Recent Purchase: Vail Resorts

I explain why I was willing to look past lofty valuation premiums and focus on growth while adding MTN to my portfolio.

A few years ago I spent a week at Stowe Mountain Resort in northwest Vermont. Honestly, that area of the country is like Heaven on Earth in late June. Stowe is known as a ski resort but during the summer there was great hiking in the area, not to mention, all of the food and amenities that the resort and local town had to offer. Needless to say, that trip made a big impression on me and I’ve had a soft spot for the green mountain state in my heart ever since. With this in mind, when I heard that Vail Resorts (MTN) was purchasing Stowe in June, my ears perked up.

I realized that I was letting emotions creep into my investment process, but the thought of owning a tiny piece of Stowe via MTN was appealing to me. I wasn’t very familiar with Vail Resorts prior to that acquisition news but I was pleasantly surprised by what I found throughout the due diligence process. MTN has expanded its operations since Vail Ski Resort opened in the mountains west of Denver in 1962, amassing a very impressive portfolio of resorts across the United States, Canada, and Australia. And it’s not just the company’s luxury resorts in iconic locations that I’m impressed with, but the company’s fundamental and dividend growth, as well.

MTN owns/operates 7 of the top 15 ski destinations in the U.S. Breckenridge is 1st, Vail is 2cd, Park City is 3rd, Keystone is 5th, Beaver Creek is 10th, Heavenly is 11th, and Northstar is 13th. MTN also owns Whistler Blackcomb, in British Columbia, Canada, which is the most visited resort in North America and Perisher, in New South Wales, Australia, which is the most visited ski resort in the Southern hemisphere.

This is an attractive portfolio, but I think it also goes to show that while MTN dominates the slopes, there is still plenty of potential
room for upside in the M&A arena. MTN’s resorts garnered ~15% of North American ski visits in 2017, which is why I think this growth story is just beginning.

Back in June MTN experienced a bit of weakness, but I missed it. The stock then rose strongly from $200 to $230, before dipping again to the $215 range. I missed this too. All year I’ve waited for a slightly deeper correction than the market gave me. MTN just doesn’t seem to want to sell off 10%. Well, when the stock dipped again recently, from $236 down to $220, I decided to bite the bullet and initiate exposure with a 1/3 starter position.

Admittedly, MTN isn’t cheap, even after a bit of recent weakness. One could even make a solid argument that the stock is expensive today, even after its pullback from the highs, but then again, MTN hasn’t traded with a market multiple since 2009. The market has been willing to apply a premium valuation on this stock that rivals the luxuriousness of its destinations. With that said, the MTN has nearly quadrupled its earnings since 2009 and nearly doubled its revenues.

The company results during its most recent quarter continued to impress. Management’s message was two pronged, focusing on the growth produced by the recent Whistler Blackcomb (the most visited mountain resort in North America) acquisition as well as the upcoming investments that it plans to make on its slopes portfolio wide.

Capex is important for a company like MTN; travelers must feel as though they’re getting the premium sort of experience if they’re going to be happy paying premium prices. Vail has done a good job of targeting world class slopes, but if it doesn’t maintain them and different itself with innovative technologies, it will lose some of its luster. With that said, I’m impressed with the results that MTN expects to receive from its capital investments.

For instance, management expects to spend ~C$50m at Whistler and highlighting the performance it expects from two new gondola systems (47% and 43% uphill capacity with increased speed which should increase the volume of runs customers receive while reducing wait times), ultimately resulting in EBITDA increasing by C$9-10m during the 2018/2019 ski season. MTN is upgrading ski lifts across much of its portfolio and this will help them to grow profits organically.

And speaking of organic growth, MTN was very positive on its Epic pass program for this season, highlighting 14% unit growth and 20% growth in terms of sales dollars through December 3rd.

Question have risen regarding this year’s ski season due to snow conditions (or the lack there of) across much of the Western mountains; however, while this will likely negative effect the early/holiday ski season, there is still plenty of time for fresh powder before things really get going in February and March.

This seasonality is a risk that all MTN investors must digest. Although MTN has taken steps to diversify itself geographically, reducing the threat of disruptive weather patterns, it is still primarily based in the Western half of North America and will continue to generate the vast majority of its sales during its second and third fiscal quarters (likely posting losses in the other two). This makes MTN a somewhat more difficult/complicated company to evaluate; however, my plan is to simply buy and hold this name, taking part in what I believe to be a long-term growth trajectory.

Although I’m bullish on the secular tailwinds that MTN benefits from and the high quality nature of its assets, I must acknowledge one rather speculative, yet potentially disruptive elephant in the room: climate change. MTN’s mountain division (basically lift passes, ski schools, food, and retail on the slopes) makes up the vast majority of its sales/income and this obviously requires snow. We’re seeing hotter, dryer seasons as the Earth’s temperature rises, though I don’t think we’re looking at a snowless
world anytime soon. With that said, global warming is a threat to MTN’s business (avid skiers prefer natural powder much more than artificial snow). Obviously since I just bought shares I don’t see this as a major threat to MTN’s operations in the foreseeable future, but climate change and weather risks are certainly worth considering when putting capital at risk here on the mountains.

But enough speculation, let’s get into the numbers. As you can see on the F.A.S.T. Graph below, MTN has a long history of trading at high multiples. Being a mid-cap company with above average growth, this is somewhat justified. Granted, I’d much rather pay 25x for the growth that MTN offers investors than 35x, but looking at the company’s history it appears that it takes a broad economic downturn to really effect this company’s multiple and I don’t foresee a recession anytime in the near future.

MTN’s rising debt load is a concern for me, though this company’s management has proven an astute ability to pick up accretive assets (most recently Whistler Blackcomb and Stowe) and while I will continue to monitor debt ratios, I don’t mind watching this company grow via acquisitions so long as it continues to target very high quality assets.

As you can see in this cut out from the company’s 2017 year’s end balance sheet, not only is debt rising, but so are revenues, net income, dividends, resort traffic, total assets, and shareholder equity. Every mountain resort that Vail buys adds validity to their brand and widens their moat against potential competitors in the luxury travel space.

I think a literal land grab in this space makes since as MTN and other players in the travel space benefit from several important demographic trends related to both the young and old (recent/upcoming retirees and millennials) who both seem to prefer using their disposable income on experiences. This societal pushback against materialism as well as the emergence of social media and the individuals’ ability to brand themselves as hip/cool when visiting places likes the ones that MTN operates bodes well for MTN. What’s more, I expect MTN (as well as the other travel names) to be major beneficiaries from the tax reform.

And speaking of tax reform, MTN, who paid an effective tax rate of 33.5% in fiscal 2017, should experience a nice boost from a lowered corporate rate as well as any real estate related benefits of the proposed legislation. Unlike many domestic oriented companies that have caught a bid in the market during the last week or so as tax reform shifted from Republican dream to realty, MTN has experienced weakness. I think this divergence in trends creates a decent entry point for someone like me who desires exposure and have been waiting for a bit of a dip to go long.

MTN’s recently updated 2018 EBITDA and net income guidance of $646-676m and $264-$300m, respectively, didn’t include any potential benefits from upcoming tax reform. Assuming that all is well with the tax reform bill, I expect to see MTN post figures even higher than these. Fiscal 2017 EBITDA came in at $593m and net income was $210, meaning that this 2018 guidance represents ~11% and ~33%, respectively. Being that these growth estimates don’t take tax reform into consideration, I wouldn’t be surprised to see MTN post EBITDA growth in the 15-20% range, which bodes well for the stock as well as the upcoming dividend announcement.

As I said in the intro, I wasn’t just interested in Vail because of its assets, but also its recent dividend growth history. It’s difficult to find many companies that have been more generous towards shareholders since instituting a dividend in 2011. In 2011, Vail paid shareholders an annual dividend of $0.30/share. Flash forward 6 years and we see Vail paying shareholders an annual dividend of $4.21. This is fantastic growth and I expect to continue to see strong double digit income increases coming from MTN.

Although I’m bullish on MTN’s dividend growth prospects, it’s important to recognize that the company’s GAAP payout ratio is rather high. In 2017 MTN’s GAAP EPS came in at $5.22, representing a payout ratio of ~80%. This is a much higher payout ratio than I’d typically target, but due to the strong bottom line growth that MTN is expected to produce (the average analyst EPS expectation for 2018 is currently $7.14), meaning that the $4.21 dividend represents a forward payout ratio of ~58%.

Now obviously investors shouldn’t expect to see ~35% bottom line growth year in and year out from this company. Once the recent acquisitions are factored into the comps MTN will have to rely on organic growth, which is likely to be in the mid single digits. From here on out I expect to see dividend growth fall in-line with EPS growth. I’m not overly excited about a company with a 2% yield growing its dividend at 5% per year, but this sort of outlook assumes that MTN is done expanding.

I don’t think it is; once management uses current cash flows to deleverage the balance sheet a bit, digesting debt from recent acquisitions, I wouldn’t be surprised to see MTN purchases more mountain resorts. It’s dangerous to rely on this sort of rollup strategy with regard to future growth but I think the underlying trends supporting growth in the luxury leisure space are strong enough to justify exposure to this name.

Even with slowing growth likely on the horizon, the Street remains very bullish on MTN. Right now Yahoo Finance tracks 8 analysts who have price targets for MTN. Right now the lowest of those 8 is $235 and the cumulative average is $252.88 (representing ~15% upside based upon current prices). S&P Capital IQ, another firm that I like to check as a part of my due diligence process, also has a 12-month price target of $250 on shares. I don’t base my decision making on the consensus Wall Street opinion, but I’m always happy when it’s aligned with my own.

Moving forward from here, I plan to average into this name at approximate 10% intervals should the stock continue to fall. My next PT for a purchase is ~$200. If the holiday ski season is disrupted by dry/hot conditions, then I wouldn’t be surprised if it got there. But if not, I’m happy to hold the shares that I own now as I look forward to the company’s upcoming dividend increase announcement which should happen in March.

Disclosure: I am currently long MTN.

Comments
No. 1-6
Nicholas Ward
Nicholas Ward

Editor

Congrats! You got in a bit lower initially than I did. I've considered trimming back some Boeing as well after its amazing run - though I just can't bring myself to do it. That said, it's hard not to believe that BA is overvalued...it's just hard to part ways with such a high quality dividend grower. I will reassess things if the stock rises to $350, which would represent an historical premium based upon management's recent guidance.

DStewart
DStewart

I pulled the trigger on a half size position in Vail today after the continued recent selloff and re-balanced by selling a 1/3 position in Boeing.

Nicholas Ward
Nicholas Ward

Editor

I like the real estate play too - I was surprised that that made up such a small percentage of their revenues (3% if I remember correctly). I would think they could leverage their land holdings into much more seasonal rent if they wanted to.

DStewart
DStewart

The unfortunate thing is as Warren Buffett understands, fantastic businesses often trade for a premium. So while not a traditional value investment, MTN offers a different form of value. As well, the continued rise of experiential consumerism bodes well for Vail. Additionally, I like the optionality the real estate development arm offers for upside.

Nicholas Ward
Nicholas Ward

Editor

DStewart, Thanks for your comment! I agree that the stock appears to be expensive. This is why I bought a relatively small starter position (the stock has a history of trading with high multiples, making it difficult to evaluate on a traditional basis). I wanted exposure because of the tremendous assets that you mentioned. I was a bit early - but will happy add on further weakness. MTN isn't a company that I'd ever go overweight, but I do think it's an interesting holding from a growth (based upon my assumption that they will continue to make high quality acquisitions) and dividend growth (management has been very generous to shareholders in recent years).