V.F. Corporation: Struggles, Failure Risks, But Glimmers Of A Turnaround (VFC)

Introduction

It’s time to talk about one of the most “dangerous” stocks on my radar. In this case, “dangerous” refers to the mix of economic headwinds, business turnaround risks, and dividend cuts.

As the title already gave away, that company is apparel manufacturer V.F. Corporation (NYSE:VFC), a $6 billion market cap giant that has seen its stock price fall from $100 in December 2019 to less than $16 after its just-released earnings.

This selloff has completely ruined the impressive performance after the Great Financial Crisis. Before the selloff, VFC consistently outperformed the market thanks to what used to be a strong position in the apparel industry.

Unfortunately, the company has now turned into a huge disappointment and is figuring out how to adjust its business for a very volatile business environment.

This included two major dividend cuts, lowering the dividend to $0.09 per share per quarter, translating to a yield of roughly 2%.

Speaking of this dividend, my most recent article on this company was written on October 31, when I used the title “V.F. Corp.: A Closer Look At Yet Another Dividend Cut.”

Here’s a part of my takeaway:

V.F. Corp, a once-thriving apparel manufacturer, is a prime example of the harsh reality. They’ve cut their dividend by a staggering 70%, and their stock price has plummeted. While they’re attempting a turnaround, it’s not an easy road ahead.

Despite the gloom, there’s a glimmer of hope. V.F. Corp. could potentially bounce back, but it’s a gamble I’m not willing to take.

Since then, VFC shares are up 16%, trailing the S&P 500 (SP500) by 2 points. However, after its earnings release yesterday, shares are down 8% pre-market, which has pushed the price below $16 again.

In this article, we’ll discuss the company’s earnings and what this means for the risk/reward. After all, if the company is able to successfully complete a turnaround, it could be a gold mine.

The problem is, for now, it’s a big IF.

Why VFC Stock Is Selling Off Again

Let’s start with the worst news, which is that the company’s fiscal third quarter saw significant weakness, primarily attributed to various factors such as unseasonably warm weather, operational challenges from the previous year, underperformance in certain regions, and the impact of a cyber incident.

VFC reported a decline in total revenue by 17% in Q3 of its 2024 fiscal year, with factors such as timing shifts in wholesale impacting quarterly results.

In terms of regional performance, the Americas experienced a significant decline of 25%, mainly driven by pressure in wholesale, which saw a 35% decrease.

Additionally, softer sell-throughs in DTC (direct-to-customer sales), down 16%, were noted.

In EMEA, revenue was down 12%, attributed to wholesale shipment timing shifts and cautious consumer behavior.

However, APAC continued its growth path with a 3% increase in revenue, driven by positive performance in all brands except Vans and Dickies.

The brand performance analysis also reveals mixed results.

• The North Face saw revenue decline by 11%, primarily due to challenges in the Americas region and softness in cold weather items.
• Vans experienced a substantial revenue decline of 29% across all regions, reflecting intentional reset actions taken to clean up the marketplace.
• Timberland revenue decreased by 22%, driven by challenges in the Americas region and specific product assortment issues.
• Dickies’ revenue was down 17%, primarily in the Americas region, while Supreme continued to see broad-based growth across regions.

Given that Supreme sells ultra-high-priced goods (Hoodies costing north of $800, among others), I believe it’s fair to say that the company’s overall results suggest that the consumer it targets is not in a good spot. This is something I have discussed in countless articles, as I believe we are dealing with a divided economy.

On the one hand, “the 1%” benefits from a strong stock market, elevated hard asset prices, and high rates on the cash market.

On the other hand, we have the majority of consumers with limited to no savings who do not benefit from elevated asset prices but suffer from the inflation wave that started in 2020.

As we can see below, consumer sentiment, in general, is poor. However, it’s the worst in the lower to middle-income categories, which are targeted by VFC.

The chart above also goes well with a Tweet someone just sent me, which shows a comment from packaging giant Crown Holdings (CCK). In general, packaging companies are fantastic indicators of consumer health, as they are impacted by the actual change in volumes (more sales require more packaging materials).

The company noted “incredible pressure across Europe,” which is confirmed by the numbers from VFC.

Unfortunately, it gets worse, as we haven’t discussed VFC’s margins.

While the company was able to expand its gross margin by 40 basis points to 55.3%, driven by tailwinds from channel and regional mix changes, operating margins contracted by 560 basis points due to significant SG&A deleverage, reflecting the urgency to reduce fixed costs, which brings me to the next part of this article.

All Eyes Are On V.F. Corporation’s Turnaround

In light of the mess that was the company’s third fiscal quarter, it knows it has to make major changes – on top of the dividend cuts and announcements it already made in prior quarters.

That’s where the turnaround strategy comes into play.

Essentially, to address challenges facing key brands, the company implemented a multifaceted turnaround strategy aimed at reinvigorating its brand identity and reconnecting with its core audience.

This comprehensive strategy involves delineating a clear brand purpose, focusing on product innovation, and implementing targeted marketing initiatives.

By prioritizing the needs and preferences of its most influential customers, the company aims to revitalize consumer interest and drive sustained growth, recognizing the imperative of adapting to evolving market trends to maintain competitiveness.

After all, as companies are unable to impact the macro environment, all they can do is adapt and focus on margins.

The turnaround work remains in progress at Vans. During the quarter we took actions to reset the wholesale channel to ensure the brand’s market positioning and product assortments are aligned with the brand direction. The impact on revenue in the quarter was approximately $50 million. – VFC 3Q24 Earnings Call.

But wait, that’s not everything.

It also has something called “Reinvent.”

This strategy focuses on key areas essential for future growth and operational efficiency.

Prioritizing initiatives such as revitalizing the U.S. business, executing brand turnarounds, reducing costs, and fortifying the balance sheet, the company aims to enhance its competitive positioning and return to value creation.

On costs we’re on track to deliver the $300 million dollar fixed cost savings target which is entirely within our control. This quarter we began to simplify and right size the company’s structure, real estate and others nonstrategic areas. – VFC 3Q24 Earnings Call.

Or, to put things differently, this strategy underscores a holistic approach to addressing immediate challenges while capitalizing on long-term growth opportunities.

With that said, looking ahead, VFC’s guidance for the future reflects a cautious yet strategic approach amidst the challenges and opportunities in the market.

While the company refrained from providing specific guidance for fiscal 2024 and fiscal 2025, it offered insights into potential areas of impact and strategic initiatives.

One key aspect of the guidance is the expectation regarding free cash flow for fiscal 2024, which remains unchanged. The company anticipates delivering approximately $600 million in free cash flow for the year.

This outlook is supported by the aforementioned efforts to reduce inventories, with expectations revised upwards for a reduction of at least 10% by year-end.

Furthermore, V.F. Corporation anticipates liquidity to be approximately $2.3 billion at year-end, hinting at a much better financial situation.

After cutting the dividend, analysts expect VFC to reduce net debt from $5.8 billion in FY2023 to $4.5 billion in FY2024, potentially followed by a further decline to $3.6 billion in FY2025.

This would indicate a gradual improvement to a 2.3x net leverage ratio.

On top of that, $600 million in expected FY2024 free cash flow would translate to an FCF yield of 9% of its market cap, which is elevated – especially because only a quarter of this is earmarked for its dividend!

Analysts expect free cash flow to rise to more than $900 million in the years ahead, which indicates a path to a 14% FCF yield.

This also bodes well for its valuation – technically speaking.

How Cheap Are VFC Shares?

Very cheap – at least based on the bare numbers.

Using the data in the chart below.

• VFC has a blended P/E ratio of just 13.4x, which is more than three points below its long-term normalized multiple of 16.7x.
• While 2024 is expected to see up to 50% lower earnings per share, analysts expect 33% EPS growth in 2025 and 28% EPS growth in 2026.
• If we combine a return to 16.7x earnings, its dividend, and expected EPS growth, the company has a fair stock price of $31 and an implied annual return of 35% through 2026!

Its current consumer price target is barely above $18, which shows that nobody expects VFC to double in the years ahead.

That’s mainly based on high uncertainty.

When I was in high school, I thought I should jump into every stock with a low P/E ratio. However, that’s dangerous – especially when dealing with struggling companies.

For example, let’s assume company XYZ trades at 5x earnings with a $100 price target. It is struggling due to a tough economy and operating inefficiencies.

In this hypothetical scenario, I buy the stock at $100, betting on a recovery.

However, the company fails to recover, and earnings fall another 50%, triggering another stock price sell-off of 50%.

Now, the stock still trades at 5x earnings, but I’m down 50%.

This also explains why VFC is down 8% after reporting earnings, as cheap stocks can get cheaper when the market has no faith in a fundamental rebound – just like expensive stocks can remain expensive when the market trusts the growth outlook.

Hence, despite its cheap valuation, I will still refrain from giving the stock a Buy rating, as I just cannot get myself to jump into this much risk.

However – and this is key – if the company is able to pull off a recovery, potentially backed by stronger consumer sentiment down the road, its stock price could adjust to a better environment.

In such a scenario, VFC could easily return 100-200% within 1-2 years.

If that were to happen, I might look like a fool with my neutral stance on the company.

So, long story short, if you are an investor who likes to take on big risks for potentially big rewards, VFC may be the right stock for you.

However, as I am a more conservative investor who only buys beaten-down companies if they have wide moats, I cannot get myself to make the case that VFC is a buy.

There are just too many uncertainties – especially in light of its turnaround strategy and the developments of consumer sentiment.

Takeaway

V.F. Corp’s turbulent journey reflects the harsh reality of investing in struggling companies.

Despite its historic success, recent challenges have led to significant setbacks, including drastic dividend cuts and a plummeting stock price.

While the company started a turnaround journey focused on debt reduction, brand awareness, and operating efficiencies, uncertainties loom large, making it a risky bet for conservative investors like myself.

However, for those willing to embrace the gamble, potential rewards may await if V.F. Corporation successfully navigates its recovery path amidst evolving market dynamics and consumer sentiments.