March 29, 2017 / 3:55 PM / 10 months ago

Fitch Affirms Wyndham's IDR at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, March 29 (Fitch) Fitch Ratings has affirmed the Issuer Default Rating (IDR) for Wyndham Worldwide Corp. (WYN) at 'BBB-'. The Rating Outlook is Stable. A full list of rating actions follows at the end of the release. 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 maintaining 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. We would expect the company to swiftly reduce leverage back closer to our 3.25x target for the rating if, for example, WYN's 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 Dec. 31, 2016, roughly 15.5% of its total core debt balance (unadjusted and excludes securitized debt). Fitch expects FCF/debt will remain above 15% over the next one to three years - a moderately lower rate due primarily to higher financing propensity and origination levels in its timeshare business. ASSET-LIGHT/FEE-DRIVEN FOCUS Fitch expects the company to focus on less capital-intensive inventory sources in its timeshare segment 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 ownership interval sales make up the majority of the balance. Fitch expects hotel ownership to play a small role in its strategy. U.S. LODGING CYCLE PEAKING Fitch sees limited upside to its 1%-2% revenue per available room (RevPAR) expectation for 2017, given results to date and an unavoidable lag for policy implementation. However, stronger corporate demand could extend this upcycle to 2018, or longer. Fitch expects 2018 RevPAR to be flat versus our prior modestly negative assumption. Stronger lodging demand will require the new administration's policy ambition to become reality. Corporations appear to be taking a wait-and-see approach with respect to travel budgets, notwithstanding increased optimism surrounding infrastructure spending and tax, regulatory and healthcare reform. RevPAR has not accelerated from its low single-digit pace so far this year, according to STR Global data. Lodging operators and owners also suggested no change to demand from the improved optimism during the recent fourth-quarter reporting season. However, trends during the seasonally stronger April through September months are more important to industry revenues. DIFFERENTIATED SEGMENT: WYNDHAM DESTINATION NETWORK Wyndham's vacation exchange and rentals segment, Wyndham Destination Network, 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 TIMESHARE EXPOSURE Fitch generally views the timeshare business less favorably 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 Wyndham Asset Affiliation Model (WAAM). Wyndham created WAAM to improve the capital efficiency of its timeshare business. The company has cycled through several iterations 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 $240 million annually. Longer term, the ratings incorporate Fitch's assumption that inventory spending will ramp up modestly, resulting in a continued solid FCF profile. INCREASED OFF-BALANCE-SHEET LIABILITIES The ratings contemplate Wyndham's off-balance-sheet liabilities, including 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. INCREASED EVENT RISK The potential for WYN to be the target of an LBO is a perennial "event risk" concern. The company has several common characteristics of an LBO candidate, particularly a strong FCF profile, a historical valuation discount to peers, and the potential perception of a misunderstood business model. This risk is heightened in the current accommodative credit environment along with the recent trend for lodging companies to follow Marriott's lead and exit the volatile timeshare segment. Marriott spun its timeshare business off to shareholders in 2010, taking back a recurring licensing fee for the use of its brand name. Starwood disposed of its timeshare business prior to being acquired by Marriott in 2016 and Hilton spun off its timeshare business and the majority of its owned assets earlier this year. Fitch would view a spinoff of Wyndham's timeshare segment as a net positive for its business risk profile, with reduced business diversity offset by the reduced volatility and capital intensity of the remaining businesses. Fitch would be less positive if Wyndham Destination Network were to be spun off, as the segment is an attractive fee-for-service business that compliments its other hospitality businesses and adds diversification. Change of control provisions in its bond indentures and the limited leveragability of its timeshare business mitigate the event risk from an LBO. Wyndham has also stated its interest in expanding its lodging and vacation rentals businesses through strategic (and possibly large, transformative) acquisitions. The company has publicly expressed 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. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Wyndham include: --U.S. lodging industry RevPAR growth remains slightly positive (low single digits) through the one-to-two year Rating Outlook horizon; --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 increased tour flow and moderate volume per guest improvement; --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. 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 Dec. 31, 2016. -- Wyndham's off-balance-sheet 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 16.5%, 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. However, Fitch does not expect this to occur. LIQUIDITY At Dec. 31, 2016, Wyndham had cash of $185 million, $1.1 billion of availability under its corporate revolving credit facility (net of commercial paper letters of credit), and $366 million of availability under its two-year vacation ownership conduit facility underpinning 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 recent recession, although transaction terms were much less favorable than in the current financing environment. The company has a $450 million senior notes issuance due in March 2018, but has no other significant debt maturities during the next four years. The company had $476 million in CP outstanding as of Dec. 31, 2016 and used availability under its CP program to redeem $300 million of senior notes subsequent to year-end. Fitch expects the company to pay down outstanding CP using proceeds from its recent $700 million senior unsecured notes issuance. FULL LIST OF RATING ACTIONS Fitch affirms the following ratings: Wyndham Worldwide Corp. --Long-term IDR at 'BBB-'; --Short-term IDR at 'F3'; --Senior unsecured credit facilities at 'BBB-'; --Senior unsecured notes at 'BBB-'; --Senior unsecured CP at 'F3'. Wyndham Global Finance PLC --Senior unsecured CP at 'F3'. Contact: Primary Analyst Stephen Boyd, CFA Senior Director +1-212-908-9153 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Michael Paladino, CFA Managing Director +1-212-908-9113 Committee Chairperson John C. Culver, CFA Senior Director +1-312-368-3216 Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email:; Hannah James, New York, Tel: + 1 646 582 4947, Email: Date of Relevant Rating Committee: March 28, 2017. Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to exclude non-cash stock-based compensation expense, restructuring costs, executive departure costs and impairments. --Fitch's adjusted leverage calculation excludes non-recourse timeshare debt from total debt and excludes related financing income from EBITDA. Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1021286 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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