Tuesday, August 13, 2013

Why VF Corp Deserves to Trade at a Premium

Outdoor clothing company VF (NYSE: VFC) is one of the most compelling growth stories in the retail sector. Its mix of brands gives it the diversity to deal with a slowdown in any one segment, and many of its brands are under-penetrated within key growth markets. Here's why it deserves to trade at a premium to the rest of the retail sector.

VF raises guidance, again

In its latest second-quarter results, the company kept up its tradition of raising guidance, hiking its full-year EPS expectations by $0.10 to $10.85.  Moreover, it declared itself on track to hit its targets for the full year. The company’s aiming for 6% revenue growth, 13% in EPS growth, and marked improvements in margins and cash flow.

While all of this is good news, it's already priced into the stock. The real question: In a weak retail environment, how is VF reporting such good numbers? And can it continue?

Diversity helps VF to outperform

The first factor that distinguishes VF is that it has a range of brands in its portfolio. This gives it significant flexibility to deal with changing retail conditions.

A good comparison would be something like Nike (NYSE: NKE).  Michael Jordan’s favorite sportswear company is doing well at the moment, but this is largely due to outperformance in North America. Moreover, much of its growth is focused on footwear.  However, the other parts of its empire are not performing particularly well, and the pressure is building up on Nike to continue to execute. Nike just doesn’t have the same kind of diversity that VF's mix of outdoor wear, sports clothing, footwear, and jeanswear generates.

You can see how well VF imanages investments in its various segments by looking at margin growth in the last quarter.

Source: company accounts.

Five out of its six segments saw margin increases, and a look at its profits for the first six months illustrates their relative importance.

Source: company accounts.

Within its Outdoor & Action Sports division lie three diverse brands. The North Face gives it exposure to the rugged outdoor hiking and mountaineering market, and equally importantly, people who want to be associated with this lifestyle. Vans generates a similar appeal to people attracted by skating, surfboarding and snowboarding, while Timberland has long been a leading outdoor wear brand. All three are placed in distinct fashion niches.

The big three brands

It isn't all plain sailing for VF. For example, Timberland has had problems due to its heavy exposure to Europe. Timberland’s European revenues were down in double-digits,but it managed to record only a 3% overall decline in revenues. On a more positive note, Timberland’s Asian revenues were up 10% and, it generated low-single-digit-growth in the Americas.

VF reacted to weak conditions in Europe for Timberland, by investing in direct-to-consumer (DtC) initiatives such as e-commerce enabled websites. These actions led to positive DtC comparables in Europe, and high-single-digit growth in the Americas.

Furthermore, its other two key brands (Vans and The North Face) have great potential to grow via international expansion. Both brands tap into the growing trend for consumers to wear outdoor activity clothing as a fashion statement. Indeed, Vans generated 15% growth in the quarter, with international sales up 20%; incredibly, Europe rose 20%. As for the The North Face, it generated 5% growth overall. The North Face’s international sales were up 20% with European sales increasing an impressive 10%.

VF has a good mix of growth opportunities from regional expansion, growing its DtC business, and favorable lifestyle trends .It can selectively invest across its brands and regions in order to counteract any weakness elsewhere.

How VF compares across its industry

Here's a brief look at how the company matches up versus its industry peers.

Frankly, VF doesn't merit its discount to Nike, because of the advantages (as discussed above) that VF holds over its footwear-focused rival. On the other hand, its premium to Columbia Sportswear (NASDAQ: COLM) is well-deserved.

Columbia is forecasting full-year sales to decline by up to 2.5%. Its brands do not have the kind of lifestyle appeal that VF has managed to generate with Vans or The North Face. Columbia's core clothing tends to be for activities like skiing and fishing. Arguably, these are not hobbies whose clothing has the kind of crossover appeal that VF's brands generates.  .

The bottom line

In conclusion, VF’s diversity gives it good growth prospects for the next few years. Its valuation of over 18 times forward EPS estimates may look expensive, but the company has low-teens-growth forecasted for the next couple of years. In addition, it is expecting to generate around $1.4 billion in cash flow for 2013.

Arguably, the stock is fairly valued right now, but if it hits its low-teens EPS growth targets, then it’s reasonable to expect the stock to return at least low-teens returns for investors over the next few years.

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