will refer to comparisons to the same period of the prior year, unless specifically stated.
We reported third quarter adjusted EBITDA of $248 million and adjusted diluted earnings per share of $1.54, increases of 6% and 20%, respectively. Year-to-date, adjusted EBITDA growth is 5% and adjusted EPS growth is 16%. The adjusted EBITDA growth was achieved in spite of several headwinds in the third quarter, which include the fires in Maui, 2 hurricanes in Florida and up the East Coast of the U.S. and higher-than-anticipated healthcare expenses. Although not individually material, they amounted to $5 million and combined to push our results to the lower end of our guidance range.
Vacation Ownership reported segment revenues of $812 million, an increase of 8%, while adjusted EBITDA of $203 million also increased 8%. We delivered 187,000 tours in the third quarter, representing 18% growth and VPG was $3,108 above the top end of our expectations. The Vacation Ownership segment also incurred some incremental marketing expenses in the quarter associated with the ramp-up of our tour package pipeline and opening of additional new owner marketing locations, both of which are designed to benefit our tour flow in 2024 and beyond.
Revenue in our travel membership segment was $174 million in the quarter compared to $183 million in the prior year. Adjusted EBITDA was $62 million compared to $65 million in the third quarter of 2022. Exchange member count has started to recover, but not enough to offset the reduction in transaction potentially. We expect the headwinds to exchange transaction propensity to continue into the fourth quarter.
Turning to our balance sheet. Our financial position remains strong. And in the third quarter, we continued to return capital to shareholders through share repurchases and recorded dividend of $0.45 per share. Through the first 3 quarters of the year, we repurchased $267 million of common stock and paid $104 million in dividends.
In October, we closed our third ABS transaction of the year, a $300 million transaction with a weighted average coupon of 6.8% and an advance rate of 92%, continuing to demonstrate our ability to access this market on a regular basis. In addition, during the quarter, we renewed our $600 million ABS condo facility and moved the maturity date to September 2025.
Adjusted free cash flow was $81 million through 9 months, compared to $195 million in the same period last year. Similar to the first 6 months, this is due to higher year-over-year originations on our loan portfolio, certain other working capital items and an increase in interest payments on our corporate debt. For the full year, our expectation for free cash flow conversion from adjusted EBITDA is for it to be around 50%, with the majority of free cash flow generated in the fourth quarter.
Our net corporate leverage ratio for covenant purposes was 3.7x at the end of the third quarter. We continue to expect our leverage ratio to decline by the end of the year to below 3.5x.
Turning to our outlook for the rest of the year. We are reducing our expectation for full year adjusted EBITDA to range between $900 million to $915 million, a 5% to 7% increase over 2022. Our expectation for the fourth quarter is for adjusted EBITDA of between $233 million to $248 million.
With respect to Vacation Ownership, we remain confident in our core timeshare business and its ability to continue to deliver strong sales performance. We are increasing our outlook for gross VOI sales for 2023 to a range of $2.15 billion to $2.2 billion on improved VPG guidance of $3,100 to $3,150. In the Travel & Membership segment, we expect fourth quarter adjusted EBITDA to be in the range of $45 million to $50 million.
Related to EPS, we are expecting our effective tax rate to be around 27% for the full year with stock-based compensation expected to be around $12 million in the fourth quarter and anticipate net interest of $62 million in the fourth quarter.
Looking ahead to next year, we expect the rapid rise of interest rates in ’22 and 2023 to stabilize at elevated levels in 2024. As such, our expectation is that interest expense on our asset-backed securitizations will once again be an incremental $30 million headwind to adjusted EBITDA in 2024, similar to 2023.
As we continue our 2024 planning process over the next few months, we will also revisit our longer-term outlook. This will allow us to take into account the impact of the interest rate environment over the full time horizon, slower travel membership growth and the updated view of our well-performing VOI business. We’ll provide more color in the first quarter of 2024.
In summary, we are pleased with our third quarter performance, our continued growth in adjusted EBITDA and double-digit growth in adjusted diluted earnings per share as well as our continued return of capital to our shareholders.
With that, Kevin, can you please open up the call to take questions?

Question and Answer Session

Operator

(Operator Instructions) Our first question is coming from Joe Greff from JPMorgan.

Joseph Richard Greff

Michael, you mentioned that you think travel membership is going to trough here in the fourth quarter. What gives you that confidence in both the exchange business and travel clubs? And then when you think about next year, do you look at next year as a growth year? Or is it just the rate of change is less negative next year than what it was this year?

Michael D. Brown

Well, let me start with the sector one. No, we expect 2024 for the Travel and Membership segment to be a growth year for a number of different reasons. So let me jump back to the first question is.
As we went came into 2023, we expected exchange propensity to reflect pre-COVID levels. 2022 was a revenge travel year. And I think what — the trends we saw in 2022 masked a little bit of what was happening in exchange propensity. VOI was super strong in exchange propensity with similar to pre-COVID levels. As travel normalized in 2023, the unmasking of post-COVID travel trends in VOI and COVID and exchange really came forward.
The first 2 quarters, propensity was slightly down, and I had expected the second half of this year for a rebound in recovery in that propensity rate to pre-COVID levels because that’s what we saw throughout leisure travel. Instead, what we saw is more and more of owners within the timeshare industry were returning to their home resorts. It’s no different within the Wyndham Travel Club and as the year progressed, instead of getting that rebound that I had forecasted that we had forecasted, it continued to dip, as I mentioned to a level that was around 20% below pre-COVID levels.
So what gives us confidence that we think Q4 is going to trough? Number 1 is we have seen a stabilization in that propensity over the last few months. So we think we have a good anchor as what the true propensity is once the revenge travel and once we’ve made our way through 2023 is. You’ve heard us refer to the fact that membership dropped about $0.5 million in RCI through COVID period. And finally, the membership is beginning to grow again, and that is absolutely happening.
And then lastly, as we head into 2024, on the Travel Club side, although our transactions are flat to last year, that’s taken into account the loss of one of our major clients. So absent that loss, we’re actually seeing growth in our travel clubs, and we will start to lap that in the second quarter of next year.
So I know that’s a long answer to a lot to what’s happening. But in the end, we absolutely expect, through a number of the actions A, we’re taking in Q4, but also with the clear visibility of what the travel trends in should return travel and membership will return travel and membership to a growth profile in 2024.

Joseph Richard Greff

And then you also mentioned that you’re reducing costs in this business. Can you help quantify that? And how much of that is revenue dependent versus fixed costs coming out?

Michael D. Brown

Well, we — we are, as I mentioned, going to be going through that here in Q4 to make sure that our overall cost structure aligns to the revised forecast. You would expect that. And instead of being reactive to it, we’ve already proactively begun to look at the realities of our revenue forecast this year and make sure that our cost structure is reflected to it. We’ll give you an update a bit more later in the quarter. But as is the case, we will adjust to the realities of our revenue forecast.

Operator

Next question is coming from David Katz from Jefferies.

David Brian Katz

I wanted to just focus for a minute on the SI deal. And those of us that are huge sports fans see the opportunity out there is potentially very, very large. But maybe you could help us just set our expectations as to how big an opportunity this could really be? And what your vision for it is?

Michael D. Brown

Well, thanks for the question, David. And let me just — since this is the first quarter we’ve been on the call, let me take a little bit of time with this answer on a number of different subjects.
First of all, the overall model looks very similar to the Vacation Ownership model that we currently have with Wyndham, targeting similar margins and returns as this business grows. Three primary revenue streams, the sale of Vacation Ownership, the operations of resorts in the club and as well the financing income streams. The difference from the outset is, as today, we talked about 35% to 40% new owners on an annual basis with Wyndham.
In the first year, it’s 100% new owners into our system and we’re excited about the opportunity because the timeshare model used to be the 2 things you have to secure are new tours and new inventory.
Over the last decade, securing inventory has not been anyone’s issue because people appreciate the model and wanting to do developments with timeshare companies. It’s all about growing your addressable market. And the reputation of Sports Illustrated, the reach that it has in a number of different ways, not just data, social media, but also passion, there’s probably not a more passionate lifestyle in America than college sports.
We were excited…