Shares of V.F. Corp. (VFC) are trading near their 52-week low as broader market concerns weigh on the stock. In the interim, the market has failed to acknowledge that the company’s Vans segment continues to grow at a robust pace while the company Imagewear business benefits from the acquisition of Williamson-Dickie and the divestiture of Licensed Sports Group and JanSport. Meanwhile, V.F. Corp. owns the iconic North Face and Timberland brands, which are not growing quickly, but remain excellent brands with sustainable, long-term value. Overall, I believe the stock looks relatively cheap at less than 17x next year’s earnings with a dividend yield of 2.9%. After the stalling jeans business spinoff is completed in FY19, I believe V.F. Corp. could have a cleaner balance sheet that positions the remaining V.F. Corp. to earn a higher earnings multiple.
JeansCo – Slow, Stable Business with M&A Potential
“JeansCo” will be comprised of the Wrangler and Lee brands of denim. While not high fashion, both are stable brands with loyal followings sold through the likes of Walmart (WMT), Amazon (AMZN), and Target (TGT). Wrangler is the definition of mass market, at one point achieving as much as 20% market share in the US. Wrangler is an iconic American brand, as is Lee. Lee occasionally has a slightly higher price point in the US, selling at J.C. Penney (JCP), Kohl’s (KSS), Amazon, Walmart, and Target. Both brands have similar overlap and customer bases in the United States, Canada, and Latin America. JeansCo will also house the V.F. Corp. outlet business.
Interestingly, both brands are positioned as higher fashion outside of the United States with more of a focus on direct-to-consumer sales in China and Europe. Per the announcement of the spin, there will be a big focus on growing this business in China post-spin.
Recent financial performance of the segment has been subpar. From 2015-2017, revenue has declined 4.9% to $2.66 billion while operating profit fell a whopping 21% to $422 million – a decline in excess of $100 million. Still, the segment posted a 15.9% operating margin, and spent only $30.7 million on capex. At the same time, the segment had $53.2 million in D&A charges, so the segment likely generated $330-360 million in free cash flow. I expect this business will take at least $1.5 billion in debt from the current V.F. Corp., which would leave JeansCo with a leverage ratio of 3.2x EBITDA – manageable and not too cumbersome for an enterprising acquirer.
Speaking of M&A, the new JeansCo could be an attractive M&A target for a soon-to-be public Levi Strauss & Co. I believe the two would have massive cost and revenue synergies, and it would make tremendous sense for a company to invest heavily in China with a portfolio of iconic American brands. Additionally, Levy Strauss could leverage its strong presence in Europe to help drive international expansion.
JeansCo is struggling with customer bankruptcies, as both Sears (OTCPK:SHLDQ) and Bon Ton shudder stores. As a result, sales are down nearly 3% YTD to $1.24 billion, and the company will miss its 1-3% annual sales growth target.
Still, former JeansCo leader Scott Baxter will become CEO. He is currently the CFO of V.F. Corp., and previously resided over the business from 2011-15 when the business achieved mid-single digit annual revenue growth. He might have some ideas as to how to boost the business, or he might simply benefit from a more normalized environment after JeansCo starts to lap apparel bankruptcies.
Still, let’s not lose sight of the simple fact that JeansCo is a cash machine, can take away some of the parent’s debt, and it could be a target of M&A – especially other denim players with operational synergies. Additionally, a spin-off may reveal areas of cost opportunity that the company had not previously identified.
V.F. Corp. – Strong Stable of Brands with a Focus on M&A
V.F. Corp. has been a business built on the back of M&A. The company houses powerhouse brands like North Face, Timberland, Vans, Dickie’s, and Red Kap. Although some brands like North Face and Timberland have some overlap, most are fairly uniquely situation and unlikely to cannibalize each other.
North Face
North Face is a unique asset, known as a premier cold weather brand. Sales grew at a 6% CAGR from 2012 to 2016, reaching $2.3 billion. Sales were up 4% in FY17, and I believe the company has struggled to compete against Canada Goose (GOOS), which has taken premium winter wear to a whole new stratosphere. I doubt North Face will be able to trade into a more upmarket product to compete against Canada Goose, but a delevered V.F. Corp. could potentially acquire Canada Goose to have a full spectrum of product. More relevant, North Face sales are up 6% YTD, and I think the company should be able to achieve its 6-8% annual growth target as the company continues to produce high value products and increases its direct-to-consumer penetration.
Timberland
V.F. Corp. acquired Timberland in 2011 for $2 billion, and it grew at a CAGR of 8% per year from 2012 to 2016, reaching $1.8 billion in sales, though sales growth slowed to just 2% in 2017. Without question, this has been a value-creative acquisition, as VF has likely paid for at least half of the deal in the first five years alone.
Recently, Timberland has stumbled, with sales down 2% YTD in FY18. Although I think the company is pursuing interesting initiatives that are resonating in the United States, the direct-to-consumer and wholesale businesses are falling in EMEA and APAC. Going forward, management has high expectations for APAC and non-US Americas, with growth targets of 6-8% and 8-10%, respectively, driving global growth of 4-6%.
I think Timberland is an invaluable brand with a clear opportunity to interestingly increase the penetration of its classic products internationally while growing non-classics in the United States.
Vans
Vans is absolutely on fire as a brand at the momentum, driving by a migration towards both 90’s styles and fashion footwear over performance footwear. The brand grew at a CAGR of 14% from 2012-2016 with sales topping $2.3 billion. Sales accelerated beyond this trend in FY17, growing 19% y/y, and is up an even more robust 30% YTD. Investors were somewhat dissatisfied that Vans growth is expected to moderate in H2’18; however, it is important for brands to limit SKU availability to maintain momentum and not flood the marketplace, as tempting as it may be.
Without question, the Vans Old Skool is the Stan Smith of the momentum – a shoe owned by both genders in every country in the world in increasing amounts. Although I believe growth will slow, it is important to note that Vans remain a relatively small player in the global footwear market with just 5% of the total addressable market.
I like that the brand has used the resurgence of the Old Skool to create new adjacent models leveraging new takes on exiting platforms. Consumers are more likely to experiment with these new models given the popularity of the brand overall. Going management expects an 8-10% CAGR until 2021. Most of that CAGR may be achieved through 2018 alone, but I expect solid growth to continue thereafter, especially as the brand better accesses the apparel opportunity in front of it, especially in Greater China.
Work
Workwear is an interesting segment that is not nearly as sexy as other apparel, but likely provides shareholders with even more opportunities for M&A. The Work business is built around Bulwark, Red Kap, Timberland PRO, Wrangler RIGGS, and Horace Small, as well as the recent acquisition of Williamso-Dickie – best known for its Dickie’s brand. Overall, workwear is a near $30 billion market that’s highly fragmented with several large, legacy players like V.F. Corp., Diluth Trading, Carhartt, Wolverine, and Red Wing shoes. All of these legacy players could be acquisition targets.
Additionally, workwear often carries some special attributes, including product durability, flame-resistance, and other capabilities not possible with a cotton t-shirt. In addition, customers are not always just consumers; rather, buyers often include companies that demand their employees use certain high performance work clothing and footwear. I can think of multiple instances of employers happily shelling out $200 multiple times per year for Red Wings work boots.
I actually believe this could be the most interesting part of the business for bolt-on M&A, as there are several interesting targets. Additionally, V.F. Corp. is able to add some differentiated capabilities in terms of e-commerce and fashion. Several workwear brands have found second lives as fashion staples, and I believe V.F. Corp. could be the right partner to unlock the full potential of many workwear brands.
Valuation – Not Pricing In Much Beyond Consensus
At the present moment, shares of VF trade at roughly 16.8x FY18 earnings. It will be much more clear when the official documentation is filed with the SEC just what one is getting with each company, but I think V.F. Corp. will likely saddle JeansCo with debt in order to free up balance sheet capacity for additional M&A. V.F. Corp. is targeting annual shareholder returns of 14-16% with a dividend “in-line” with the S&P 500, which I would take to mean about 2%. JeansCo will pay a higher dividend, and I expect that it will be a cost-savings story. It is challenging for management teams to achieve both a growth mindset and a penny pinchers mindset, so I think a spin-off will truly be the best option for both organizations.
Again, it will take a filing to determine which is the better investment asset; however, I think 16.8x reflects a discount to the multiple that V.F. Corp. will receive on its own (think 21-25x, in-line with peers like Nike (NYSE:NKE)), and it also does not incorporate cost-savings upsides which are likely achievable after a spin-off. Overall, I think the security is worthy of a look with the presently discounted multiple, though again, it is tough to know exactly what the business will look like post-spin.
Disclosure: I am/we are long TGT. 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.
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