The Dividend Investor's Guide: Part XVIII: The Fickle Apparel Industry

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Includes: RL, VFC
by: Mark Bern, CFA

Back to Part XVII - Telecommunications Industry

By Mark Bern, CPA CFA

If you are joining the series for the first time, you may find it informative to refer to the first article in the series, "The Dividend Investors' Guide to Successful Investing," where I provide more details about my process for selecting companies for my master list and details about why I use the metrics that I do.

The apparel industry is mostly a fickle investment territory. I say this because there are often hot new trends in fashion that are spotted (or created) early by one or more companies in the industry and these companies become hot investments for as long as an advantage can be maintained. The problem is that the advantage is difficult to sustain for very long. Fashions change every year and often it is the case that the hot stocks in this industry change with them. I tend to ignore the short-term trends and concentrate of those companies that consistently create increased shareholder value. I also concentrate on companies that pay rising dividends; something that is hard to find in the apparel industry.

But there are a few companies here that have caught my attention and deserve to be followed and owned by long-term, dividend oriented investors. These companies own brands that have loyal followings in the global marketplace; companies that do not get battered by the ebbs and flows of the changing fashions. These are also companies that continue to increase profit margins while also increasing sales. The result is what we are looking for: consistent increases in earnings per share and free cash flow.

It is not likely that the growing world population will decide one day that clothing is optional. If that trend begins we will try to buy the best positioned sun screen providers. It is also not likely that the millions of people who are rising out of subsistence to become consumers each month in developing countries will spend less on clothing once they can finally afford to buy more of what they want. Food will be first, then clothing and household products will be adding to the regular consumption. Then appliances and better modes of transportation will be purchased to make life easier and free up more time for education and leisure activities. So, apparel manufacturers stand to benefit from the impending global growth in consumption that is already under way. But we must be careful to select those companies best positioned to take advantage of this demographic trend.

At the top of my list is VF Corporation (VFC), the world's largest publicly-traded supplier of apparel. The company is a leader is selling jeans, work cloths, sportswear, and clothing for outdoor adventurers. It also sells footwear. Primary brands include Jansport, John Varvatos, Lee, Napapijri, Nautica, Reef, The North Face, Timberland, Vans, and Wrangler. The company buys leading brands and expands each one geographically using its worldwide distribution system while also expanding the offerings of each to accommodate both new and existing markets. Sales from outside the U.S. account for 34 percent of revenues. EPS at VFC barely dipped during the Great Recession and the stock price, which dropped by 60 percent from the 2007 top to the 2009 trough, is now trading at about 56 percent above the 2007 high.

A good example of how the company expands a brand is Vans, which VFC acquired in 2004. Vans has tripled in size since the acquisition and the company has plans of doubling the sales of Vans again over the next four years. The other thing I really like about VFC is that the net profit margin continues to trend fractionally higher, now at about 9.4 percent compared to 8.4 percent in 2007. Increasing sales with increasing margins is a great recipe for happy investors. The stock is trading right at the P/E I expect to be maintained over the long-term. Thus, it may not be a bargain, but it also is not overpriced, in my opinion. Now let's take a look at the metrics.

Metric

VFC

Industry Average

Grade

Dividend Yield

1.9%

1.0%

Pass

Debt-to-Capital Ratio

29.0%

20.8%

Neutral

Payout Ratio

32.0%

14.0%

Fail

5-Yr Average Annual Dividend Increase

6.1%

N/A

Neutral

Free Cash Flow

$1.48

N/A

Pass

Net Profit Margin

9.4%

7.2%

Pass

5-Yr Average Annual Growth in EPS

11.0%

7.6%

Pass

Return on Total Capital

14.5%

12.4%

Pass

5-Yr Average Annual Growth in Revenue

9.0%

3.5%

Pass

S&P Credit Rating

A-

N/A

Pass

Click to enlarge

One fail, two neutral rankings and seven passes is a commendable showing. The fail is in the payout ratio and at 32 percent is not outrageous. It means that the company is committed to returning value to shareholders in a more meaningful manner than are other companies in its industry. This is by far not the worst failing, in my opinion. The two neutral rankings are in the debt-to-capital ratio and dividend increases. The debt is manageable and nothing to get worried about as debt tends to climb due to acquisitions and fall again in subsequent years as the company pays down the leverage. This has been the trend in the past and I see no reason to expect anything different going forward. The company has actually been reducing its payout ratio over the past three years but I don't expect the trend to continue into the future as management seems more comfortable with the new payout level and I expect the increases to be more in line with increases in EPS in the future. My five-year price target for VFC is $225, which would yield an average annual total return of about 12 percent.

My other favorite in this industry is Ralph Lauren Corporation (RL), which designs apparel for men, women and children, home products, accessories, and fragrances. Ralph Lauren is a premiere brand including the names Blue Label, Club Monaco, Polo, RL Black Label, RL Purple Label, Rugby, and others. EPS at RL did not skip a beat during the Great Recession. Dividends policy has been sketchy and often the company has gone several years without an increase, however increases have been significant in recent years and will hopefully keep up with EPS growth in the future. Net profit margins are also rising along with impressive top line growth. Again, this is a trend I like to see. RL has exceptionally low debt levels and has built up ample cash from its great free cash flow levels. Let's take a look at how RL fares against my metrics.

Metric

RL

Industry Average

Grade

Dividend Yield

1.1%

1.0%

Pass

Debt-to-Capital Ratio

7.0%

20.8%

Pass

Payout Ratio

11.0%

14.0%

Pass

5-Yr Average Annual Dividend Increase

32.0%

N/A

Pass

Free Cash Flow

$4.51

N/A

Pass

Net Profit Margin

9.9%

7.2%

Pass

5-Yr Average Annual Growth in EPS

13.8%

7.6%

Pass

Return on Total Capital

17.6%

12.4%

Pass

5-Yr Average Annual Growth in Revenue

12.4%

3.5%

Pass

S&P Credit Rating

A-

N/A

Pass

Click to enlarge

RL has made a clean sweep of ten for ten passes. There are only two problems that I have that don't really show up by using the metrics system. The first is that, even though the dividend yield is above the industry average, it is still low my most dividend investor standards. The second is that it seems as though I am not the only investor to notice the quality of this company since the price of the stock looks overvalued to me. My five-year price target for RL is $200 per share which works out to an average annual return of about 8.7 percent. I would like to won RL at a price below $130 a share.

As you may already know, if you have read one or more of my articles in this series, I do not include companies that pay no dividend. I also exclude companies that pay a flat dividend or that have cut dividends. I also avoid companies that have not been able to rebound since the Great Recession. I want companies that can growth earnings and bounce back after economic shocks to achieve ever higher top and bottom line results. Of the remaining companies within the industry several have not been able to regain the price levels attained prior to 2008. This list includes Columbia Sportswear (COLM), Gildan Activewear (GIL), The Jones Group (JNY), Oxford Industries (OXM), and True Religion Apparel (TRLG). TRLG is the only company in the group that has seen its price rise above its pre-recession high only to have it fall back to 15 percent below again. It is the one company that may deserve watching over the next couple of years if its fundamentals continue to improve.

That concludes my assessment of the apparel industry. I hope you have found it interesting and informative. If you would like to read my assessments on other industries, a complete list of all articles in this series is available with the articles listed both chronologically by date of publication and by industry in my blog titled, "The Dividend Investors' Guide to Successful Investing Index Blog." As always I welcome comments and will attempt to answer any questions. The exchange of information is always welcome and it is how we all become better informed investors.

Disclosure: I am long VFC.