Shares of leading apparel maker V.F. Corp. (VFC, Financial) are down 25% over the last year, including a 19% decline so far this year. As a result, shares now trade below the long-term average valuation as well as the stock’s GuruFocus value.
Due in part to this decline, V.F. Corp. now offers one of its highest yields in a very long time, one that is supported by the company’s business performance and appears very safe. In this article, we will examine the company, its dividend safety and valuation to see why I believe V.F. Corp could be an excellent deep value and income opportunity.
Company background and earnings history
V.F. Corp. was founded in 1899 and has grown to become one of the largest makers of apparel and footwear in the world. The $23 billion company’s top brands include The North Face, Timberland, Vans and Dickies. V.F. Corp spun out its jeans businesses into Kontoor Brands (KTB, Financial) in 2019 to focus on its core brands.
V.F. Corp. reported its third-quarter fiscal 2022 results on Jan. 28 (the company’s fiscal year ends the Saturday closest to the end of March). Revenue grew 22% to $3.6 billion, beating Wall Street analysts’ estimates by $18 million. Adjusted earnings per share of $1.35 compared favorably to adjusted earnings per share of 93 cents in the prior year and was 13 cents better than expected.
Both revenue and adjusted earnings per share were the best marks since well before the pandemic. This was in the face of supply chain bottlenecks as well.
Year-to-date, revenue has increased more than 35% to $9 billion. Adjusted earnings per share of $2.66 compares very favorably to adjusted earnings per share of $1.03 in the prior year. Top- and bottom-line gains are due primarily to the reopening of stores that were closed in the prior period.
V.F. Corp.’s revenue is down slightly over the last decade, but this obscures two items of note. First, this doesn’t account for the spinoff of the company’s jeans business and, second, this includes the impact of Covid-19 forcing physical store locations to be closed for long periods of time.
Looking at the prior 10 years, revenue has a compound annual growth rate (CAGR) of 3.5%. Switching to earnings per share, the 10-year CAGR is -4.6%. Again, this was due to the spinoff and Covid-19. Looking at the prior decade, the CAGR improves to 5.8% annually.
As of Friday’s close, V.F. Corp.’s stock pays a dividend yield of 3.4%. This compares to the 10-year average yield of 2.3% and is well ahead of the 1.4% average yield of the S&P 500 Index. For context, V.F. Corp. hasn’t averaged a yield above 3% for an entire year since 2010.
Dividend history and recession performance
The total dividend paid to V.F. Corp.’s shareholders did dip in 2019, but this was due to the spinoff of Kontoor Brands. V.F. Corp. is still credited with a dividend growth streak of 49 years, making the next increase, which will likely be announced next fall, the one that could grant the company entrance into the Dividend Kings Index.
Nearly five decades of dividend growth means that V.F. Corp. has successfully navigated a number of recessions and still managed to raise its dividend.
Listed below are V.F. Corp.’s adjusted earnings per share results before, during and after the Great Recession:
- 2006 adjusted earnings per share: $1.18
- 2007 adjusted earnings per share: $1.35 (14.4% increase)
- 2008 adjusted earnings per share: $1.39 (3.0% increase)
- 2009 adjusted earnings per share: $1.29 (7.2% decrease)
- 2010 adjusted earnings per share: $1.61 (24.8% increase)
- 2011 adjusted earnings per share: $2.01 (24.8% increase)
- 2012 adjusted earnings per share: $2.41 (19.9% increase)
Despite operating in a somewhat cyclical sector, V.F. Corp. experienced just a minor decline in adjusted earnings per share in 2009 compared to the market. The next three years saw high double-digit growth as the company enjoyed the recovery from the Great Recession. Following this was a period of several more years where the bottom-line improved.
Dividend growth did slow during the 2007 to 2009 period to just 5.5% total, but a dividend cut never was likely as the payout ratios were very low at the time.
Even as business results were greatly affected by Covid-19 in 2020, the company still raised its distribution. As with the Great Recession, the increase was minimal at just 2%. The same 1 cent per quarter per share raise was announced late last year, but this was the prudent move as V.F. Corp. is still getting over the pandemic.
The positive that investors should take away from this history is that V.F. Corp.’s dividend growth does tend to slow under economic duress, but the increases do continue. That is the case because the payout ratios are in solid shape.
Dividend growth and payout ratios
Shareholders have seen their dividend payments compound at a rate of almost 13% over the last decade, and this includes several years of low growth and a slight reduction related to the removal of the jeans business. Dividend growth has slowed to 6% in the medium-term, but is still a decent figure.
Shareholders have received $1.48 of dividends per share for the first three quarters of the company’s fiscal year, which results in a payout ratio of 56% for this period of time. This is nearly identical to the 10-year average payout ratio of 55%. However, this does include the 100%+ payout ratio that the company recorded last fiscal year, which was adversely impacted by the pandemic. Removing this year, the average drops to 45%. Still, the year-to-date payout ratio remains reasonable.
Now let’s consider free cash flow. V.F. Corp. has paid out $579 of dividends so far for the fiscal year while generating free cash flow of $519 million for a free cash flow payout ratio of 112%. This level of payout ratio is obviously sustainable long-term.
That being said, the company’s most recent quarter, which saw a much more normalized operating environment, saw an improvement in cash flow. For the quarter, the company distributed $195 million of dividends while producing free cash flow of $877 million for a free cash flow payout ratio of 22%.
The three prior years saw an average free cash flow payout ratio of 77%. It could be that the most recent quarter was a one-off event, but even the short-term average is an improvement over the year-to-date total. Free cash flow will be something I will be watching in future quarters, but, for now, it appears that V.F. Corp.’s dividend is likely safe using this metric.
The impact of debt of dividend security
Debt is another item that investors need to consider before making a purchase as the higher the level of interest expense and obligations, the more likely a dividend cut could occur.
At present, V.F. Corp. doesn’t have enough cash flow to cover its dividend payments, let alone its interest expenses. Therefore, I will use the average of the last three years to help determine how debt could impact the company’s dividend.
For this period, V.F. Corp. averaged interest expense of $112 million, dividends of $758 million and free cash flow of $979 million. Total debt stood at $6.84 billion as of the most recent quarter, giving V.F. Corp. a weighted average interest rate of just 1.6%.
The chart below shows how high the weighted average interest rate would have to increase before dividends would no longer be covered by free cash flow.
Source: Author’s calculations
Looking above, we see that V.F. Corp.’s cash flow would continue to cover dividends until the weighted average interest rate reached above 4.8%. Assuming free cash flow recovers to pre-pandemic levels soon, it appears that the company’s dividend is safe from a debt standpoint.
Valuation
Leadership stated on the last conference call that the company expects to see adjusted earnings per share of approximately $3.20 for the full fiscal year of 2022. With shares trading at close to $59, this implies a forward price-earnings ratio of 18.4. The last decade has seen V.F. Corp. trade with an average multiple of more than 20 times earnings.
While the stock is trading at a slight discount to the historical valuation, V.F. Corp. looks extremely undervalued when using the GF Value chart.
V.F. Corp. has a GF Value of $99.15, giving the stock a price-to-GF-Value ratio of 0.60. Rising to meet the GF Value would result in a 68% gain from current levels. A return of this magnitude probably requires a sharp increase in business performance and several quarters of results that are above estimates.
It likely wouldn’t take much of a return to growth for the stock to see an significant improvement in the share price given that V.F. Corp. appears out of favor with the market. In any case, GuruFocus rates shares as significantly undervalued.
Final thoughts
V.F. Corp. is still in the recovery phase from the Covid-19 pandemic. Supply chain constraints have also been an issue, but the company posted its best quarter in some time due to the strength of its brands.
Dividend growth has slowed in the near term, but V.F. Corp. has been resilient enough to raise its dividend through multiple downturns, an excellent characteristic for those looking for income producing stocks.
The earnings payout ratio is very reasonable and debt obligations likely won't hinder V.F. Corp.’s dividend payments. Free cash flow, on the other hand, needs to be watched as the company’s payout ratio is quite high. V.F. Corp. remains undervalued against its own historical performance as well as the GF Value.
These factors suggest that for investors looking for value and income, V.F. Corp. could be an excellent opportunity, though the more risk-averse might avoid it due to the amount of debt compared to the free cash flow.
