In a previous article, I detailed how we could learn from apparel firm V.F. Corp.'s (NYSE:VFC) "expensive" past. There were many examples of where shorter-term price movements deviated from business results, but perhaps the most pronounced period was from 2009 to 2014.
During this five-year stretch, the per share dividend increased by 88% and earnings per share were up an impressive 139%. Yet the share price increased much, much faster - jumping 309% in that the same period. This put into action a lot of things for the security.
The payout ratio actually declined (earnings growth outpaced dividend growth), but the earnings multiple went from 14 all the way up to 24. And the dividend yield dropped from 3.2% down to just 1.5%. Even with solid growth, the shareholders of 2009 through 2014 captured way more than their "fair share" of business results.
And this played out in 2015 and 2016. Despite a healthy uptick in the dividend and a moderate gain in earnings, the share price of V.F. Corp. declined by nearly 17% in 2015 and by about 14% during 2016. The total return in each instance is a bit better due to dividends received, but the "carry through effect" of the past outperformance is plain to see.
So here we sit today, with shares ~29% lower than they were a couple of years ago. The dividend yield is up, the valuation is down and the business has the ability to generate more income in the years to come. While we can learn a good deal from this type of history, a more direct inquiry would be: "Would you consider V.F. Corp an interesting investment today?"
Naturally, this question varies by the individual - your opinions and guesses about the future are going to be different, so the outcome as to whether or not you'd like to invest will vary as well. However, we can provide a framework for how you might go about thinking about the process.
On a high level view, I consider investing to be the intersection of quality and valuation. You can get into all sorts of details, but when you get down to it nearly everything comes back to these two things.
So let's start with quality. When I look at a company like V.F. Corp., I'd start thinking about quality in three ways: past, present and future. Or perhaps more realistically: financial strength, current pricing power and future staying power. First, I like to check in on where the company currently sits. That's more or less quantifiable, and the balance sheet is a good place to begin.
Next, I consider pricing power and whether or not the business can demand terms that are favorable to the firm. Without pricing power, you better have another competitive edge to make it in the profitable business department. And finally, I try to think about what the business could look like in the decades to come. None of this is perfect, but it gives you a framework for thinking about a security.
Keeping it high level, if you look at the most recent balance sheet for V.F. Corp., you'd see $4.8 billion in current assets against $2.2 billion in current liabilities. Things like cash and a portion of receivables ought to be good, but you could discount inventory and be more conservative. As Charlie Munger put it: "the liabilities are always good, it's the assets that you have to worry about."
Even with a conservative view, the "current look" appears more than manageable. Total liabilities come in at $5.6 billion against total assets of $10.4 billion. Personally, I like to stay conservative here as well and "forget" or at least discount things like property, goodwill and intangible assets. Certainly there is value here, but not always in the sense of being able to use those assets as currency should an unexpected expense come up. Instead, these things often materialize as earnings power over a period of time.
To that point, long-term debt sits at $2.4 billion requiring interest payments of less than $100 million a year. V.F. Corp. has earnings power north of $1.3 billion, so you have a solid amount of coverage there. For what it's worth, Value Line offers a financial rating of "A" and S&P provides the same (in letter, not necessarily in meaning) "A" as a credit rating for the company. You don't necessarily want to rely on that sort of thing, but from a basic view I'd consider the starting point of the company to be in reasonable shape.
Next you could think about pricing power. If you're looking to quantify this, you could see that net margins hovered in the 8% range from 2006 to 2009, in the 9% range from 2010 to 2012 and over 10% from 2013 onward. You wouldn't anticipate margins expanding forever, but you are checking in on to see how steady this aspect can be. Granted you can also accomplish this via cost cuts and the like, but over the long term, the ability to maintain pricing tends to show up in this metric.
From a subjective point of view, you ask yourself simple questions like: "are consumers willing to pay more for a Timberland boot or a North Face Jacket?" I'd contend the answer here is: "yes." So from that view, in combination with improving margins, you have the beginnings of what I would describe as pricing power.
Finally, on the quality side, I like to think about the future viability of the firm. On all these factors I might be wrong, but the point is: come up with a logical baseline. It gives you a framework for investing, and offers a roadmap for evaluating your upcoming triumphs or failures.
For V.F. Corp., I'd consider the future, say the next decade or three, to be a bit cloudier than a prototypical "high quality" firm like Johnson & Johnson (NYSE:JNJ). You have some things that management is going to need to address like declining retail traffic, fashion risk and online sales.
Now, none of this is to suggest that the company cannot figure it out. There are always going to be challenges, and large profitable businesses often come up and meet the challenge. However, what I am saying is that I don't think it's inevitable that you're going to be buying a North Face jacket 20 years from now. It's conceivable, sure, but that may no longer be the trend, price point or best quality option available to you. The finicky nature, for me at least, gives a "quality pause."
Put together, I'd judge the quality of V.F. Corp. to be "above average, but not exceptional." You have a solid set of financials and evident pricing power, but continuing challenges as well.
Next we can think about valuation, the counterpoint. Any investment can look good or bad, regardless of underlying quality, depending on valuation. For an above average quality firm, you might be looking for at least a "fair," perhaps better, valuation.
We'll run through a scenario quickly to continue the high level view, but it's important to recognize that this is the first step - the "am I even interested step?" - and not the end point.
Despite the material decline in the share price, we're just now back to a typical valuation for the firm. Over the past couple of decades, something in the 14 to 17 times earnings range has been typical. Only dating back to the 2013 to 2015 stretch did you see shares trade much higher than this benchmark.
Analysts are presently anticipating rather robust intermediate-term growth from V.F. Corp - on the magnitude of 8% to 9% per year. Personally, I like to stay conservative, so let's scale that back to say 5% annual growth. At that rate you'd anticipate the company generating $4 or so in per share earnings. At an earnings multiple of say 15, this equates to a future price of about $60.
The current dividend sits at $0.42 per quarter, or $1.68 on an annual basis. If the dividend were to grow in line with earnings, you'd anticipate collecting $9.75 or so in cash payments during the next half decade. As a baseline, think about it as the potential for a $70 total value (prior to reinvestment) against a current share price of about $53. That equates to a total anticipated gain of roughly 5.7% per annum.
Naturally, these estimates could be too low or high, but the point is to come up with a reasonable, perhaps understated starting point. Now this sort of return is acceptable for a high quality firm, but I would contend not overwhelmingly compelling as of yet. (It could very well turn out much better - i.e. higher growth rate or ending valuation - but you don't want to get overly optimistic and set yourself up for disappoint either.)
In sum, from a high level view, V.F. Corp. probably passes the financial strength and pricing power "quality checks" but has a bit less certainty on the staying power front. On the valuation side, the current quotation appears fair in relation to the expectations of the business, but perhaps not overly captivating at the moment. The point is not to take the above as an absolute, instead it's about thinking about these two (or four) factors and coming up with your own expectations. From there you can begin to weigh those assumptions against your alternatives. So, would you consider V.F. Corp. today?
Disclosure: I am/we are long JNJ.
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.