Dividend Growth Stock of the Month for November 2016

November 21, 2016

VF Corporation (VFC) is a USA-based multi-national producer and distributor of apparel. The company has increased its dividend 44 straight years, including an upcoming 14% increase payable in December.

Let’s take a look at VF’s attractiveness as a dividend growth stock.

VF’s Dividend Picture

captureThis is one of the best dividend resumes that we have seen.

• The yield of 2.9% is pretty high for a company with such a long growth streak and fast growth rate. For comparison, the average yield of all 778 Dividend Champions, Contenders, and Challengers is 2.8%.
• With a 44-year streak of increases, VFC is a Dividend Champion.
• The 2016 increase (14% payable in December), 2015 increase (20%), and 5-year dividend growth rate (20% per year) are all very good numbers.
• The company’s rate of dividend growth each year has been steadily high since the Great Recession ended in 2009.

capture• VF gets good dividend safety grades from both Safety Net Pro and Simply Safe Dividends. (For more on dividend safety, see DGI Lesson 17.)

As you can see in the following chart, VF’s price growth has more or less mirrored its dividend growth over the past 10 years. As always, the price signal is noisier than the dividend signal.

captureVFC’s price has fallen significantly over the past year. As we shall see later, that brings VF into a more desirable buying range.

Business Model and Quality

VF Corporation is one of the world’s largest apparel manufacturers. It was founded in 1899 and is located in Greensboro, NC.

VF began as a glove and mitten company. In the early 1900s its lingerie line was known as Vanity Fair.

That’s where the “VF” comes from.

The company went public as Vanity Fair Mills in the 1950s. (VF divested the Vanity Fair business in 2007.)

Today, VF operates in these segments: Outdoor and Action Sports; Jeanswear; Sportwear; and Contemporary Brands.

VF owns a strong portfolio of brands in the categories like outerwear, footwear, denim, backpacks, sportswear, and performance apparel. VF’s better-known brands include North Face, Wrangler, Lee, Timberland, Vans, Nautica, and JanSport. The first 5 are “super brands” generating more than $1 Billion each in annual sales; together they account for over 60% of VF’s sales.

VF has grown both organically and through acquisitions. Most of its well-known brands came as acquisitions, with examples being Lee in the 1950s, Wrangler in the 1970s, North Face in the 1990s, and Nautica in the 2000s.

VF distributes globally, with the Americas being its largest market (about 62% of revenue). Products are marketed to consumers via specialty stores, upscale and traditional department stores, national chains, mass merchants, and VF’s own direct-to-consumer operations. International distribution is through licensees, distributors, and independently-operated partnership stores.

Morningstar awards VF a wide-moat rating. That is largely based on the pricing power that VF has attained through its strong brands, skillful maintenance of its brand portfolio through acquisitions and divestments, and distribution network. VF customers have been willing to pay somewhat higher prices for well-respected brand names like North Face and Timberland, because they are associated with quality and innovation.

VF also gains advantages from self-manufacturing, centralized procurement, and logistics/distribution. In 2015, about 23% of VF’s products were manufactured in VF-operated facilities.
In June 2013, VFC delineated its five-year growth plan. VF’s growth strategy is to:

• Increase revenue from $11.4 billion in 2013 to $17 billion in 2017 (“17 by 17”).
• Achieve nearly three-quarters of total revenue from lifestyle brands by 2017.
• Improve gross margin to 49.5% and operating margin to 16%.
• Grow international business at a compounded annual rate of 13% to reach 43 percent of VF’s total revenues in 2017, up from 37 percent in 2012.
• Increase direct-to-consumer business to reach $4.4 billion by 2017. VF is establishing a network of single-brand stores plus VF outlets.

captureVF’s Financials

VF has a good return on equity (ROE) of about 23%. Since the Great Recession, that figure has held steady.

So has VF’s earnings per share (EPS), which has generally been growing since the recession. This display (from Morningstar) shows the steadiness of those metrics:

captureMore good news is that VF’s good ROE is not a function of high debt. The company’s D/E (debt to equity) ratio stands at 0.5. That compares favorably to all of the Dividend Champions, Contenders, and Challengers, whose average D/E is 1.0.

As I have stated a couple of times in the past, a D/E ratio of 0.5 these days practically qualifies as a low-debt operation.

captureVFC’s Stock Valuation

My 4-step process for valuing companies is described in Dividend Growth Investing Lesson 11: Valuation.

Step 1: FASTGraphs Default. The first step is to compare the stock’s current price to FASTGraphs’ basic estimate of its fair value.

In VFC’s case, that basic estimate is based on reference point price-to-earnings ratio (P/E) of 15, which is the long-term average P/E of the stock market as a whole. That fair-value estimate is shown by the orange line on the following chart.

captureUsing this approach, VF is overvalued. Its current price is 21% over fair value price.

This method suggests a fair price of $47 per share, compared to VF’s current price of about $57 per share.

Step 2: FASTGraphs Normalized. The second valuation step is to compare VF’s price to its own long-term average P/E ratio. This lets us adjust for the fact that some stocks always seem to be highly valued by the market, while others always seem to have have a low valuation.

captureThis closes the gap somewhat. VFC’s 10-year average P/E ratio has been 16.0 instead of 15, meaning that the market has tended to more highly value VF than companies as a whole.

But that still renders VF as overvalued by 14%. Its fair price computes to $50.

Step 3: Morningstar Star Rating. Morningstar uses a discounted cash flow (DCF) process for valuation. Their approach is comprehensive and detailed. Many investors consider DCF analysis to be the best method of assessing fair valuations.

Morningstar makes a projection of all the company’s future profits. The sum of all those profits is discounted back to the present to reflect the time value of money. The resulting net present value of all future earnings is considered to be the fair price for the stock today.

captureOn Morningstar’s 5-star system, VFC gets 4 stars. That means that they believe the company is undervalued. They calculate a fair value of $73, which is about 28% above the current price. Note that the DCF analysis, in this case, produces a significantly different fair value for VFC than we got in the first 2 steps.

Step 4: Current Yield vs. Historical Yield.

Finally, we compare the stock’s current yield to its historical yield. This is an indirect way of calculating fair value. It is better for a stock’s yield to be near the top of its historical range than near the bottom.

captureThe display above is from Morningstar. It shows VFC’s yield as 2.6%, instead of the 2.9% we saw earlier, because they appear to use the trailing yield rather than the inicated yield.

Using 2.9%, this approach suggests that VFC is undervalued by 2.9 / 1.8 = 61%. To be conservative, I cut off valuation estimates at 20% when using this method.

So this approach suggests that VFC is undervalued by 20% and its fair price is $68.

Valuation Summary:

Using the 4 approaches just described, our valuation summary for VF looks like this:

captureFor a reality check, I also looked at S&P Capital IQ’s valuation analysis. They suggest a fair value of $53, a 12-month price target of $58, and they have a 3-star “hold” rating on the stock.

Miscellaneous Factors

There are some factors that do not fall into the earlier categories.

captureBeta measures a stock’s price volatility relative to the S&P 500. I like to own stocks with low volatility, because they present fewer occasions to freak out over price drops.

VFC’s beta of 0.8 suggests that the stock has been 20% less volatile than the market. I consider this a minor plus-factor.

The analysts’ recommendations come from data collected by S&P Capital IQ. Their most recent report shows the opinions of 25 analysts. Their average recommendation is 3.6 on a 5-point scale, where 4.0 = Buy and 3.0 = Hold. In other words, their average recommendation is about halfway between “hold” and “buy.” This is another minor plus-factor.

This chart shows VFC’s share count over the past 10 years.

captureWe see a modest share decline, down about 7% overall. I prefer it when share counts are declining, but this slow a decline does not amount to much. So this is a neutral factor.

Bottom Line

Here are VFC’s positives:

• Stellar dividend resume: Decent yield at 2.9%; excellent dividend growth rate of 20% over the past 5 years; upcoming increase of 14% in December; strong dividend safety, protected by very good cash flow; and 44-year streak of increasing dividends.
• Stock is fairly valued.
• Well-run, high quality company with strong brands and wide moat.
• Methodical, achievable growth strategy. Outdoor and action sports categories have plenty of room for growth. International expansion and direct-to-consumer distribution channels also have room to run.
• Good financials, including high return on equity, moderate debt, and projected earnings growth in the 9-10% range.
• Below-market price volatility.

Here are the negatives:

• Many of VF’s clothing categories are discretionary areas that can suffer during economic stress.
• Foreign markets expose VF to risks of currency fluctuations.
• Two valuation methods (of the 4 that I utilize) suggest that price is overvalued.

As always, do your own due diligence, and please do not take this article as a recommendation to buy or hold VFC. Instead, use it to inspire your own research. And always be sure to match your stock picks to your financial goals.

– Dave Van Knapp

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