Hilton Grand Vacations Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Hilton Grand Vacations Inc. (HGV) is a timeshare company that develops, markets, sells, and manages vacation ownership properties, primarily under the Hilton brand and its subsidiaries, primarily within the US, Mexico and Caribbean.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

HGV’s business model centers around the sale of vacation ownership intervals (timeshares) and the subsequent management of those properties. It operates under a point based system through its HGV and Hilton Clubs. These points can be used to book stays at different resorts in its portfolio and gives access to the Hilton brand.

Business Overview

  • Revenue Streams: HGV generates revenue primarily through three main segments:
    1. Sales of VOIs: This involves the sale of vacation ownership intervals (timeshares) and related products, including ancillary offerings, to customers. These sales are often financed with loans provided by HGV.
    2. Resort operations and club management: This segment generates revenue from managing resort properties, including fees from membership programs and maintenance services to the owners of properties at HGV.
    3. Financing: This segment is the revenue generated from providing loans to those purchasing timeshares. This can include interest income and fees from the financing segment.
  • Industry Trends: The timeshare industry has seen a shift towards more flexible ownership models, with point-based systems gaining popularity. It has also undergone consolidation in recent years as major players acquire smaller ones. Vacation ownership, however, can be extremely sensitive to macroeconomic factors, like recessions and decreased consumer spending.
  • The recent economic data and rising interest rates, and specifically the recent turmoil in the banking sector, could have a negative impact in vacation and travel industry as the cost of vacations rises.
  • Margins: HGV’s operating margins depend on the overall health of the timeshare market. The margins from recurring sources of income are relatively consistent but sales can fluctuate. HGV has been focused on improving marketing and sales efficiency, to reduce cost.
  • HGV is expected to achieve gross profit margins around the mid-30 percent levels which is the average of the timeshare industry and consistent with its competitors in that area.
  • Competitive Landscape: The timeshare industry is relatively concentrated, with big players and established brand, such as HGV, Marriott Vacations Worldwide, and Wyndham Destinations dominating the space. The competitive advantage will include brand recognition and large, well-established loyal customer base. Newcomers to this space will have a high hurdle to overcome to compete with the well-established companies, especially due to cost structure advantages that are built into the business models.
  • What Makes HGV Different:
    • Brand: HGV operates primarily under the Hilton brand, which is well-known globally and offers appeal of luxury and familiarity to customers.
    • Large loyal customer base: With a large established base of owners, HGV has a better advantage to retain and encourage repeat purchases of its offerings.
    • Point-based system: Its points-based model offers flexibility to customers, enabling them to choose where and when they want to travel.
    • Proprietary Financial Division: HGV has its own financial division that handles financing, including financing of its own operations and providing loans to customers. This gives HGV a vertical integration and an advantage on managing margins.

Financials

  • Income Statement:
    • HGV had a good 2022, increasing its revenues from $1.7B in 2021 to $2.8B in 2022, which represents a ~65% revenue growth. Also, its income was $374M in 2022 against a loss of $15M in 2021. That means a substantial jump in operating margins for the company.
    • The Q1 2023 earnings had similar good metrics, revenue grew 16% YoY, with sales seeing growth of 12% YoY.
    • For Q2 2023 earnings, total revenues decreased 7% YoY to $1.0B with sales down 12% YoY and resort operations increasing 9% YoY.
    • For Q3 2023 earnings, total revenues have been up 24% YoY to $1.1B, with sales being the major contributor, up 28% YoY, but resort operation revenue has increased 17% YoY as well.
    • The primary driver of sales revenue is “contract sales.”
  • The company is focusing more heavily on their business, and this is what their management has mentioned that has led to greater success and better numbers. They attribute success in the current quarter and in the previous quarter to better execution and focus, a greater emphasis on selling, less emphasis on finance.
  • Balance Sheet:
    • HGV has total assets of approximately $11B and total liabilities of approximately $8.6B, as of September 30, 2023.
    • The company uses leverage from debt, which is normal in the industry, and had a Debt-to-Equity ratio of around 2.2, at the end of 2022, though the equity section has seen growth, and the debt section has been reduced in the most recent quarter.
  • Most of the assets are comprised of intangible assets and goodwill.
    • The equity has increased from $1.8B to $2.6B from 2021 to 2022, respectively, and has increased further in the following quarters.
  • Cash Flow:
    • HGV consistently generates positive cash from operations.
    • The cash flow from investing activities is primarily attributed to acquisitions.
    • The company is actively using cash to repay debt and perform buybacks.

Moat Analysis

  • Intangible Assets (Brand): The Hilton brand is a valuable asset that HGV leverages. It’s widely recognized for quality and comfort, and helps with customer acquisition and loyalty. Rating = 2.5/5 because even though Hilton is a well-known name and brand, the product is not truly exclusive, and it is just the brand name that has value.
  • Switching Costs: While there are costs associated with giving up vacation clubs, such as lost loyalty points, it is relatively easy to switch timeshare providers, as there is no major lock-in involved. Rating = 1/5.
  • Network Effects: While there can be network effects in the form of a network of available accommodations across the world to its owners, these are not a major driver for the value of the business. Rating = 1/5.
  • Cost Advantages: HGV does benefit from economies of scale, given its established operations. However, this advantage is not necessarily sufficient to fend off well-funded and big competitors. In the current state of operations and structure, HGV’s costs do not have a substantial advantage compared to others. Rating = 1/5.

Overall Moat Rating: 2 / 5 - While HGV possesses some elements of a moat, such as a strong brand, the lack of meaningful switching costs, weak network effects, and weak cost advantages indicates the overall moat is only a narrow one.

Risks to Moat and Business Resilience

  • Economic Downturns: Recessions or economic slowdowns can significantly impact consumer spending on discretionary items such as vacations, reducing demand for timeshares.
  • The management is aware of a looming recession but have noted that they have worked hard to lower their overhead costs, and be as lean as possible to withstand any sort of downturn. They also noted that they have a large existing owner base, that gives them recurring revenue through different fee based contracts.
  • Increased Competition: New entrants with unique product or technology offerings can emerge. Increased competition can cause a price decline or loss of existing market share.
  • Changes in Consumer Preferences: Shifts in consumer preferences towards alternative vacation options or flexible vacation systems can reduce demand.
  • Operational Risks: Issues stemming from bad acquisitions or acquisitions with less-than-anticipated synergies or results can have a significant negative impact to future earnings, cash flows, and ROIC.
  • Financial Risks:
    • The use of leverage makes the company susceptible to changes in credit conditions.
    • High level of debt can significantly impact HGV’s financials.
  • Geopolitical Risks: With the growing global operations in South America, HGV will be exposed to the political turmoil that those countries are currently experiencing.
  • Seasonality: The majority of revenue occurs in the first and fourth quarters, due to high consumer demand and vacation planning cycles. This means that the company needs to be extremely efficient and diligent in their operations, and they need to operate the business effectively in order to sustain profits.

Business Resilience: HGV’s business model is vulnerable to economic downturns, and that can cause considerable pain to its sales, especially for new contracts for timeshares. There are a few levers that are available for the company to act on, primarily, reducing costs and improving existing operations and increasing the amount of cash generated by recurring operations, and the existing client base that is extremely sticky.

Understandability Rating: 3/5

The business model of timeshares is relatively straightforward. The key aspects are easily understood: sell timeshares and manage them. However, the nuances and complexities of the company’s financial model, including the specific accounting for timeshares can make a full understanding of the business tricky for newcomers. Furthermore, a large level of intangible assets and debt also make the business moderately complex. The way it generates revenue is also a little complex and there are multiple avenues from where income can arise.

Balance Sheet Health: 4/5

HGV’s balance sheet is relatively healthy. Though the company has debt, its growing book value and liquidity and positive free cash flow generating capabilities give it a good cushion to be able to handle the debt. However, HGV operates within a capital-intensive industry, and that means that large amounts of investments are needed at all times to maintain its operations, which could be risky in the future. There are concerns regarding how well HGV will perform in an economic slowdown, as the discretionary income will be constrained. Therefore, the rating is 4 out of 5.