We think VF Corp is probably one of the less-known Dividend Aristocrats out there. A Dividend Aristocrat is a company that has raised its dividend for the past 25 consecutive years--a pretty nice accomplishment. But while we agree that having a management team that rewards shareholders with growing dividends is important, we also think that evaluating a company's intrinsic value is equally so (if not more important). Let's dive into VF Corp's (VFC) intrinsic value in this article.
A comprehensive analysis of a firm's discounted cash-flow valuation and relative valuation versus industry peers is one of the best ways to identify the most attractive stocks, in our view. This process culminates in what we call our Valuentum Buying Index, which ranks stocks on a scale from 1 to 10, with 10 being the best. If a company is undervalued both on a DCF and on a relative valuation basis, it scores high on our scale. We compare VF Corp to peers Coach (COH), Estee Lauder (EL), and Nike (NKE) in this article. In the spirit of transparency, we show how our performance has stacked up versus that of peers:
Our Report on VF Corp
• VF Corp earns a ValueCreation™ rating of EXCELLENT, the highest possible mark on our scale. The firm has been generating economic value for shareholders for the past few years, a track record we view very positively. Return on invested capital (excluding goodwill) has averaged 26.9% during the past three years.
• The firm is trading at attractive valuation multiples relative to peers, but our DCF process indicates a less compelling opportunity. We'd wait for a clearer signal on valuation before jumping into the firm's shares.
• VF Corp has an excellent combination of strong free cash flow generation and low financial leverage. We expect the firm's free cash flow margin to average about 10.6% in coming years. Total debt-to-EBITDA was 1.1 last year, while debt-to-book capitalization stood at 26.5%.
• The firm sports a very nice dividend yield of 2.1%. We expect the firm to pay out about 32% of next year's earnings to shareholders as dividends.
Economic Profit Analysis
The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital (ROIC) with its weighted average cost of capital (GM:WACC). The gap or difference between ROIC and WACC is called the firm's economic profit spread. VF Corp's 3-year historical return on invested capital (without goodwill) is 26.9%, which is above the estimate of its cost of capital of 10.3%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. VF Corp's free cash flow margin has averaged about 10.4% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. For more information on the differences between these two measures, please visit our website at Valuentum.com. At VF Corp, cash flow from operations increased about 27% from levels registered two years ago, while capital expenditures
expanded about 126% over the same time period.
We think VF Corp is worth $156 per share, which represents a price-to-earnings (P/E) ratio of about 16.1 times last year's earnings and an implied EV/EBITDA multiple of about 11 times last year's EBITDA. Our model reflects a compound annual revenue growth rate of 5.6% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 14.6%. Our model reflects a 5-year projected average operating margin of 15%, which is above VF Corp's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 2.4% for the next 15 years and 3% in perpetuity. For VF Corp, we use a 10.3% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $156 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for VF Corp. We think the firm is attractive below $117 per share (the green line), but quite expensive above $195 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate VF Corp's fair value at this point in time to be about $156 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of VF Corp's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $201 per share in Year 3 represents our existing fair value per share of $156 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from
the upper and lower bounds of our fair value estimate range.