V.F. Corp. (VFC) recently posted Q1 results that were better than anticipated on both the top and bottom lines, with continued strength in its core growth brands. Following the updated guidance and strong performance, I am increasing my fair value estimate to $92-97, and I believe the stock looks attractive at current levels. Let’s dig into current trends, and why I think there is upside from the current price.
Q1’20 Results: Vans and North Face Cannot Be Stopped
After the spinoff of Kontoor Brands (KTB), V.F. Corp.’s asset portfolio is much more concentrated towards higher growth assets, and the new weighting was reflected in Q1 results. On a comparable basis, revenue jumped 9% y/y (11% ex-FX) while reported revenue increased 6% y/y to $2.3 billion. V.F.’s active segment, led by Vans, grew a whopping 8% y/y on a reported basis to $1.2 billion.
Vans, which experienced fantastic growth in FY19, continued its hot streak, growing 23% y/y on a constant currencies basis in Q1. The brand continues to bring heat globally, with double-digit growth across most geographies, and a strong 24% growth rate in its largest geography, the US. In my view, Vans provides a strong product mix for the consumer who has moved away from active footwear to lifestyle, and I believe the brand has established itself as a strong fashion staple. That being said, I would like to see continued growth from Vans’ progression footwear. The category was up 26% y/y in Q1, but I suspect it remains much smaller than the legacy business. Going forward, it will be critical for driving durable sales growth comparable to a brand like Nike (NKE).
V.F.’s second largest segment, Outdoor, posted strong Q1 results, even though it is seasonally one of the smaller quarters for the segment. Sales grew 7% y/y on a reported basis to $611 million with the growth primarily driven by the segment’s largest brand, The North Face. Sales at The North Face jumped 11% y/y on a constant currency basis with wholesale revenue up 14% y/y and direct-to-consumer revenue growing 9% y/y. Like Vans, The North Face’s growth was broad-based with a strong performance from APAC (+20% y/y fx-neutral) and particularly impressive growth from the company’s move into more lifestyle product. The company’s Urban Explorer product category saw sales jump a whopping 49% y/y. In my view, this is a prime example of why V.F. Corp is a strong company – management has identified a formula for driving growth in older brands, and by leveraging the existing brand name while adding adjacent product categories that address changes in consumer tastes.
Although this formula is working well in both Vans and The North Face, V.F. Corp. has yet to work out the same formula to the same extent within the Timberland brand. Sales grew only 2% y/y on a constant currency basis, though the US performed relatively well (+7% y/y) against a backdrop of mid-single digit growth in EMEA and Other Americas and a 4% constant currency decline in Europe. Relative to Vans and The North Face, Timberland possess a greater slant towards classic work boot silhouettes, which clearly continues to weigh on the overall ability of the brand to grow. Nevertheless, management noted that growth in non-classic footwear was relatively strong, and importantly, I am confident in management’s ability to find new growth outlets for its legacy brands.
In terms of profitability, the more focused brand portfolio translated to margin growth, as gross margin jumped 120 basis points y/y to 54.4% of sales, though gross margin was 100 basis points higher on a constant currency basis. I believe V.F. will continue to see gross margin expansion as its direct business grows in tandem with continued outperformance of its best brands.
On the operating margin side, V.F. Corp.’s SG&A spending jumped 8% y/y to $1.1 billion, slightly outpacing revenue growth, but overall, adjusted operating margin increased about 100 basis points y/y to 7.2% of sales. I anticipate continued modest expansion as the company invests heavily in e-commerce and other less accretive near-term activities that should drive revenue growth over the long term. Within the next 3-5 years, I believe V.F. Corp. could see its operating margin rise to 16-18%.
Why I’m Increasing My Fair Value
My primary fear heading into FY20 was the difficult comparison for Vans, but Q1’s outstanding 23% constant currency growth rate alleviated some of my trepidation, especially after the relative slowdown in Q4’19. More importantly, I have become more confident in management’s ability to apply is brand expansion formula beyond Vans, as demonstrated with another solid quarter from The North Face and the signs of a turnaround at Timberland in the United States. Therefore, I am increasing my fair value estimate to $92-97, reflecting more optimistic growth in FY20 and strong operating margins in the out years.
Overall, the stock is not incredibly undervalued at its current share price, but I see the current price, balance sheet strength, and yield just shy of 2% as a likely combination to deliver a low double-digit total return annually for the next 3-5 years, barring global economic issues.
Disclosure: I am/we are long VFC, KTB, NKE. 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.