The VF in VF Corp's (VFC -0.31%) name stands for Vanity Fair, a once-iconic name in the clothing space. The stock was pretty iconic as well, having increased its dividend annually for decades. But the spin-off of Kontoor Brands (KTB 1.65%) in early 2019 cemented a major change of direction for the company. This just isn't the same dividend stock that it was before. Let's see why.
Shifting gears
To be fair, VF Corp didn't suddenly switch gears when it jettisoned Kontoor Brands in 2019. That company owns clothing brands like Wrangler, Lee, and Rock & Republic, as well as the VF Outlet business. These are all tied to an older business model, in which the company made products that were largely sold through other retailers' stores.
It was a slow and consistent model, but one that was augmented over the years with the addition of hotter fashion brands. Timberland, Vans, and The North Face are good examples. The company's not done, either -- note the 2020 addition of Supreme to the list.
Image source: Getty Images.
VF Corp still sells its products through other retailers, but it has increasingly opened up stores under its own nameplates. This puts the company into direct competition with other fashion-focused retailers, including those that may be selling its products. Fashion trends are notoriously difficult to predict. Kontoor Brands' focus on jeans, a basic clothing staple, makes it less reliant on fashion trends. While Kontoor's brands were a part of VF Corp, they helped to diversify the company's business.
The problem is that Wall Street generally thinks about maximizing short-term results, not long-term consistency. While you may want to have a diversified portfolio that includes reliable but slow growth stocks and faster-growing ones, Kontoor's brands were seen as slowing down the growth potential of VF Corp's fashion brands. The idea was basically that the unusual move of spinning off Kontoor would allow investors to fully value VF Corp's more exciting fashion brands.
VF Corp's stock is down by roughly two-thirds since the spin-off was completed, so things haven't exactly gone as well as hoped. By comparison, Kontoor's shares are up 3% -- not something to write home about, but much better than VF Corp's performance.
A bigger problem
While VF Corp has a notable collection of brands in its portfolio, it is now much more reliant on getting fashion trends right than it had been in the past. And that's been a big issue of late, with its two biggest brands, Vans and North Face, posting mixed results through the first half of fiscal 2023.
In the recently ended second quarter of its fiscal 2023, North Face's sales rose 8%, but Vans' sales dropped 13%. Through the first six months of the fiscal year, North Face's sales were higher by 15%, while Vans' sales declined 10%. These two brands make up nearly 60% of the company's sales.
While you can look at the performance of North Face and highlight the good side of the company's results, the weakness at Vans left fiscal Q2 2023 sales down 4% and first-half sales down 1%. A fashion misstep at one of VF Corp's two big nameplates is, well, a big problem and is directly related to its increasing focus on owning fashion brands.
VFC Payout Ratio data by YCharts
Here's where things start to get worrying for dividend investors. As a result of the pandemic, inflation, and weak performance at some of the company's brands, the dividend payout ratio is now well over 100%. Dividends aren't paid out of earnings; they are paid out of cash flow. So a company can pay dividends in excess of earnings for a little while. However, such a high payout ratio is a warning sign that investors need to worry about the sustainability of the payment.
Another warning sign is a very high dividend yield, which at 7.3% is a further concern here. A yield that high, coupled with a worrying payout ratio, suggests that investors are anticipating a dividend cut.
Time to reexamine what you own
In the company's defense, it increased the quarterly dividend by 2% a share in late 2022. That is likely a statement by management that it thinks financial results will improve in the future, so that dividend coverage won't be an issue.
But for conservative investors, the risk/reward balance here isn't the same as it was before the Kontoor spin off. VF Corp's payout ratio is a concern, and its business model is increasingly reliant on tapping into the hottest fashion trends. If the company stocks the right wares, there's probably big upside from current levels. If it continues to struggle, the dividend could end up being cut.
If you are looking at VF Corp, you should strongly consider the risks you will be adding to your portfolio. And if you have owned the stock for a long time, you might want to look at it again to make sure you fully appreciate the changes that may have taken place since you bought it.
