Monday, January 9, 2017

I am adding V.F. Corporation to my Dividend Portfolio

I am always looking for bargains to add good quality dividend paying stocks to my portfolio regardless of what the stock market is doing. There are always bargains or discounts available in the stock market even during the current overvaluation period.

The key is to find a market sector that is currently unloved or out-of-cycle and find the best stock in that sector. It's like buying the best house in the worst neighborhood which has the potential of best gains when the market turns around.

Retail is one of such sectors/neighborhoods that has been taking quite a beating due to the recent holidays sales disappointment and continued pressure from online retailer Amazon.

Major big box retailers such as Macy's, Kohl, and Nordstorm are down 25% - 30% in just one month.

These big box stores seem like good bargains; however, they are too risky for my liking. Even after the recent selloff which was mainly due to the brutal competition from online giant retailer Amazon and ever growing online shopping trend.

Instead of buying just one retailer, I wanted to buy a company that has a major play in global retail and not just limited to selling their product under a single store brand, but rather a supplier of goods to many retailers including Amazon.

This is when I thought of V.F. Corporation or Vanity Fair Corporation. It has been on my stock watch list for over a year, but its valuation has been too high for me to start a new position until recently.

 Historical Price Graph
Copyright 2017, F.A.S.T Graphs - All Rights Reserved www.fastgraphs.com
As with the rest of the retail stocks, the VFC has taken the beating and has been trading close to its 52-week low price point. However, majority of the decline in VFC share price is due to foreign currency (expensive dollar) headwinds and warmer weather that has caused inventory buildup during the past year and has been called out by management in various earning calls:

From 2015 annual report/earning call:

“... we faced the warmest weather ever recorded during the period.”

" Additionally, 2015 revenue growth was negatively impacted by unseasonably warm weather in the fourth quarter, a softer retail environment and the 53rd week in 2014. The extra week in 2014 negatively impacted 2015 revenue growth comparisons by 1%."

Form Q3'2016 earning call:

“…during the past four quarters, weak consumer spending, the warmest winter on record, retail bankruptcies and excess inventory in the off-price channel have had an outsized impact, particularly on our U.S. business." 

Management has taken steps to improve margins and better inventory management:

“…we've reduced our inventory buys to protect our brands and ensure channel health. And we're pulling various levers to preserve gross margin expansion and ensure profitability. With inventory up only 1%, we're confidently managing the business to be in line with the environment.”

A Turnaround is in the Making

VFC is seeing a turnaround in its earning and cash flow growth. During Q3' 2016, the reported EPS grew 13% to $1.20. Currency - neutral earnings were up 16%. Also, for 2017 both earnings and cash flow are estimated to grow at the rate of 9.23% and 16%, respectively.

Now we know where the company and its stock price stands, let's now look deeper to see whether it would be a good investment at the current price/valuation. 

Company Profile

According to Wikipedia:

VF Corporation is an American worldwide apparel and footwear company founded in 1899 and headquartered in Greensboro, North Carolina. The company’s more than 30 brands are organized into five product categories: Outdoor & Action Sports, Jeanswear, Imagewear, Sportswear and Contemporary Brands. The company controls 55% of the U.S. backpack market with the Jansport, Eastpak, Timberland and North Face brands.


Dividend

Dividend History
VF Corp. is a dividend Aristocrat with a history of 44 years of consecutive dividend payments and increases.  There are only 50 companies that make up the prestigious Dividend Aristocrat list.

Current Yield/Rate:
As of 1/05/2017, VFC pays a generous dividend of ~3.2% at a rate of $1.68/sh. 
This is the highest yield seen for VFC since coming out of 2008-2009 recession.

Dividend Yld Historical Graph
Copyright 2017, F.A.S.T Graphs - All Rights Reserved www.fastgraphs.com
Dividend Growth
VFC has a 5-year DGR CAGR of 17.0% with the most recent dividend increase of 14%.
For 2017, dividend is estimated to grow by 10%.

Dividend Coverage and Payout Ratios (as of Q3' 2016)

Dividend paid (TTM) : 620 million dollars.
FCF (TTM) : 1,231 million dollars.

Earnings Per Share: $2.63
Dividend paid Per Share (TTM): $1.48

FCF Payout Ratio (TTM) : 620/1,231 = 50.3%  - Dividend is nicely covered by FCF.
Earnings Payout Ratio (TTM) : 1.48/2.63 = 56.2%  - Payout is a bit higher but it comes down to 51% based on full-year 2016 earnings estimate.

Dividend Coverage and Payout Ratios based on 2017 estimates
High: 1.68/3.54 = 47%
Low: 1.68/3.3 = 50.9%
Average: 1.68/3.42 = 49.1%  - This brings VFC’s payout ratio under its historic 50% payout.

Bottom-Line
Dividend is very well covered both through earnings and FCF; however, it is at high end of VFC’s historic payout ratio of 50% due to recent 2015-2016 declines in earnings and cash flow. The payout ratio should go down to 49% based on improved earning and cash flow estimates for 2017. 

VFC increased dividends even during the last two recessions, this shows the long-term management commitment to shareholder value and why VFC is a dividend aristocrat.

Debt and Credit Rating
Before I can jump into valuation, I need to look at company's debt and credit rating. These two metrics help determine the financial health of a company.

In personal finance, people borrow money from banks, and banks give them a loan at some interest rate based on person's credit rating and how much they can afford depending on their income. The interest rates along with any closing cost determines the cost of getting a loan.

This borrowing cost is an additional expense to an individual's monthly expense that must be paid along with the monthly principal amount for the period of the loan.

Same is true in corporate borrowing. When a company goes to borrow money, which most of them do, the bank has to look at their credit rating and then determine the risk.

A company with a lower credit rating would be asked to pay more in interest costs than a company with excellent credit rating. This interest cost is an additional drag to the company's cash flow and dividends as it must be paid before paying any dividends to the shareholders.

As a consequence, a company with large amounts of debt may not have a good credit rating and may not be able to grow or even sustain dividends. There are of course exceptions, for example utilities are known to have high levels of debt due to high capital cost to maintain infrastructure; however, they also are regulated and have more control over their earnings and cash flow than a regular corporation.

There are three types of credit ratings, they have similar meaning/scale but they are given by three different credit rating companies: Fitch, S&P, and Moody's.

Source: Fitch, Standards & Poor, and Moody's
I normally only look at S&P ratings as they are usually inline with the other two and most widely accepted/used.

VFC's S&P Credit Rating is 'A' which puts it in the middle of 'Low credit risk' category.

This is a very good credit rating as it is a solid 'A' rating given to companies with top financial health and investment grade.

A company with a rating below BBB- is considered a 'non-investment grade' and has substantial to high credit risk. It is therefore why I would never buy a company below BBB- rating.

Debt Ratios
The easiest way to look at debt is to look at the following ratios:

Debt/Equity: 48%
Debt/Capital: 29%
Interest Coverage: 17.19 - means VFC can pay its debt 17.19 times over with its current earnings.

Debt ratios and interest coverage are both quite good for VFC.

Valuation Analysis
Valuation analysis is simply the process of determining whether the current price of a stock is fairly valued, undervalued, or overvalued. You don't want to overpay for a stock or an investment, so the idea here is to determine what would be the fair value of the given stock.

I will start with looking at data from Morningstar.com which gives us some valuation ratios such as Price-to-Earnings (P/E), Price-to-Book (P/B), Price-to-Sale (P/S), and Price-to-Cash Flow (P/CF) ratios. In addition we have PEG ratio which is P/E over next year's growth rate estimate. So, it's a forward looking valuation metric.

For VFC, I will mainly focus on earnings and cash flow ratios which simply state market value as a multiple of company's earning and cash flow. Other metrics such as Price-to-Sales compares company's market value as a multiple of its sales or revenues. P/S is more useful when there are no earnings to report. Similarly, Price-to-Book is another valuation metric which compares the current market value of a stock/company to its value in the accounting books, essentially P/B is the theoretical value of a given company. P/B is widely used when valuating banks.

Okay, so let's just focus on P/E, PEG, and P/CF ratios for VFC.


Source: Morningstar.com
Based on the above valuation data from Morningstar, both on current and forward basis, VFC stock looks undervalued when compared to its 5 year average P/E valuation and overall S&P 500 valuation.

Forward P/E is also cheap compared to S&P 500. Also, PEG is at 1.4, a PEG < 1.0 is considered below fair value. So, on PEG ratio basic the current price seems a bit expensive but not by much. Unfortunately, Morningstar does not have Industry Average PEG number for VFC.

The other thing to note is that the first three years of the last five year period, VFC stock has been trading at very high valuations ranging from P/E of 20 to all the way to P/E of 25 just before starting its nearly 2-year decline.

Therefore, if I just look at the last 5 years, the valuation would be skewed due to the large bubble the stock has seen during 2013 till mid 2015 period. I want to see how the stock has traded prior to the bubble years. Therefore, I am going to extend the time period to 7 years and then see what the normal P/E looks like:

7-Year Normal P/E Historical Graph
Copyright 2017, F.A.S.T Graphs - All Rights Reserved www.fastgraphs.com
Now we are looking at 7 years worth of data and we can see how the VFC stock traded between the normal P/E of 18.2 and the fair value P/E of 15 before breaking out and entering the bubble territory.

From the chart above and on the basis of next year's earning estimate, the stock price still has some room (about 3.5%) to go down till it hits its 2017 fair P/E valuation (the orange line). However, from the normal P/E perspective the stock is still undervalued and has a potential to gain 17.4% in its price over the next 12 months.

To summarize, there is a short-term (12mo) upside potential of 20.4% in price appreciation vs. a 3.9% downside risk. This is clearly shown in the two F.A.S.T Graphs charts below:

7-Year Normal P/E - Upside Potential
 Historical Graph - Copyright 2017, F.A.S.T Graphs - All Rights Reserved www.fastgraphs.com

7-Year Fair Value P/E - Downside Potential 
 Historical Graph - Copyright 2017, F.A.S.T Graphs - All Rights Reserved www.fastgraphs.com
Okay, so we have establish that in short-term (12mo) period, at the current market price of VFC stock, it has a fairly large upside potential and a small downside potential.

At this point, I want to look at how the stock is positioned for long-term (say 5 years) using the upper valuation (7-year normal P/E of 18) and fair valuation (P/E of 15), this is shown in the two charts below:

5-Year Growth Forecast Normal P/E
Forecast Calculators  - Copyright 2017, F.A.S.T Graphs - All Rights Reserved www.fastgraphs.com

5-Year Growth at Fair Value P/E 
Forecast Calculators  - Copyright 2017, F.A.S.T Graphs - All Rights Reserved www.fastgraphs.com
Using upper valuation limit of P/E 18.0, the 5-year potential capital appreciation would be 69% (without dividends) and total ROR (with dividends) of 87.9%. This comes out to annualized return of 13.54%.

When applying fair valuation multiple of P/E 15.0, the potential for capital appreciation at the end of 5 years would be at 40.85% (without dividends) and total ROR 59.74% (with dividends). This gives us total annualized return of 9.88%. Still not too shabby.

Alright, so what I have done so far is used both upper and lower (fair) valuation limits to see what type of returns I could potentially get in one year and five years period given I were to invest my money now at the current price of $53.18.

My Final Take on Valuation:
VFC is currently trading at a valuation higher than its fair value; however, it is not overvalued by much. With the decline of nearly 31% in the past year or so, the current valuation is closer to its fair value than it has been in the past three years.

I see far more upside potential than downside. Also a dividend > 3.0% along with double digit dividend growth rate is likely to act as a bottom support or resistance for further price decline.

Therefore, I feel comfortable starting a position at the current price or valuation. I would ease into full position over the next two months using the following dollar-cost-average model:
  1. Bought first 25% position today (1/9/2017) at a price of $52.97/sh
  2. Buy second 25% incremental position between now and earnings (2/20/17) on further dips
  3. Buy third 25% position after the Q4 earning
  4. Buy fourth and final position after investor presentation in Q1
Conclusion
For a company of such high quality and long-term dividend history with aristocrat status, the chances for further downside are usually minimal. I see more long-term potential gain than short-term risks and see current weakness as a good entry point for a long-term position.

Hope you enjoyed reading this article and learned something new from it. As always, I look forward to hearing feedback from my readers. Thanks!

Disclaimer: I own shares of V.F. Corporation. 
Author of this article is not a licensed/registered financial or investment advisor and does not provide investment advice. This article is for informational purpose only. Full disclaimer can be read here: Full Disclaimer

6 comments:

  1. Hey MrATM,

    Thanks for the words of encouragement left on my blog! I had to do a bit of moving these past couple of weeks (I got a promotion!!) so I haven't had internet to blog with but I will start and kick things off again hopefully this week (I think it'll be a slow start, but a start nonetheless). Thank you for checking my blog periodically, I appreciate it :)

    This is a solid analysis of the company. A pretty thorough one out of the investment blogs I read. I wonder what their strategy is in navigating through the tough environment that retailers are facing right now. Suppliers can't survive if the retailers don't survive!

    ReplyDelete
    Replies
    1. Retailers especially brick & mortar are facing what is called 'Death by Amazon". There is actually an Index by this name that is maintained by Bespoke Investment Group which tracks retailers that are on the path to extinction.

      VFC is not in the Index, at least last I checked, mainly because they are not just a retailer but rather a manufacturer and wholesaler of some of the most widely worn and liked apparel brands, some of which have been around for a long time (e.g. Wrangler, Lee).

      VFC management is trying to focus more on online sales as well as DTC (direct-to-customer) via their retail stores. Per last report, both DTC and their direct online sales were up.

      I think big box retail is due consolidation as the weaker store chains will be bought by the big guys. As for VFC, they will continue to sell their products through whatever channels available, including Amazon.

      Clothing is one of the basic human needs after food and shelter, so there will always be demand for cloths until we invent virtual clothing.

      P.S: Welcome back FS and congrats on your promotion :)

      Delete
  2. Thanks for sharing your recent pick up. As VFC is approaching the low $50s and the yield is climbing north of 3% it becomes too much of a good value and dividend play to ignore. Many of our fellow investing peers have been adding to this stock.

    ReplyDelete
  3. Yup, VFC presents a great opportunity for us dividend focused investors. Thanks for stopping by.

    ReplyDelete
  4. Mr ATM
    Thank you very much for this informative analysis. The steps and relevance of those steps are laid out so clearly that I can only assume you intended the piece to be useful as a tutorial as well as an analysis of VFC.

    In any case to a newb investor such as myself it seems an excellent tutorial for analyzing a company, and I thank you for it.

    ReplyDelete
    Replies
    1. That was my intent to provide an example of how to evaluate a stock while using actual data and research for my own investment.

      Thanks for reading and commenting. Means a lot to me that my work was useful to someone.

      Delete