V.F. Corporation: Strong Margins, 2.7% Dividend Yield, And Potential For 20% Share Appreciation

| About: V.F. Corporation (VFC)

Summary

V.F. Corporation’s appointment of Steven Rendle could signal a resumption of more aggressive M&A activity for the company in 2017.

In the meantime, the recent weakness in VF’s brand portfolio appear to be transitory – something its third quarter earnings will either confirm or reject.

Investors can be opportunistic and use any short-term weakness to purchase shares, which have a sector-leading dividend yield and high potential upside for patient investors.

Steven Rendle To Become VF Corporation CEO in January

V.F. Corporation (NYSE:VFC) recently announced that Steven Rendle, a company insider for the last 16 years, will become its CEO effective January 1, 2017. He will be replacing current CEO Eric Wiseman, who will assume the mantle of Executive Chairman of VF.

There are a number of challenges awaiting Rendle when he assumes leadership of VF, including a tepid share price, with the company having missed Wall Street earnings expectations in two of the last four quarters.

VF is set to report its third quarter earnings on October 24th, with the owner of global brands such as Nautica, The North Face, Lee and Timberland, expected to post earnings per share of $1.15, which would be a 7.5% improvement over the third quarter of last year.

Even so, VF's shares have slipped by nearly 13% this year, with the company guiding just 5% earnings growth for the entirety of 2016 on the back of 3% to 4% revenue expansion. Such a rate of revenue growth would be less than half the 8.8% growth rate expected for the industry. Previously, VF had been expecting a mid-single-digit growth (likely between 5% to 6%) but a weaker-than-previous outlook for both its Outdoor & Action Sports and (especially its) Sportswear segments have scuttled that forecast.

In any case, a lower share price has produced one side-benefit: a higher dividend yield. VF shares' current 2.7% dividend yield is among the highest in the apparel sector. Thus, an investor who invests $10,000 in VF shares can expect to receive around $272 in cumulative dividend payments over the course of a year. This is more than the investor would have earned in dividends from the S&P500.

Considering the foregoing, investors are probably wondering whether it's a good time to get into VF. Let's take a look:

Growth by Acquisition on the Horizon?

Beyond tepid growth from its portfolio that has seen The North Face and Vans growing more slowly than previously and Timberland dealing with inventory issues, the market appears to be disappointed that VF hasn't made any acquisitions recently. No major acquisitions in the last four years seems like an odd development for a company described by Eric Wiseman as an 'active portfolio manager[s].' Earlier in the year, there was some speculation that VF could acquire either Puma or Decker.

The impetus for a purchase seems fairly obvious: with the company's core brands not growing much, a 'growth by acquisition' strategy could be the sort of deal that shakes the company up - that being said, if growth is a priority, perhaps not closing a deal to buy Puma or any other athletic lifestyle brand might make sense given that the previously buoyant athleisure market appears to be slowing amidst an over saturation of choices and lackadaisical consumer spending.

Having said that, an opportunistic acquisition does make sense for VF at a time when industry valuations are generally reasonable and while a deal may not be imminent, it would make sense for VF to pursue one, particularly if core brands like Timberland continue to experience headwinds even as these pursue long-term revenue expansion.

An acquisition is likely where incoming CEO Rendle will look to make his mark since, if he follows company tradition and retires at 60 (Wiseman and his predecessor, Mackey McDonald both vacated the CEO position at that age), he'll need to make one in the next three years (he's 57). This factor can't be overlooked, especially since there's been a paucity of deals for VF in recent years.

Looking ahead to its third quarter, investors will need to pay attention to whether VF upgrades its 2016 outlook - its second quarter guidance had some worrisome forecasts for its Sportswear, which had its revenue outlook downgraded from being slightly lower to dropping by double-digits. What's more, some issues such as Timberland's inventory issues may be transitory in nature. Thus, it will be interesting to hear whether VF walks its forecast back since, all else being equal, this would improve its overall outlook for the year.

Healthy Margins mean Safe Dividend

In any case, VF does have very healthy margins to fall back on as it seeks to navigate what has so far been a pedestrian year. At the 48.7% and 14.5% forecasted rates for its annualized gross and operating margins, respectively, the company would be ahead of its industry peers. This, in turn, feed into a fairly healthy balance sheet and its robust A3 credit rating, which has also benefited from VF's diversified product portfolio and distribution channels (among other things, VF derives 16% of its sales from e-Commerce)

In practical terms, VF's strong margins, healthy cash flow generation and low leverage mean that it can sustain its dividends going forward - indeed, VF's annualized interest expense is equivalent to just 12% of its cash and its strong credit rating mean that the company can re-capitalize itself using leverage if necessary. In fact, this is exactly what VF has been doing, issuing new debt even as it repurchased $833 million worth of shares in the first half of 2016.

Upside Potential

VF is currently trading at 18.2-times its trailing 12-month earnings and with 5% earnings growth expected for 2016, it's trending towards a 17-times near-term earnings valuation. Both these measures are considerably lower than the 24.3-times earnings of the S&P500.

Although we believe that there could be some upside to VF's estimate given the positive outlook for holiday spending, we believe a $3.19 earnings forecast is appropriate at this time (i.e. 5% better than 2015 or in-line with the company's forecast). Looking towards 2017, we see earnings growing by 10% as the company resolves its issues with its outdoors and sportswear segments and Rendle implements his vision for the company. A potential acquisition could also add upside - but for now, we see 2017 earnings at $3.51 per share, which is slightly below the consensus of $3.56.

Even so, our 2017 forecast means that VF is trading at just 15.5-times forward earnings - a discount to the S&P500's 18-times multiple. The S&P500 is in the midst of what could be six quarters of negative earnings growth so we find its multiple premium over VF - which is expected to see earnings growth - to be inconsistent.

Consequently, we anticipate some gap compression; at 18-times earnings, we have a $63.20 target price for VF Corporation, which is in-range of the consensus target price of $65.02 per share. This implies that there is between 16% to 20% upside for the stock.

Conclusion

We believe that VF is worth a portfolio allocation given the potential upside for the stock and the fact that recent issues it's experiencing are likely to be transitory. A solid dividend yield (for its sector) as well as its robust balance sheet and globally-recognized portfolio of brands are also strengths that long-term investors shouldn't overlook.

Rather than viewing Rendle's ascension to the CEO position as an uncertainty, we view it as an opportunity. After all, Rendle is a long-time company insider who is familiar with the company's workings and so is likely to be cognizant of the steps it needs to take to address its current issues - much more so than an outsider. Furthermore, as we've mentioned, he is likely to be more aggressive on the M&A front as he seeks to establish his imprint on the company. This can only lead to an improvement in the stock price.

To be sure, VF's third quarter numbers are unlikely to be especially savory - US retail sales, particularly clothing, were generally weak in the third quarter - but poor results could actually be the opportunity for patient investors who are seeking to establish an entry point into the stock.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in VFC over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.

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