Can VF Corp Thrive While Department Stores Struggle?

V.F. Corporation's (VFC 0.35%) large brand portfolio includes billion-dollar names like Vans, The North Face, Timberland, Lee, and Wrangler. However, that hasn't completely protected the company from challenging retail headwinds. 

In this episode of Industry Focus: Consumer Goods, the team digs into a listener question regarding whether VF stock is poised to bounce back. The company's international and direct-to-consumer businesses continue to grow, but it's not clear whether that will be enough to offset further declines in the domestic wholesale channel.

A full transcript follows the video.

This podcast was recorded on Feb. 28, 2017.

Vincent Shen: Going into the mailbag, this question is from Levi Waddell, on a company that I don't think I've actually covered previously on the show, and that is VF Corporation. Levi wrote us back in mid-January asking, "Wondering if you guys had any thoughts on VFC? Retail is getting crushed right now, and a lot of VFC brands are big in mall stores. It's right around 52 week lows," or it was at the time, "Is this stock worth looking into right now, or is the risk associated with retail too much for it to overcome?"

For any Fools listening who are not familiar with this company, you'll probably recognize at least a few of the 30-ish major brands that exist within the company's portfolio. Some of the most recognizable ones are The North Face, Vans, Timberland, Wrangler, JanSport, Nautica. As you can tell from the handful of names I've mentioned, their products span different categories. Think apparel, footwear, luggage, accessories, but also different segments in terms of the target markets. That includes outdoors, action sports, denim jeans, and also professional sports licensing as well.

They sell their products through a pretty big network of company-owned stores, but also through wholesale business, they're trying to grow their direct-to-consumer efforts as well. This company has about a $22 billion market cap, $11.9 billion of revenue in 2016, free cash flow of over $1.2 billion. I actually have it right here, they do 20% of their business direct-to-consumer and over 1,500 retail stores. Overall, though, what do you think about the company?

Adam Levine-Weinberg: VF is a pretty interesting battleground stock right now. As the listener question explained, they definitely have a big exposure to mall-based stores, in particular the department stores, including some of the ones we were just talking about. So, with department stores sales declining, that obviously hurts a company like VF. Then, there's actually a follow-on effect in that with the sales declining, department stores are often trying to reduce their inventory commitments, which leads to even bigger sales declines for suppliers like VF Corporation. So, after years of strong growth, up until around 2014, you've seen operating income, EPS and free cash flow all stagnate for the past three years or so. So, it definitely raises the question, is VF ready for a comeback or is this the new normal for them? I would say that the reasons to be optimistic about the outlook are mainly that VF has a pretty good international business and direct-to-consumer business, and both of these are still growing, whereas the wholesale business in the U.S., which is the part of the business that's selling to department stores is declining, but as a result, it's sort of similar to the Nordstrom parallel that I was talking about earlier. This declining department store business in the U.S. is now not as important to the story for the company as a whole. 

So, if the international business continues to grow, and if the direct-to-consumer business continues to grow, going forward to, that could actually offset any further declines that they see in the U.S. department store business, which would be pretty good news for VF shareholders.

For 2017, the company does expect another decline in EPS, but a lot of that is due to the strong dollar, and with constant currency, they're calling for a mid-single-digit increase in EPS. Looking at valuation, the shares aren't very cheap right now, they trade for around 17 times earnings, so not really expensive, but also not cheap. The good news is that you're getting a 3% dividend, which is a pretty good yield in this environment. So, I would say that VF isn't a screaming buy right now. I think that the risk of further declines in the department store sector are definitely a risk that investors should be concerned about. And I think you can also see trouble both other stores in the mall, including other direct-to-consumer businesses that VF runs haven't been doing any better than department stores recently. So that's definitely a risk, that the direct-to-consumer business runs out of steam.

You've seen with Under Armour, they had huge gains for many years, and they have a really strong brand as well, and that hasn't been able to overcome this sluggish retail environment. So even the great brand, it's definitely a good asset to have in the long run, but it's not a guarantee of a smooth upward climb. So, I would say that if the U.S. wholesale business can stabilize, then you could see a return to EPS growth in the coming years, and it's just a question of when that happens. I think that eventually people will get out and start spending money on clothing again. It's just not clear when. So, this might be a good time to take a starter position for an investor in a company like VF, because there's definitely some upside here if they can stabilize the declining aspect of their business, and concentrate on continuing to grow their international and direct-to-consumer lines. But, there's enough risk that I wouldn't go bet the farm on the stock at this point.

Shen: Sure. And just to flesh out some of the points that you made, the company generates 38% of its revenue through international markets. As you mentioned, you compared it to Nordstrom, as the part of its business that's suffering loses share, it helps if the company can focus on direct-to-consumer, e-commerce, and also the international markets that are seeing growth. And, the company, I should add, in terms of its yield, over 3%, which is pretty good, I'm pretty sure it's a dividend aristocrat, as well. It has a long history here.

They've also spent over $1.6 billion in 2016, same plan for 2017, returning capital to shareholders, buying back shares. They've reduced their share count by around 6% to 7% in the past two years. It's funny, the struggles that a lot of the companies we've talked about earlier in the show, between Macy's, J.C. Penney, Nordstrom, all running into issues over the past two years. VF Corporation is very much following that same trend in terms of the timing. The stock itself, in terms of the pricing, peaked at over $66 last March, went below $50 to some of its 52-week lows very recently. It's recovered a little bit, it's now around $52. At a 17 times valuation, I'm in the same boat as you, it's not great but it's definitely a company that I did not follow previously, but it's a very interesting business, I think, in terms of having that portfolio of pretty strong brands. It's not a perfect insulation from problems in the overall retail sector, but there's some strengths there, that I think shouldn't be overlooked entirely. Otherwise, any last points for Levi?

Levine-Weinberg: Yeah, I would just say in terms of risk factors that investors should be aware of, one important thing is, again, chance of a recession at some point in the future. It's going to happen. We don't know when, but recessions do occur. Just as with these other retailers, if they're not doing well right now, they're going to do worse during a recession. That definitely offsets some of the potential profit growth. Obviously, they might be able to stabilize their business in the next year or two. But if a year or two later you have a recession, they could end up back where they are now or even worse.

A second one is, there's been a lot of rumors going around about what's known as a border-adjusted tax that Republicans in Congress want to implement. This would basically penalize companies for importing goods from overseas. Retailers have really pushed back against this hard because they import everything from overseas. So, that also includes a company like VF Corporation. They're not making a lot of clothing in the United States. It's mostly getting made overseas and brought to the U.S. for the 60%-plus of their business that is still domestic. So, they would not do well under that scenario, because they're going to have a much higher tax bill. So, it's certainly not clear that this border tax is going to happen, but if it does, that would definitely cause problems for a lot of retailers, but also for a company like VF.