Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDR) for Hilton Grand Vacations, Inc. (HGV) and Hilton Grand Vacations Borrower LLC at 'BB-'.
The ratings reflect HGV's strong competitive position as one of the largest timeshare operators and its strong profitability and cash flow profile.
Fitch expects HGV will restore leverage back below Fitch's negative leverage sensitivity during FY 2024 through continued EBITDA growth. However, the Rating Outlook remains Negative given the increasing macroeconomic headwinds and cyclical nature of the timeshare industry. Fitch could stabilize the Outlook should the strong recovery in HGV's cash flows continue (or Fitch has a higher degree of confidence it will continue) and drive faster de-levering.
Key Rating Drivers
Timely Post-M&A De-levering: Should timeshare sales continue to show strength through 2023, Fitch expects HGV to reduce its leverage (total adjusted debt/operating EBITDAR) to 5.0x by FY 2024. Fitch's leverage calculation excludes HGV's net interest margin from timeshare financing and the related non-recourse debt but includes an adjustment to ensure proper capitalization of the company's captive finance operations. The forecasted deleveraging results from a combination of EBITDA growth and Fitch's belief that there will be excess readily available cash to allow for Fitch's captive finance adjustment to be partially reflected as a reduction to readily available cash rather than an increase in gross debt.
HGV has a public leverage target of 2.0x-3.0x net debt to adjusted EBITDA (company-defined), which includes financing income and nets the gross debt with cash, securitized debt, and gross receivables eligible for securitization. HGV's closing pro forma leverage post-Diamond Resorts acquisition in 3Q21 was 6.5x and HGV originally intended to reduce leverage to sub-3x within 24 months. Due to faster-than-expected EBITDA growth and some cost synergies, HGV is well within its own leverage sensitivities and has reduced its defined leverage to 2.1x at 2Q22.
Cash Flows Rebounding Quickly: Fitch expects HGV's total revenues to grow through fiscal 2023 due to a combination of vacation ownership interest (VOI) sales growth, higher tours flow, improving volume per guest (VPG), and increasing occupancy rates. HGV generates a substantial portion of its revenues from recurring sources (46% in fiscal 2021) including consumer financing, club management, and rental and property management fees. Fitch expects HGV to generate substantial FCF in the medium term due to limited development spend under its 'just-in-time' model and modest inventory spend.
Recovery Meeting Expectations: HGV's domestic resorts ended 2Q22 with occupancies in line with or better than 2019 levels, while international resorts occupancies continue slowly rebounding given travel challenges and, to a lesser extent, customer risk aversion. Additionally, HGV's provisions for loan losses and default rates in fiscal 2021 were in line with fiscal 2019 levels, reflecting its focus on targeting higher-FICO score customers and improved performance of its notes receivable portfolio.
Increasing Focus on New Buyers: Fitch positively views HGV's increasing focus on new owner sales, and expects new owner sales as a percentage of total sales to grow to more than 35% through 2025. New buyers, who contributed 30% of HGV's 2Q22 revenues, are particularly important in the timeshare industry as companies rely heavily on existing owner purchases for revenue. New buyers bring lower VPG but are still profitable because of the relatively low tour cost, commission structure, and the fact that new owners tend to come back and purchase more points in the future.
Inflationary Risks Manageable: Fitch's assumptions for the timeshare industry include a heightened level of inflation and an increasing prevalence of recessionary risks. However, Fitch expects inflation risks to be manageable for the timeshare industry, and for HGV, specifically. Rising inflation can improve the value proposition for timeshare properties relative to the increased cost of alternative products such as hotels and vacation rentals. Moreover, wages and other expenses at the property level are borne by the homeowners' associations and HGV's marketing and sales positions are commission based. Finally, Fitch expects inflation to have a limited impact on HGV's development spending as the issuer has no material construction projects underway and has ample excess inventory on its balance sheet with the ability to reacquire low cost inventory.
Well Positioned in a Competitive Industry: HGV is the second largest timeshare operator based on owner families, which provides some economies of scale and facilitates third-party marketing relationships. HGV is well positioned within the high-end spectrum of the timeshare industry and has a diversified portfolio of vacation ownership brands. Furthermore, the integration of Diamond Resorts further broadens HGV's addressable market through an expanded regional network in the U.S. as well as a wider range of products and price points. Finally, HGV has exclusive rights to the Hilton name for the timeshare business on a 100-year license and has access to 118 million members in the Hilton Honors program, which is one of the strongest loyalty programs in the industry. Loyalty programs are crucial for chains like Hilton, as these programs drive repeat business which translates into repeat selling opportunities in the timeshare industry.
Cyclicality of Timeshare Industry: The domestic timeshare market is mature, with above average economic cyclical sensitivity owing to the consumer discretionary nature of the product. During the Great Financial Crisis, industry-wide VOI sales declined over 40%, which exceeded most other Gaming, Lodging & Leisure sub-sectors' degrees of cyclicality. The industry has limited barriers to entry as well as a variety of competitive alternatives, including the rapid growth and adoption of alternative lodging accommodation businesses, such as Airbnb, Inc., Vrbo and FlipKey.
HGV's ratings reflect its strong position in the timeshare industry, its strong brand affiliation and network and its strong liquidity due to limited near-term debt maturities. The discretionary and cyclical nature of timeshare sales balance the ratings.
HGV is the second largest timeshare operator with approximately 720,000 owner families in its system. Travel + Leisure Co. (TNL; BB-/Negative) is HGV's closest peer with 900,000 owner families, followed by Marriott Vacations Worldwide (VAC) with 700,000, Holiday Inn Club Vacations with 345,000 and Bluegreen Vacations Holding Corp. with 220,000.
HGV's revenues are less diversified than TNL's and VAC, which own the Resorts Condominium International and Interval International timeshare exchange networks respectively. Fitch notes that HGV has historically operated with lower leverage than TNL and VAC, but expects HGV will operate with leverage more in line with peers post the Diamond acquisition. HGV's net leverage targets pre-acquisition and post-acquisition are 1.5x-2.0x and 2.0x-3.0x, respectively.
Fitch rates the IDRs of the parent and subsidiary on a consolidated basis using the weak parent/strong subsidiary approach and open access and control factors - based on the entities operating as a single enterprise with strong legal and operational ties.
Under Fitch's Corporate Rating Criteria treatment for corporate issuers with captive finance subsidiaries, Fitch calculates an appropriate target debt-to-equity ratio for the finance subsidiary based on its asset quality, funding, and liquidity. If the finance subsidiary's target debt-to-equity ratio, based on Fitch's calculations, is lower than the actual ratio, Fitch assumes that the parent injects additional equity into the finance subsidiary to bring the debt-to-equity ratio down to the appropriate target level. Fitch's Corporate Rating Criteria assumes that the corporate entity (HGV) funds the capital injection either by an increase in gross debt, a reduction in cash, or a combination of the two. On an as-reported basis, Fitch considers the effect of this equity injection in its analysis of HGV's credit profile vis-a-vis an increase in gross debt.
For HGV's captive finance subsidiary, Fitch calculates an appropriate target debt-to-equity ratio of 1.0x, which is below the actual ratio as of FYE 2021. As a result, Fitch makes an adjustment by adding $649 million of non-recourse timeshare receivable debt to its adjusted leverage calculation for HGV. This represents the capital injection needed to bring its captive finance subsidiary's debt-to equity ratio down to 1.0x.
Given the strong FCF profile of HGV, Fitch expects cash will accumulate through the forecast years above an assumed $300 million minimum amount required for operations through the cycle. HGV has averaged cash and cash equivalents of around $300 million at each reporting period post-pandemic and post-Diamond acquisition. On a forward basis, Fitch assumes HGV will build readily available cash with retained FCF after assumed share buybacks, net working capital requirements and net acquisitions.
Fitch allocates a portion of the captive financing debt adjustment as a reduction to cash ($132 million), which considers Fitch's view of HGV requiring $300 million of estimated minimum operating cash. The remaining $517 million is allocated as an increase in debt and held constant through the forecast horizon. Given HGV's strong underlying free cash flow profile and limited near-term traditional debt maturities, Fitch assumes the majority of FCF will be allocated towards shareholder returns.
Revenues and net VOI sales reach approximately 175% and approximately 250% of fiscal 2019 levels by 2025, respectively, due to a combination of the Diamond Resort integration and a recovery in timeshare industry fundamentals;
EBITDA margins maintained in the 23% to 24% range through 2025;
Inventory spend of $200 million annually through 2025;
Share buybacks of $250 million annually through 2025;
No material acquisitions or dispositions occur through 2025.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Adjusted Debt to Operating EBITDAR sustaining below 4.0x;
Greater cash flow diversification by brand and/or business line;
Evidence of through-the-cycle sustainability in the company's capital-light inventory sources such that it does not materially affect HGV's financial flexibility and operational strategy.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Adjusted Debt to Operating EBITDAR and FCF/Debt above 5.0x and/or lower than 5.5%, respectively;
Severe disruption in the ABS markets such that HGV needs to provide material support to its captive finance subsidiary;
Material decline in profitability, leading to EBITDAR margins sustaining around 15%;
Consistently negative FCF.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Strong Liquidity Profile, Limited Near-Term Debt Maturities: At 2Q22, HGV has $374 million in cash and cash equivalents on hand, and $824 million of available capacity, net of letters of credits, under its $1.0 billion revolving credit facility. The strength of HGV's liquidity profile is further driven by a lack of meaningful near-term debt maturities.
Since HGV is reliant on the asset-backed securities (ABS) market to help fund its timeshare customer lending activities, Fitch notes that a significant economic downturn resulting in tightened credit markets could pressure HGV's securitization market access and potentially require the company to provide support to its finance subsidiary. This risk is mitigated by the company's annual extension of its two-year $750 million receivable securitization warehouse facility, which HGV upsized from $450 million, in May 2022. HGV also has a conduit facility with a borrowing capacity of $125 million that matures in 2023.
At 2Q22, HGV has $874 million of available liquidity across its warehouse and conduit facilities, which should provide sufficient liquidity to finance the sale of VOIs through 2023. HGV has already completed two separate securitization transactions through August 2022. HGV completed a $246 million securitization of vacation ownership loans in April 2022 at a weighted average interest rate of 4.30% and an advance rate of 95%. HGV also completed a $269 million securitization transaction in August 2022 at a weighted average interest rate of 4.83% and an advance rate of 96%.
Hilton Grand Vacations, Inc. (NYSE: HGV) is a global timeshare company that develops, sells and manages timeshare resorts under the Hilton Grand Vacations brand. HGV's operations consist of selling vacation ownership interests (VOIs), financing and servicing loans provided to consumers for their VOI purchases, operating resorts, and managing its points-based exchange programs.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg