Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
We're deep in the heart of summer here in America, with temperatures regularly reaching the 90s in many parts of the country. Up in New York City, however, stock analysts are already turning their thoughts to the upcoming school year -- and the back-to-school shopping extravaganza that will accompany it.
Which stocks will profit from this year's retail frenzy? Merrill Lynch made its pick this morning, upgrading shares of apparel, footwear, and backpack manufacturer VF Corporation (NYSE:VFC), the company behind such iconic brands as North Face, JanSport, Eastpak, Wrangler, Lee, Timberland, and Vans.
Here's what you need to know.
Back to school and off to the races
In fact, it's that last brand -- Vans -- that has Merrill Lynch so excited about VF today.
Last quarter, if you recall, VF had a difficult time of things on Wall Street after it reported 20% sales growth but missed analyst estimates for sales and earnings. One of the bright spots at VF, however, was its Vans shoes brand, which was the company's top revenue grower, with sales up 45% globally and 45% in the Americas.
Vans sales appear to have momentum this year, and in an upgrade covered on StreetInsider.com (subscription required), Merrill Lynch argues Vans "will be a 'go-to brand' for Back-to-School" in 2018. Indeed, channel checks that analyst has conducted show that Vans' sales momentum is "accelerating" as the fall 2018 school season approaches. As Merrill Lynch explains, VF has picked the right price point for budget-conscious consumers, pricing many of its wares in the $50 to $60 range.
Vans isn't VF's only success story, of course. Merrill Lynch is also seeing strength in sales of Lee and Wrangler jeans, as well as Dickies workwear -- but it's Vans leading the charge, and Vans that's the linchpin of the analyst's argument that VF stock is a buy worth $96 a share.
Right on the details, wrong on the big picture?
Merrill Lynch's price target of $96 a share is a story in itself, by the way. Last time we heard from this banker, when it was rating VF only neutral, the analyst had VF stock pegged for only a $65 price target. And yet, VF stock has roared right past that target, and is in fact up 49% over the past 12 months.
But doesn't that mean VF stock is now too expensive to buy?
Merrill Lynch doesn't seem to think so, but although I agree with the analyst that VF seems to be enjoying great success in shoe sales, I'm less enthusiastic about the stock price -- or about VF's ability to grow into that price target.
Consider that with $659 million in trailing profits, VF stock currently sells for a trailing P/E ratio of 50 -- kind of pricey for a stock in the volatile consumer fashion segment. Moreover, S&P Global Market Intelligence reports that analysts who follow the stock are predicting VF will grow its earnings at about 12.5% annually over the next five years. That gives VF a sky-high PEG ratio of 4, which seems to me way too much to pay for a stock in this industry, where fickle consumer tastes can so easily transform a fad into a dud.
Caveats and provisos
Granted, you can't allow P/E to be the sole determiner in deciding whether to buy or sell a stock like VF. There are always other factors to consider.
For example, VF has $680 million in cash on its balance sheet, but $3.7 billion in debt. Thus, it's carrying $3 billion in net debt on top of its $33 billion market capitalization, which raises the stock's enterprise value to $36 billion. From this perspective, you could say VF is more expensive than it looks.
On the other hand, VF also generates significantly better free cash flow ($1.2 billion) than it reports as net income ($659 million). Valued on these cash profits, the stock's enterprise value-to-free-cash-flow ratio is 30 -- significantly lower than its P/E of 50, and implying that the stock is cheaper than it looks.
All that being said, whether you think of VF as a 50 P/E stock or a 30 EV/FCF stock, 12.5% profits growth still doesn't seem fast enough to support the valuation it commands today, much less the price target Merrill Lynch has set for it. In the final analysis, I have to conclude that Merrill Lynch is right on the details, but wrong on the valuation.
Kudos to VF for its success with Vans -- but the stock still costs too much to justify a buy.