WGF is a wholly-owned subsidiary of Wyndham Worldwide Corp. through which the company issues commercial paper (CP) in
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 time share segments. The ratings also consider management's public commitment to maintaining 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.
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
Fitch's expectation is that management will continue to focus on asset-light alternatives in the timeshare segment (e.g. Wyndham Asset Affiliation Model [WAAM] 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.
The ratings reflect the company's strategic purchase and ongoing ownership of two hotel properties that are part of mixed-use developments that include lodging and timeshare. Fitch expects the franchising of its hotel brands to remain Wyndham's primary focus with hotel ownership representing a very small component of its overall strategy.
POSITIVE LODGING FUNDAMENTALS
Wyndham's lodging business primarily includes franchising midscale and economy hotel brands in the U.S. (roughly 80% of its room system at
Fitch expects Wyndham's RevPAR to grow slightly below the industry average rate at this stage of the lodging cycle, as hotels in the mid- to lower-end segments generally have less pricing power than ones in the upper-scale segments.
Strong occupancy rates and low supply growth are supporting greater pricing power within the U.S. lodging industry, in general. Supply growth has passed its trough, averaging 0.5% and 0.7% in 2012 and 2013, respectively. Fitch expects U.S. hotel supply to accelerate to 1.1% during 2014, but remain comfortably below the 2% annual industry average since 1988.
DIFFERENTIATED SEGMENT: EXCHANGE & RENTALS
Fitch views Wyndham's vacation exchange and rentals segment as a modest credit positive that distinguishes it from the traditional businesses of other high-profile lodging companies. 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. 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, it has a fairly flexible cost structure allowing for easier cost reductions during a downturn.
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.
Fitch views vacation rentals as an attractive fee-for-service business that complements Wyndham's other hospitality businesses from a longer-term perspective. The company has a strong competitive position, which should allow it to capitalize on consolidation opportunities in the fragmented rentals industry. Fitch expects smaller 'bolt-on' acquisitions to be Wyndham's focus, while acknowledging that consolidation may introduce some M&A risk.
HIGH EXPOSURE TO TIMESHARE
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
In Fitch's view, the WAAM model is more efficient with respect to capital allocation, but the level of risk taken by Wyndham has increased as the WAAM model has evolved. WAAM began as an opportunistic extension of Wyndham's timeshare sales and marketing platform whereby the company earned commission revenues for selling timeshare inventory owned and developed by unaffiliated third parties.
The most recent iteration of WAAM has Wyndham selling owned land and work in progress (e.g. existing inventory) to a third party that will finance and build the timeshare units under the company's supervision. Wyndham agrees to repurchase the inventory based on a prescribed takedown schedule.
Each WAAM deal has been somewhat idiosyncratic and future deal terms could change. Wyndham will also continue to develop timeshare resorts on its balance sheet. Longer term, Wyndham's goal is for approximately 50% of its run rate development spending to be WAAM deals.
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
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 recent management agreements with
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.
Fitch believes the company has attributes commonly associated with leveraged buyout (LBO) targets, such as a high FCF yield and a diverse set of operating business with varied cash flow profiles and return characteristics. This risk is heightened in the current accommodative credit environment.
However, 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 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. Market accessibility was better than Fitch's expectations through the recent recession, although transaction terms were much less favorable than the current financing environment.
Wyndham has no major debt maturities during the next four years. The company had
--Fitch has set Wyndham's core lease-adjusted leverage target at 3.25x with a cap of 3.5x for an IDR of 'BBB-', Stable Outlook. 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 3.4x as of
--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 21.3%, 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 has affirmed the following ratings:
Wyndham Worldwide Corporation
--IDR at 'BBB-';
--Short-term IDR at 'F3';
--CP at 'F3';
--Senior unsecured notes at 'BBB-'.
Fitch has assigned the following ratings:
--Short-term IDR at 'F3';
--CP at 'F3'.
Additional information is available at 'www.fitchratings.com'.
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (
--'2014 Outlook: Cross-Sector Lodging & Timeshare (The Penthouse View)' (
--'Inn the Footnotes: Comparison of Adjusted Credit Metrics and Contingency Risk for U.S. Lodging C-Corps' (
Inn the Footnotes: Comparison of Adjusted Credit Metrics and Contingency Risk for U.S. Lodging C-Corps
2014 Outlook: Cross-Sector Lodging & Timeshare (The Penthouse View)
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Source: Fitch Ratings
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