In years to come, it's possible that outdoor and sporting clothing company VF Corp's (NYSE: VFC )
last quarter could become a trivia question. Throughout the last two
years, quarter after quarter, VF has raised its full-year earnings
guidance. So what will the market do with the stock when it fails to do
so?
The answer is that it will mark it higher, because
VF kept guidance unchanged but disclosed that it would spend an
additional $40 million, or $0.25 of earnings per share, on marketing its
key growth brands. The full-year EPS guidance of $10.85 was kept the
same as well. While all of this is good news, the stock is up over 41%
year-to-date. Is there further room for VF to run?
Good value vs. Nike and Lululemon
Eagle-eyed readers will note that VF currently trades for nearly 20 times its 2013 guidance. This doesn't look cheap on an absolute basis, but it still trades at a discount to peers Nike (NYSE: NKE ) and yoga gear company Lululemon Athletica (NASDAQ: LULU ) .
VFC EV to EBITDA (TTM) data by YCharts
The key advantage that VF has over these companies
is diversification. Nike is a fantastic business, but it's increasingly
reliant on North America and footwear for its growth. Going forward, Nike needs to address its underperformance in China as it tries to strategically reset its business there. For
example, Nike generates four times as much in earnings from North
America as it does from China. Moreover, in its last results its futures
orders from North America were 11%, compared to just 2% from Greater
China.
As for Lululemon, the company is very focused on
selling premium products in the yoga category. It doesn't offer much
diversification and it's susceptible to encroaching competition. In
addition, Lululemon has had to deal with some quality issues with its
black yoga pants (one of its top selling items) this year. An issue that
highlights how hard it is to preserve premium prices in a competitive
market. It's one thing to build a lifestyle cache around a brand, but at
the end of the day it is still basically selling expensive yoga pants.
On a forward P/E ratio of over 27 times earnings, the stock is hardly
cheap.
VF Corp's upside potential
Frankly, VF needs some upside earnings catalysts. The good news is that it has at least five of them!
First, the weather might be more helpful this year.
VF's outdoor & action sports coalition (58.1% of 2012 total
coalition profit) contains three major brands, of which The North
Face--and to a lesser extent Timberland--see stronger sales when winters
are colder. While Europe saw a cold winter last year, the last two
years have seen mild winters in the US. Retailers have been cautious
with inventories going into this holiday season. In other words, if
there is a cold winter this year, then investors can look forward to
some pricing upside because retailers' inventories could turn out to be
too lean.
The second upside catalyst is that VF is innovating
its major brands in order to broaden their appeal. For example, in an
attempt to make The North Face less of a winter-focused brand, VF has
launched training apparel and some new collections for the spring
season. In addition, Timberland has seen an increased focus on apparel
to diversify away from a reliance on footwear.
Third, VF has a margin expansion opportunity by
growing its direct to consumer, or DtC, sales. DtC sales (comprising
things like its own store and e-commerce sales) increased 14% in the
quarter, and now make up 19% of total sales. They obviously come at a
higher margin than sales via retail channels. Furthermore, the
higher-margin outdoor & action sports coalition grew sales by 6.5%,
compared to 4.7% for the total company. A combination of these two
factors saw gross margins expand by 90 basis points to 47.6%.
Fourth, the increased investment of $40 million in
the second half should increase revenues. Furthermore, the bulk of this
investment is going into higher-margin areas. From the conference call:
"With a focus on The North Face, Vans and Timberland, 80% of the spend is in Outdoor & Action Sports. And about 70% positioned outside the U.S. and heavily D2C weighted."
And finally, VF still has significant opportunity
to expand internationally. For example, Vans revenue was up a remarkable
25% in Europe, and its jeans-wear coalition (26.6% of 2012 total
coalition profit) has long-term growth opportunities in China
(particularly with the Lee brand) even if it's still dealing with some
excess inventory issues.
Where next for VF Corp?
On its current valuation, the stock is starting to look fairly valued. However, analysts should start upgrading next year's estimates due to the increased marketing spend this year. Moreover, a cold winter and continued excellent execution with its DtC initiatives will lead to increases in growth
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