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Using your Discretion: Value in VF Corp

Posted on: September 16, 2008 - Email Article - Printable Version

Adam Brown

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Of all the sectors in the S&P, the Consumer Discretionary sector is the most prone to economic sensitivity. A look back at the past several economic downturns reveals the discretionary sector as consistently one of the worst hit. Intuitively this makes sense, as the consumer is quick to cut out purchases they deem nonessential. A good way to look at the sector: ‘When it rains, it pours.’ As of late, the U.S. economy has not seen a drop, putting the Consumer Discretionary sector in a drought. And not without good reason. The sector contains some of the least recession-proof industries: home builders, auto makers, gaming, specialty retailers, etc. The Consumer Discretionary index is down 12% from a year ago, despite a recent jump upon the retreat of oil. With the rebate check stimulus coming to a close and consumer sentiment near all time lows, this sector will continue to struggle in the coming months.

VF Corporation

It has been my experience that in times of economic distress, the market tends to clump subsectors together and trade more from a macro-perspective. While a frustrating experience for an individual stock investor, a jittery market quickly curtails its risk tolerance. In my opinion, the most surprising development in the Consumer Discretionary sector during this credit crunch has been the markets’ continued discretion amongst branded apparel retailers. Over the past year we have seen Urban Outfitters [URBN: 15.19, 0.00 (0.00%)] trade up over 50%, while Abercrombie & Fitch [ANF: 24.58, 0.00 (0.00%)] is down ~30% year-over-year.

VF Corporation [VFC: 57.00, 0.00 (0.00%)] is a $9 billion market-cap designer, manufacturer and marketer of branded apparel. The company derives 72% of its revenues domestically, with a growing portion coming from abroad. VF Corp may not be the first name that comes to mind in the branded apparel market. However, a closer inspection of their brands (seen below) reveals several names familiar to the consumer. The stock is up ~30% over the past three months and presents an interesting opportunity in the Consumer Discretionary sector.

A Unique Business Model

VF Corp operates under a rather unique business model. Management classifies its business segments under two broad ‘Coalitions’: Heritage and Lifestyle. The Heritage coalition, including its Jeanswear and Imagewear brands, represents less discretionary products than the Lifestyle coalition. While the growth in this segment is lacking, it acts as a ‘cash cow’ by funding growth elsewhere in the company. The Heritage coalition accounted for 55% of the company’s total sales and 60% of its operating cash flow in 2007.

The Lifestyle coalition, taking advantage of steady free cash flow from the Heritage coalition, has been the source of growth for VFC over the past several years. The Outdoor brands (Northface, Vans, Reef, Eastpak) saw a 17% revenue increase in Q2FY08. Of particular note was Northface’s international revenue growth at 40%. For the second half of ’08, management has projected 15% revenue growth for the Outdoor brands. The Contemporary brands, while contributing a minimal 5.2% of revenues in the last quarter, continue to grow ahead of management’s expectations. While the Sportswear brands (Nautica, Kipling, John Varvatos) had revenues decrease 4.4% for Q2FY08; this represented an improvement over Q1FY08’s revenue decline of 11%. Despite the Kipling and John Varvatos brands seeing +30% increases, Nautica continues to weigh on this segment.

International Expansion

International revenues accounted for 28% of business in 2007. Management projects a 13% annual increase for this number over the next five years, making up a third of revenues by 2012. The drivers of the international growth are:

Positioning and marketing in Europe
Improved product offering
Extension of existing business in India, Russia and China

Of particular note is the expansion of the Jeanswear segment, which had a 13% increase in revenues for 2007 in international markets, including Europe, Canada, Mexico, Latin America and Asia.

Moving Forward

After releasing second quarter numbers, VF’s management provided some color for the second half of ’08. VF increased earnings growth expectations to 12% from 10% and raised its EPS guidance to ~$6.05. Revenues are projected to increase 9% on the year. Having met or exceeded analysts’ expectations the last nine quarters, management’s traditionally prudent approach should allow investors to take stock in these projections. The company’s balance sheet remains lean with $800 million in operating cash flow and a debt/equity ratio of 0.42. Additionally, management has committed to a hefty annual payout ratio of 40%, distributed to dividends and share buybacks.

While my commentary above may sound like a rousing call to snatch up shares of VF Corp, that is not necessarily the case. VFC trades at a forward P/E of 12.41x versus an industry average of ~14x. While I still think VFC is relatively cheap, analysts’ mean 1-year estimates of $95 a share may be a bit ambitious for the current retail market. If the stock dips below ~$77.00/share, I would say start buying. Until then, keep an eye on the branded retail market and trust the market’s continued ability to distinguish strong performers in this segment.

-Adam Brown

Disclosure: The mutual fund the author is associated with is long VFC

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