VF Corp. (VFC) is an outdoor fashion and equipment company that owns famous brands such as Vans, North Face, Timberland and Dickies. Revenue from these brands accounted for 88% of net revenue in fiscal 2021, with Vans and The North Face being the main revenue drivers:
As VFC’s products are sold primarily through retail stores (but also through direct-to-consumer channels), the company’s revenues and profits have been particularly hard hit by the pandemic. Like most stocks, VFC shares also staged a massive comeback after falling around 50% in early 2020 as traders and investors looked past the pandemic. Shares peaked in May 2021 at around $90, valuing the company at a fairly high forward P/E ratio of 28. However, as headwinds of inflation became apparent, shares began to decline and currently sit around $66, pricing the stock at a more palatable forward P/E of 21.
Given this fairly large selloff, it seems worth considering whether the stock was indeed overvalued in May 2021 or if VFC’s growth engine is indeed running full steam ahead and investors should consider taking a position.
VFC changed its fiscal year end in 2018 from December to March. Nonetheless, I think the long-term revenue trend is significant, as only the 2017 and 2018 numbers are slightly skewed. As a result, VFC’s revenue has not increased since at least 2015 (see below). It should be noted, however, that VFC divested its jeans company Kontoor Brands (KTB) in May 2019 (Wrangler, Lee and Rock & Republic).
Although the revenue growth in fiscal year 2022 looks phenomenal, this is naturally mainly due to the world having “reopened” after the pandemic. On a two-year basis, growth still looks excellent with an annualized compound annual growth rate (CAGR) of 6.7%. However, this includes approximately $600 million in sales from Supreme Holdings Inc., which was acquired in December 2020 (Q4 2021 Earnings Call and p. 23, 2021 10-K) for about $2.3 billion. Accounting for the acquisition results in a CAGR of approximately 4.8%. Supreme is expected to grow at a near-term rate of around 8-10% in terms of revenue.
VFC’s main growth driver is its expansion into China. In fiscal 2021, Greater China revenue grew 24% (p. 32, 2021 10-K), but it should be emphasized that this growth rate is – in part – the consequence of the fact that China was hit by the pandemic earlier than the Western world. Still, the company’s China business topped revenue by $1 billion, beating management’s long-term plan targets (Q4 2021 earnings call).
Overall, VFC’s long-term sustainable revenue growth is difficult to gauge, but I find it unwise to assume a short-term growth rate of more than 5% over the next ten years. In the long term, I assume a growth rate of 2.5%, which might be conservative for VFC, but I generally prefer to err on the side of caution. This also seems reasonable when looking at VFC’s past growth in terms of normalized free cash flow (FCF), which has remained essentially flat over the past decade. Note that I always normalize FCF for recurring impairment charges, stock-based compensation expenses, and atypical movements in working capital. VFC’s capital expenditures of around $275 million per year, also taking into account recurring software purchases, are quite substantial. On a normalized basis, the company generates an annual FCF of $800 million.
Morningstar classifies VFC as a “Narrow Moat” company, which seems appropriate in my view, given the company’s well-known brands that account for nearly 90% of revenue. Nevertheless, the fashion industry is fiercely competitive and brand loyalty remains limited, especially with non-luxury or highly exclusive brands.
VFC’s operating margin of around 12% is quite good and slightly above the industry median of 10%. Similarly, in terms of net margin, VFC is among the industry leaders. However, its conversion to FCF of around 64% is quite low and this should be kept in mind, especially by income-seeking investors who intend to acquire stocks due to the growth of stocks. dividends.
The company’s return on invested capital (ROIC) of 15% is certainly acceptable for a fashion company. Given VFC’s fairly low FCF conversion, its cash return on invested capital appears quite low at 8%. Assuming a cost of equity of 10%, which results in a weighted average cost of capital of 8.6%, the company is a net creator of shareholder value with an excess ROIC of 6%.
Balance sheet quality and dividend security
VFC engages in mergers and acquisitions and also divests or spins off businesses (see above) from time to time. As a result, the rather large amount of goodwill ($2.4 billion at the end of FY2021) in terms of equity, currently 79%, appears understandable. The company had to recognize goodwill and intangible asset impairment charges of $20.3 million and $323 million in fiscal years 2021 and 2020, respectively. The largest impairment charge related to the company’s Timberland business unit.
Overall, I consider VFC’s track record quite weak, but still acceptable. Altman’s Z-Score (weighted by coefficients proposed by PJ Waites in 2014) currently sits at 3.4 and does not signal a problem. However, the company’s debt ratio seems high at 3.5. As VFC carries significant debt on its balance sheet and its conversion to FCF is low, it would currently take the company 7 years to repay its financial debt if all of the FCF were directed to deleveraging. Similarly, VFC’s interest coverage ratio in terms of normalized FCF before interest is quite low at 7x.
Prior to the pandemic, VFC regularly made large share buybacks (i.e. $1 billion in some years), and as a result, the company’s leverage ratio (net debt to EBITDA) of 3 .3 at the end of fiscal year 2021 seems understandable, but not particularly acceptable.
VFC is often touted as a dividend growth stock. The shares are currently yielding 3.0% and the long-term CAGR is very respectable at 11.4%. However, the rate of dividend growth has slowed significantly in recent years, which seems understandable given VFC’s balance sheet and the near-non-existent growth in FCF. Going forward, I don’t expect VFC’s dividend to grow at a double digit rate, but probably a bit slower than its revenue growth, given the lower FCF conversion to the average of society. A long-term growth rate of 3% therefore appears reasonable, especially since the current payout rate in normalized FCF is above 90%.
Taken together, VFC’s record is certainly nothing to write home about. Considering that VFC sells consumer discretionary and exhibits cyclical behavior, I find the company’s low interest coverage ratio particularly concerning. I’d like to see management direct cash flow toward deleveraging and not prioritize stock buybacks, which are typically done to offset stock-based compensation dilution and to increase earnings per share.
Evaluation and conclusion
As already mentioned in the introduction, VFC shares have sold off considerably since the peak in mid-2021, mainly due to investors pricing in inflationary headwinds. On a forward-looking basis, VFC is currently (January 28, 2022) trading at a P/E ratio of 21, which is still quite high but fairly normal for VFC. Historically, the company’s shares change hands at a P/E of around 24, so shares can be bought at a 15% discount today. Still in terms of historical P/S ratio, VFC appears slightly undervalued. However, based on my own assessments of fair P/E and fair P/S, given the company’s market position, growth prospects and balance sheet, I still consider that the stock is overvalued. A DCF calculation also suggests significant overvaluation, even assuming an annualized FCF growth rate of 5% over the next ten years. Assuming a cost of equity of 10%, investors willing to buy the stock at $66 expect the company to grow its FCF at a terminal growth rate (!) of 7%.
From the perspective of income-oriented investors, equities are slightly undervalued at a 3% dividend yield. However, since I don’t expect the dividend to grow more than 3% per year, stocks don’t seem like a good investment for dividend growth investors. After ten years, the return on cost would still be only 4%, assuming a CAGR of 3%.
However, given that VFC stock has always been a premium company in terms of valuation, I wouldn’t be surprised to see the stock price rebound off that seemingly stable support at $66 following the release of positive results. Overall, I suspect it will be difficult to acquire VFC shares below their intrinsic value and it would likely take significant external events (such as March 2020) to drive the shares to a level where a position long would be promising.
Thank you for taking the time to read my article. If you have any comments or reviews to share, I’m happy to hear from you in the comments section below or via private messaging. Also, if you have any questions regarding the calculation of any of the measurements presented, I will be happy to answer them as well.