Monday, May 13, 2013

V.F.Corp Continues to Find Growth

V.F. Corp is one of those infuriating stocks that never seems to be cheap precisely when you want it to be. The latest set of results kept up its tradition of raising EPS guidance even if the revenue numbers were far from stellar. Indeed the key takeaway from these results was the margin improvements achieved within difficult end markets. This is one of the best run stocks in the retail sector, but it faces some headwinds in 2013. Is it good value right now?

V.F. Corp Prospects and Challenges

With its key brands of The North Face, Vans, and Timberland the company has benefited from the trend towards wearing outdoor sports clothing as a kind of fashion statement. I doubt that most people wearing mountaineering or hiking clothing have ever been on a climb or a trail. Moreover wearing Vans and listening to Sonic Youth doesn’t necessarily qualify you as bona fide skate boarder, but who cares as long as it adds to the bottom line of the company’s numbers.

In order to explain how Timberland makes money here is a breakdown of its segmental profits in Q1. The key brands are in the outdoor & action sports wear division.

Throughout 2013 the company is going to be faced with the following challenges

  • Timberland’s has significant exposure to Europe and markets like Italy and Spain are some of its biggest existing markets. Fortunately, Vans and The North Face were ‘built out’ of Northern Europe.

  • J.C. Penney is a key retail channel and in particular with Lee jeans and Vans. The difficulties with the department store and ongoing restructuring efforts could affect sales generation.

  • It’s Chinese operations haven’t performing great and it is a key part of its international expansion plans

  • In general the mid-market consumer is challenged in the current environment. It offers neither the income secure spending of the high end or the potential to benefit from trading down by the mass market.

Of course much of this known and the plan to deal with challenging markets is to expand its direct to consumer (DtC) sales via increasing the number of stores and investing in e-commerce facilities. Indeed DtC made up 21% of revenues in 2012 and are expected to rise to 23% in 2013.

What makes V.F. Corp different is that its diverse set of brands, channels and end-markets allow it to select areas in which to focus to generate growth through the cycle. Moreover its brands benefit from some secular fashion trends (as discussed above) whereas a company like The Gap $GPS is more exposed to general macro trends. Indeed, The Gap has had to completely restructure its business and separate its three brands (The Gap, Old Navy and Banana Republic) into three global entities. The idea being that this will create the ability to focus and innovate in order to drive growth. Note the difference here, The Gap is trying to innovate its brands to make the ‘cool’ while V.F. Corp is innovating in its sales channels. I’d argue that the latter is easier to do.

The J.C. Penney question is an uncertain one. The store has been hit hard by consumer spending changes and a misguided strategy of promising lower prices in general instead of the kind of discounting and promotional activity that the rest of the sector has been using. Whether the restructuring will work is open to question and it’s something to consider for V.F. Corp shareholders.

Q1 Performance

We can see how well V.F. Corp is run by looking at the profit margin movements in the quarter.

Margins were the real story this quarter because overall revenue growth was only up a paltry 2.2% and significantly below the 6% target for the full year. EPS was ahead of expectations and full year guidance was raised to $10.75 from $10.70 previously.

The standout performers in the quarter were the North Face and Vans which increased revenues 6% and 25% respectively. Moreover they achieved growth in the DtC channels of 25% and 20% respectively. As for the troubled region of Europe, The North Face recorded ‘modest’ growth while Vans rose an incredible 30%.

As discussed earlier the problematic brands in 2013 are likely to be Timberland and Jeanswear. Timberland revenues were up only 2% and flat in the Americas. Fortunately mid-teens increases in Asia managed to offset mid-single digit declines in Europe.

Where Next For V.F. Corp?

As I write the stock trades on 16.3x forward earnings. It is certainly not the cheapest stock out there and it has some headwinds to meet in 2013. With that said some of its brands are recording very strong growth and the DtC expansion is very impressive.

The problem with buying the stock up here is that I get the sense that all the positives are priced into it already and as good as the management are, the target of 6% growth for 2013 when only 2.2% was achieved for Q1, raises more questions than answers. Cautious investors will want to monitor events here and wait for a more favorable risk/return proposition.

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