V.F. Corp (VFC): A Fast-Growing Dividend Aristocrat That Could Be On Sale

Dividend aristocrats, those 51 companies in the S&P 500 that have raised payouts for 25+ consecutive years, often make excellent starting places to look for high-quality, long-term investments.

 

However, a common problem is that many dividend aristocrats are very large, slow growing blue chips that are so well known that they often trade at premium valuations.

 

One exception could be V.F. Corp (VFC), a less famous dividend growth legend but one of the fastest-growing members of this venerable group.

 

In fact, in addition to 44 uninterrupted years of dividend increases, VFC’s rate of dividend growth has been among the best of any dividend aristocrat, 18.5% annually over the past 30 years.

 

Wall Street is highly bearish on the stock right now because of the company’s retail focus, so let’s see if V.F. Corp could be one of the few undervalued dividend aristocrats worth buying today.

 

Business Overview

Founded in 1899 In Greensboro, North Carolina, V.F. Corp is a leading global lifestyle apparel maker in the outerwear, footwear, denim, backpack, luggage, accessory, sportswear, occupational, and performance apparel categories.

 

It operates 30 manufacturing facilities and 46 distribution centers around the world, serving customers in 62 nations. The majority of the business is sold on a wholesale basis to retailers, but the company also owns 1,500 retail stores that market its roughly 30 iconic brands, including five with sales of over $1 billion per year.

 

 

In 2016. U.S. sales made up 62% of revenue with the rest coming from Europe and Asia.

 

Business Analysis

In order to pay fast-growing dividends for nearly half a century, V.F. Corp needs to have a steadily growing business and a number of competitive advantages.

 

First, many of the company’s largest brands have carved out leading mindshare with consumers in their respective product categories because they have delivered quality for so many years – The North Face (1966), Vans (1966), Timberland (1973), Lee (1889), Wrangler (1947), Eastpak (1952), Red Kap (1923), Nautica (1983), Jansport (1967).

 

Strong brands help V.F. Corp charge more for its products and maintain prime shelf space with retailers (i.e. retailers need VFC’s products to draw in traffic – consumers expect them to have North Face, etc., and might shop elsewhere if they don’t carry it).

 

While V.F. Corp has had to evolve its products’ designs and marketing strategies over the years, its long-standing brand recognition and successful relationships with retailers (there is only so much shelf space for each product category) serve as major competitive advantages.

 

To stay relevant, V.F. Corp invests significantly in advertising (over $675 million in 2016, representing over 5% of sales) and consumer research. V.F. Corp realizes that developing a deep understanding of consumers’ needs must be at the core of how it designs and markets products to win customers’ loyalty.

 

Over the past five years, for example, V.F. Corp has conducted thousands of in-person interviews and surveyed more than 125,000 people in 15 countries to gain better consumer insights.

 

The best brands create strong, emotional connections with consumers, and VFC has proven time and again to excel at this objective.

 

V.F. Corp’s supply chain is another advantage. The company produces more than 500 million units of apparel, footwear, and accessories every year, representing hundreds of thousands of combinations of style and color. Over 29,000 of V.F. Corp’s employees support supply chain activities, and retailers require timely fulfillment of quality products that will sell.

 

Unlike some of its competitors, V.F. Corp also manufactures roughly 25% of its own products (the other 75% are outsourced to third parties). Products manufactured in VFC’s own facilities have lower costs and shorter lead times.

 

The company’s scale and in-house work helps it maintain very competitive production costs and supply chain reliability that smaller players would struggle to match.

 

The company’s exceptional and long-term focused management team has clearly spent decades carefully acquiring and expanding its portfolio of active lifestyle brands that successfully compete in a global market that represents $515 billion in annual sales, according to Morningstar.

 

For example, the company’s iconic Wrangler jeans have the largest market share in its industry at 23%.

 

Of course, because the apparel and retail industry is highly discretionary and marked by changing fashion tastes over time, sales, earnings, and free cash flow growth have their ups and downs.

 

 

V.F. Corp cut its guidance last year as it continued struggling with falling traffic at U.S. department stores and combatted sales declines in its core denim and sportswear categories, which were perhaps driven by changing consumer fashion trends (e.g. the shift from jeans to yoga pants).

 

While Wall Street has been focused on the company’s relatively poor recent top and bottom line growth and lack of homerun acquisitions (VFC’s last large deal was its $2 billion acquisition of boot maker Timberland in 2011), investors need to keep in mind that part of running a successful apparel company means managing the brand portfolio.

 

For example, VFC sold its contemporary brands coalition in 2016 for $120 million in order to focus on faster-growing and higher-margin business lines, especially the action sports business. This partially explains the poor sales performance in 2016.

 

However, we need to remember that VFC has a very good track record of not only focusing on the most iconic brands but also in strong overseas expansion, especially in fast-growing emerging markets such as China, where the middle class is expected to expand by 300 million people by 2021.

 

VFC Q1 2017 Results

 

So while VFC’s core U.S. business may be growing very slowly, the company has been  successful in winning market share abroad, as well as with professionals, who generally tend to be less price sensitive and more brand loyal.

 

Just as important, its direct-to-consumer (DTC) business, which accounted for 28% of 2016 sales, is growing strongly, especially the digital (i.e. online) unit.

 

This means that VFC’s business is likely doing reasonably well competing with Amazon (AMZN), and its business should be able to adapt to the rise of e-commerce that is proving to be such a disruptive force for many other traditional retailers.

 

In fact, management’s goal is for DTC to account for $4.4 billion, or about 35%, of total sales in 2017. This not only shows that VF Corp can likely continue growing into the future, but also with a smaller emphasis on brick and mortar stores, which means the company’s margins could remain relatively high (for an apparel maker).

 

 

In fact, thanks to V.F. Corp’s highly diversified but efficient supply chain and growing economies of scale, the company has some of the best margins and returns on shareholder capital in the industry.

 

 

Going forward, management has outlined a long-term growth strategy it calls V.F. Corp 2021, which is focused on four key aspects.

 

 

Specifically the company is looking to optimize its advertising into its top selling, fastest growing, and most profitable brands, notably its outdoor and actions sports lines such as Timberland, Vans, and North Face.

 

In addition, the company plans a more aggressive push into Asia, especially China, which is by far its fastest growing and largest potential market.

 

Next V.F. Corp will work towards increasing its DTC business, thus moving away from wholesale retailers with aggressive investment into its online sales channels.

 

Finally, the company plans to continue optimizing its economies of scale in its supply chain and manufacturing base to help achieve further long-term margin improvement.

 

In fact, by 2021 V.F. Corp believes it can achieve:

• 4% to 6% sales growth
• Gross Margin expansion to 51.5%
• Operating Margins of 16.0% (almost double today’s figure)
• EPS and FCF per share growth of 10% to 12% a year

 

Overall, V.F. Corp’s reputation for quality, strong portfolio of brands, long-standing relationships with retailers, and skill in navigating a competitive landscape marked by constantly evolving consumer preferences form the foundation of its successful business.

 

Key Risks

There are three main risks to focus on with V.F. Corp.

 

First, all apparel makers are ultimately at the mercy of fickle consumer tastes, especially when it comes to high priced clothing. For example, North Land parkas often sell for $289 while Vans sneakers usually retail for $60 and up.

 

Thus V.F. Corp’s future growth potential relies on U.S. and increasingly global consumers remaining loyal to its brands and being both willing and able to afford its high-margin merchandise.

 

Similarly, increasing consumer preferences for experiences over goods and digital shopping has made for a challenging brick-and-mortar retail environment, especially in apparel.

 

If consumers were to lose interest in the outdoor, action sports, and jeanswear apparel categories, which account for nearly 80% of V.F. Corp’s revenue and contain the firm’s biggest brands, the company’s growth plans would be challenged.

 

While these are certainly clothing mainstays, consumer preferences could still evolve within these categories and favor new brands or styles that emerge.

 

It wouldn’t hurt if VFC had greater brand and product category diversification, but the company’s existing brands have shown remarkable durability over many decades of time. Risk is also mitigated somewhat by management’s ability to grow or acquire new brands and plug them into the company’s existing distribution network.

 

Another risk to consider is currency fluctuation, especially the risk of a strong dollar, which can act as a headwind to the company’s overseas growth efforts.

 

That’s because VFC’s sales abroad are in local currency,  so if the dollar strengthens than those local sales convert to fewer U.S. dollars for accounting purposes.

 

In addition to currency fluctuations, V.F. Corp’s business can be affected over the short-term by shifts in consumer spending, weather, raw material costs (e.g. denim), and inventory management issues. However, none of these risks seem likely to threaten the company’s long-term earnings power.

 

Finally, realize that, historically, V.F. Corp’s strong growth has come on the back of disciplined, well executed, and sizeable brand acquisitions.

 

However, going forward there is no guarantee that management will be able to locate sufficiently high-quality and profitable buyout targets to continue this trend.

 

As a result, the company might end up falling short of its growth targets, which would likely mean slower dividend growth and poorer total returns going forward.

 

V.F. Corp’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

V.F. Corp has a Dividend Safety Score of 85, suggesting that it has a highly secure and dependable dividend compared to most other stocks in the market. That’s not surprising given that V.F. Corp has been steadily increasing its dividend at a double-digit clip since 1973.

 

This impressive combination of both high dividend security and fast, steady growth is courtesy of two main factors.

 

First, management is very disciplined in growing the dividend, making sure to keep its EPS and FCF payout ratios low enough (below 60% each year) to ensure a very comfortable safety cushion in the event of unexpected economic downturns, such as occurred in 2008-2009.

 

 

The next major protective factor is management’s wise approach to debt, resulting in a very strong balance sheet. This is important for two reasons.

 

First, low debt levels mean that during periods of economic and/or industry distress, V.F. Corp has the financial flexibility to make opportunistic acquisitions at highly profitable (i.e. low) prices without needing to sacrifice its payout.

 

The second is that the apparel manufacturing industry is moderately capital intensive, as well as cyclical, meaning that overleveraged apparel firms can run into trouble servicing their debts and short-term obligations during recessions.

 

Fortunately, VF Corp’s low debt levels, strong cash position, and very high current ratio (short-term assets/short-term liabilities) mean it is able to survive such downturns without having to divert cash flow from its dividend.

 

 

The company’s financial strength is especially apparent when we compare its debt metrics to its peers.

 

 

When we do, we can see that V.F. Corp has a much lower leverage ratio (Debt/EBITDA) and a very high interest coverage ratio. This explains its very strong investment grade credit rating, which allows it to borrow at very low interest rates of just 2.8%.

 

Overall, V.F. Corp’s dividend payment is about as reliable as they come. The company consistently generates free cash flow, maintains a conservative balance sheet, and has healthy payout ratios.

 

V.F. Corp’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

V.F. Corp’s Dividend Growth Score of 70 indicates that the company appears to have above average dividend growth going forward. This isn’t surprising given the company’s historically strong rates of payout increases, which have averaged in the double-digits annually over the last two decades.

 

 

Given the current payout ratios, which are optimized for fast growth while retaining a high safety margin, investors should expect V.F. Corp’s future dividend growth to closely align with EPS and FCF per share growth.

 

And given that management believes that its growth plans, including revenue growth of 4% to 6%, strong margin expansion, and steady 1% to 2% annual buybacks, should allow for 10% to 12% annual EPS growth in the future, this is approximately the rate of dividend growth that investors can anticipate as well.

 

Valuation

Over the past year, concerns about retail stocks have caused VFC shares to underperform the S&P 500 by about 15%. However, that means today could be a reasonable time for long-term investors to give the stock closer consideration.

 

Despite VFC’s underperformance, the stock’s forward P/E ratio of 20.4 is higher than the S&P 500’s forward P/E of 17.8 and the industry median of 20.1. It’s also greater than the company’s 13-year median P/E of 18.

 

However, valuation looks more appealing on a dividend yield basis. That’s because the current yield of 2.7% is both greater than the S&P 500’s 1.9% and the industry median of 1.6%. More importantly, it’s  higher than the stock’s historical norm of 2.4%.

 

In fact, over the past 22 years VFC’s dividend yield has only been greater than it is today about 30% of the time, perhaps reflecting investors’ expectations for slower rates of growth ahead as V.F. Corp navigates an increasingly challenging retail environment.

 

With that said, today’s share price could provide long-term investors with annual total returns of 12.7% to 14.7% (2.7% dividend yield plus 10% to 12% annual earnings growth) if management’s expectations prove true.

 

That is one of the highest potential total returns of any dividend aristocrat, but it is far from a guarantee.

 

Conclusion

Few industries can be as hard to invest successfully in as retail, thanks to unpredictable fashion trends, the cyclical nature of the business, and the potential disruptive threat of e-commerce.

 

However, V.F. Corp has proven its long-term, conservative approach to investing in a portfolio of top brands, overseas market expansion, and online sales makes it one of the few retail-focused firms that dividend growth investors can likely count on for continued income growth and reasonable total returns.

 

While VFC’s valuation doesn’t look like a bargain today, especially if retail apparel headwinds intensify in the company’s core categories, the stock is an interesting one for contrarian dividend growth investors to consider.

 

That’s especially true with shares offering some of their highest yield in years. Investors seeking more income can consider some of the best high dividend stocks here instead.